When you first start your business and hire employees, you might be worried about how you’ll make payroll each pay period. But once your business is firmly planted, you might be able to give more money to your employees. One thing you might want to offer employees is bonus pay.
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What is bonus pay?
Bonus pay is money you give employees beyond their existing base wages. It is a type of supplemental wage.
You can give employees bonus wages as a reward or gift. You might give a bonus to all employees or only a select few. And, you can determine the payroll bonus amount to give each employee.
Why should you give bonus pay?
You are not required to give bonus pay to your employees. However, if you can afford it, giving bonuses to employees can benefit your business.
Bonus payments are an easy way to thank your employees. Bonuses can also increase employee morale and motivate workers to reach goals. When your employees are happy, your business is primed to perform better than ever.
Be careful when giving out bonuses. If employees come to expect bonuses, they may become disgruntled when they don’t receive bonuses. If bonuses are not guaranteed, make that clear.
When should you give bonus pay?
As the employer, you get to choose when to award bonus compensation. There are two basic types of bonuses: discretionary and nondiscretionary.
Discretionary bonuses
Discretionary bonuses are bonuses that employees do not expect.
These bonuses are given randomly—at your discretion. If an employee or your entire team shows exceptional performance, you can give them a bonus. Or, if your business is doing well in general, you can give a bonus to all your employees.
Many employers provide cash gifts for employees. Holiday bonuses are typically given at the end of the year, near Christmas or New Year’s. Even though employees might think year-end bonuses are guaranteed, they are often at your discretion. You choose to give the bonus and how much to give.
Nondiscretionary bonuses
Nondiscretionary bonuses are bonuses you promise to employees.
You can build bonus compensation into an employee’s contract. For example, a contract might say that you will give employees a bonus when they reach a certain number of dollars in sales.
If you promise a bonus to an employee, you are legally liable to give the employee a bonus.
How do you handle bonus pay?
Giving bonus pay can be complicated. How you give the bonus can make a difference in how you handle the bonus.
How to pay a bonus
When it comes to paying a wage bonus, you have options.
You can add the bonus pay to the employee’s wages. Or, you might simply add the extra pay on the employee’s paycheck for the applicable pay period.
You can also give a bonus check that is separate from the employee’s regular wages.
Bonuses and overtime wages
If you give a nondiscretionary bonus to a nonexempt employee, you must include the bonus when calculating overtime wages. This means you will include the bonus in the employee’s regular pay rate. Then, you will use the increased regular rate of pay to calculate the overtime wages.
Let’s say that you pay an employee $10 per hour, and you pay them every week. This employee worked 48 hours last week. They also earned a $50 nondiscretionary bonus.
First, find the regular hourly rate. To start, multiply the pay rate by the total hours worked. Then add the bonus.
48 x $10 + $50 = $530
Then, divide that total by the number of hours worked to get the regular hourly rate of pay.
$530 / 48 = $11.04
Now, find the overtime hourly rate by multiplying the regular rate of pay by 1.5.
$11.04 x 1.5 = $16.56
Finally, find the total pay. Multiply the regular hours by the regular pay rate.
40 x $11.04 = $441.60 regular earnings
Then, multiply the overtime hours by the overtime rate of pay.
8 x $16.56 = $132.48