How does the Bonus Method work?

The best way to answer this question is by contrast with the normal rules for calculating CRA income tax source deductions, termed the periodic method. There are other CRA tax methods – the lump-sum and TD1X methods – but the periodic method is the one closest to the bonus method itself.

The periodic method is the default when no other method applies and is used for earnings paid on a regular pay period basis. The bonus method may also be used for exception earnings, meaning those paid on an irregular basis. Such earnings include:

  • Bonuses;
  • Sales commissions paid on an irregular basis;
  • The cash-out of banked overtime, without taking time in lieu;
  • Accrued vacation pay, paid without taking time; and
  • The taxable benefit from stock (“security”) options.

For example, when employees work overtime and are paid for that overtime in the same pay period, the periodic method applies. The same is true when employees are subsequently given time in lieu. The bonus method only applies to overtime that’s banked and then subsequently paid out, only as cash, such as on termination.

There are two things that the bonus and periodic methods share in common. First, they share the same overall logical structure:

  1. The earnings or deductions concerned are converted to annual taxable income;
  2. The annual tax owing on this income is calculated; and
  3. This annual tax is converted to the amount owing for the pay period.

Second, the bonus and periodic methods, with very minor differences, share the same logic for calculating annual tax, once annual taxable income has been determined. The minor difference applies to the calculation of personal income credits for CPP and EI source deduction amounts, but we won’t go into that level of detail here.

The differences between the bonus and periodic methods lie in how steps 1 and 3 above are performed. In order to explain these differences, we need the following data:

  • There are 26 pay periods in the current tax year;
  • The only taxable income is a fixed pay-period salary, of $2,000;
  • There are no deductions available to reduce taxable income;
  • Federal and provincial TD1s have been filed with a zero personal tax credit claim;
  • Employment is CPP and EI exempt;
  • The Canada employment credit doesn’t apply; and
  • The tax year is 2014.

Let’s first look at the periodic method (Option 1 from the T4127 guide). This method takes pay period earnings and converts them to the year, using the number of employer pay periods in the current tax year. Once annual tax is calculated, it’s converted back to the pay period, dividing the annual tax by the same number of periods per year. To keep things simple, we’re only going to calculate the federal portion of the CRA income tax source deductions owing:

Example One – Periodic Method


Federal Income Tax Calculation



Multiply pay period earnings times the number of periods per year, $26,000 times 26.



Calculate the annual tax owing, at 22%, less $3,077 (see the tax table on T4127 guide page 14, in 2014).



Divide the annual tax by the same number of periods per year, 26


To show the bonus method, we need to assume one more piece of data: the payment of a $5,000 cash bonus, the only one so far in the year.

The bonus method draws very heavily on the periodic method. In fact, the bonus method is the periodic method calculated twice, once with and once without the current bonus payment. The tax owing on the bonus is the difference between the first and second periodic method results, as at step 2:

Example Two – Bonus Method


Federal Income Tax Calculation


First Periodic Method Pass

Second Periodic

Method Pass


Multiply pay period earnings times the number of periods per year, $26,000 times 26.



Add the current bonus.


Total annual taxable income




Calculate the annual tax owing, at 22%, less $3,077.




The tax owing is the difference between the 1st and 2nd results.


Note, that in the 1st pass through the periodic method, we add the current bonus after periodic income has been converted to an annual figure. This is the key to understanding the bonus method. The periodic method assumes that whatever is earned in the current period is the same as what will be received throughout the whole year. The bonus method, by contrast, assumes that bonus income is only received once, just as if it was the last taxable income for the year.

This difference means a lower income tax rate is applied to bonus income, than if the periodic method were used. If we treat the bonus as periodic income, annual taxable income becomes $182,000 ($2,000 salary, plus the $5,000 bonus is $7,000. Times 26, this gives $182,000). Annual taxable income of $182,000 would be taxed at the highest marginal rate, 29% federally, meaning annual tax owing would be $42,099 ($182,000 at 29%, less $10,681 – again see the tax table at page 14 of the T4127 guide). Divided by 26, this would mean pay period federal income tax owing of $1,619.19.

Compare this with the sum of the federal tax owing in the examples 1 and 2 above – $1,421.65 ($321.65 plus $1,100). By using the bonus method we have lowered the federal income tax on the bonus by $197.54 ($1,619.19 minus $1,421.65).

Alan McEwen is a Vancouver Island-based HRIS/Payroll consultant and freelance writer with over 20 years’ experience in all aspects of the industry. He can be reached at, (250) 228-5280 or visit for more information. This article first appeared on Canadian HR Reporter, on January 6, 2014.

About Alan R. McEwen

HRIS/Payroll consultant and freelance writer
This entry was posted in Payroll / HR sofware and systems, Source Deductions and Reporting and tagged , , , . Bookmark the permalink.

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