When a physician signs on at a new hospital, a signing bonus is often included in the compensation package. This bonus can range from a small perk to a significant percentage of income, and its structure can be either straightforward or confusing. The signing bonus is one of the items in a physician’s compensation contract that can be negotiated, although some give-and-take is often involved. For example, in some situations, a higher signing bonus may result in a lower guaranteed salary. Where a hospital agrees to offer more, they may reduce other compensation benefits. For some hospitals, particularly those that do not need to recruit aggressively, the signing bonus, guaranteed salary, and remaining contract aspects are a take-it-or-leave-it package that is not subject to negotiation.

For many physicians, especially residents and fellows signing their first employment contract, the signing bonus may seem like a breath of fresh air; however, it can be confusing if one is not familiar with some basic income frameworks used to distribute bonuses. Furthermore, if a physician is unprepared for how the IRS views the bonus, it can be downright devastating. This article will explore a few of the most common bonus structures that physicians encounter when signing employment contracts.

In addition to how the bonus is paid, there may be stipulations regarding when it is paid. As a signing bonus, the expectation is that a check is delivered upon signing the contract. While that may be the case in a few scenarios, it certainly isn’t the norm.

When is the signing bonus paid? Many signing bonuses are paid to physicians upon receiving their first or second paycheck. However, there are situations where a physician may sign a contract six months to a year in advance and not receive their signing bonus until they start work. In this situation, it really should be called a starting bonus, but it is still referred to as a signing bonus.

Many residents and fellows sign employment contracts when their final year of training begins. This gives them an entire year between signing the contract and starting work, as they still need to complete their final year of training. Some hospital systems structure a signing bonus as a stipend, where you receive an actual income from the hospital without working there. For example, one might receive a $24,000 stipend, paid at $2,000 per month for an entire year. These stipends fall under the 1099 payment structure (explained below), so careful handling of these payments is essential, as they might not all be yours to keep.

Below are the three most common structures of how these bonuses are paid out:

W-2 bonus

A W-2 bonus might be the most streamlined bonus structure for several reasons, but it’s also the most disappointing, at least initially. A W-2 bonus is paid like your normal paycheck. And like a normal paycheck, deductions reduce the amount you actually receive. While receiving less money is usually a negative, it adds a layer of protection against spending more than you are allowed to keep.

A W-2 bonus is only paid after you start work at the hospital. You can receive W-2 income only if you are an employee, so if you receive a bonus before you start working, you can assume it’s not a W-2 bonus. The bonus is usually paid on your first or second paycheck; however, signing bonuses are sometimes paid at the end of the first full quarter of working at a hospital system. Generally speaking (but not always), the larger the hospital system, the slower the bonus payment.

The W-2 bonus can be disappointing due to it being a net bonus. This means taxes—both state (if applicable) and federal—are withheld, along with FICA (Social Security and Medicare). These withholdings can account for nearly half of the bonus. For example, if you are to receive a $30,000 bonus, and it is paid via W-2 income, the withholdings might be as follows:

• $30,000 bonus
• -25% federal taxes (may be higher if you earn more, but if you’re signing your first employment contract, you are likely in a lower tax bracket)
• -5% state taxes (more or less, if applicable)
• -7.5% FICA (this is the employee’s half—the employer also pays this)
• =62.5% net bonus

The actual dollar amounts look like this:

• $30,000 bonus
• -$7,500 federal taxes
• -$1,500 state taxes
• -$2,250 FICA
• =$18,750 net bonus

While an additional $18,750 is a nice paycheck, it’s not the $30,000 you were expecting. If you were to receive the full $30,000 bonus, you would be responsible for all the withholdings on your taxes. The hospital system, through their W-2 payroll, essentially did you the favor of distributing your taxes through the withholdings. The ease of the W-2 bonus doesn’t make it any less disappointing.

1099 bonus

Unlike the W-2 bonus, a 1099 bonus is paid on a gross basis. That means if you were expecting a $30,000 bonus, you will receive the full $30,000. While this is exciting and meets all expectations for the signing bonus, there is a major downside. Since you received income, taxes are supposed to be paid from that income. Therefore, it’s your responsibility to pay all the withholdings, and the hospital system will send you a 1099 income statement to file with your taxes for that tax year. It is then up to you to pay the taxes.

Moreover, receiving 1099 compensation denotes that you are not an employee. 1099 bonuses are generally paid before you start working at the hospital because you’re not yet employed (if you receive a bonus before you start working, you either have a 1099 bonus or a loaned bonus—see below). With 1099 income, you’re considered a contractor or a business owner. As such, you must pay the employee’s half of the FICA tax as well as the employer’s half of the FICA. This payment, for self-employed individuals, comes in the form of the “self-employment tax.” This self-employment tax doubles your FICA payment, so instead of paying about 7.5% to FICA, you must pay around 15% to FICA—in addition to your income tax.

The tax payments are also paid in arrears. If you receive the signing bonus in May, you won’t need to pay taxes until the following April, when tax payments are due. This means you receive the $30,000 bonus, and you must set aside some of the funds for taxes for nearly an entire year. Here’s how the 1099 tax withholdings look:

• $30,000 bonus
• -25% federal taxes
• -5% state taxes (more or less, if applicable)
• -15% self-employment tax (this is both the employee’s half and the employer’s half of FICA)
• =55% net bonus

You will need to pay 45% of the bonus to the IRS at your next tax filing.

The actual dollar amounts look like this:

• $30,000 bonus
• -$7,500 federal taxes
• -$1,500 state taxes
• -$4,500 self-employment taxes
• =$16,500 net bonus

You would owe $13,500 with your next tax filing.

Between the two scenarios, the W-2 keeps a greater portion of the bonus, and it’s easier to manage because the taxes are already withheld and paid. The 1099 bonus feels better upon receiving the bonus, but if proper planning is not considered, it could create problems during tax time.

Loaned bonus

The other most common bonus method is for the hospital system to loan you the bonus and forgive the loan after you have worked there for a specified number of years (generally two years). Loans aren’t usually considered income, so there’s no tax upon receiving the loan; however, a forgiven loan is considered an economic benefit, and the forgiven loan is taxed as income.

You’ll know if you have a loaned bonus when you sign your employment contract because you’ll sign a promissory note. The promissory note details how the loan is handled, and if you sign one, it likely takes up half of your contract (in page count), so you can’t miss it. For both the W-2 and 1099 bonus, once the money is sent to you, it cannot be recovered by the hospital system. However, the loaned bonus can be recovered by the hospital because it’s a loan they expect to be repaid if certain terms of your contract aren’t met. The average loaned bonus is forgiven after two years, and the promissory note will detail how the loan is forgiven. It is normally forgiven at a rate of one-twenty-fourth (1/24) per month. At that pace, the entire loan is forgiven after two years. If you stop working at the hospital after one year, then half of the loan bonus would need to be repaid. The terms of the repayment are in the promissory note, and payment may be expected within a short period of time (likely three months), but terms could vary by contract.

Upon complete forgiveness or severance of employment (if repayment is required), the forgiven portion of the loan is taxable to you as income. The IRS deems forgiven loans (with some exceptions, such as PSLF student loan forgiveness) no different from income; however, this income is viewed differently than W-2 or 1099 income. W-2 and 1099 income are viewed as earned income. Forgiven loans are considered unearned income, meaning you didn’t have to work to earn the money. This provides tax relief, as FICA taxes do not need to be paid on the forgiven loan.

Like all other income, you will receive income reporting documentation for the forgiven loan to file with your next tax return. You will receive a 1099-C, which is a cancellation of debt form. Federal and state taxes will need to be paid, and they won’t be withheld automatically, but no other tax needs to be paid on this type of income. Here are the details of the loaned bonus taxation:

• $30,000 bonus
• -25% federal taxes (this may be a low estimate, as you will have been working for two years before the bonus becomes taxable, and you’ll likely be pushed into a higher tax bracket)
• -5% state taxes (more or less, if applicable)
• =70% net bonus

You would owe 30% of the bonus to the IRS in the year the loaned bonus is forgiven.

The actual dollar amounts look like this:

• $30,000 bonus
• -$7,500 federal taxes
• -$1,500 state taxes
• =$21,000 net bonus

You would owe $7,000 to the IRS in the year the loaned bonus is forgiven.

As mentioned earlier, the loaned bonus defers taxes until the loan is forgiven. If you’re working with your first employment contract, you’ll have two full years of working with a higher salary, so federal taxes will likely be higher than if you had received a bonus when your income was that of a resident or fellow.

Summary

There’s no right or wrong way to pay or receive a bonus. From the hospital’s perspective, the cheapest way to pay the bonus is through the 1099 method, as they don’t have to pay your half of FICA taxes and receive an immediate tax deduction. In contrast, the loaned bonus requires the hospital system to wait two years before receiving a deduction for the bonus. The W-2 bonus is the most expensive for the hospital, as they pay the employer’s half of FICA taxes, but it’s likely that your total annual income will rise above the 2024 Social Security wage base of $168,600 (Medicare’s 2% tax has no wage base), so the bulk of the FICA taxes may max out eventually for the year.

From the physician’s perspective, the loaned bonus is definitely the most cost-effective way to receive the bonus, assuming the federal tax bracket isn’t 39% when the bonus is forgiven. The W-2 bonus is by far the easiest of the bonus scenarios. Here is a side-by-side comparison of the net income kept by the physician, assuming a $30,000 bonus is received, and all tax rates are identical:

• W-2 net income: $18,750
• 1099 net income: $16,500
• Loaned bonus net income: $21,000

Understanding how your bonus is paid and taxed can help you plan for the future, develop tax strategies for the bonus, and relieve the stress of unknown tax traps ahead. Even though you may receive your full bonus in some situations, that doesn’t necessarily mean you can keep it all.

Paul Morton is a certified financial planner.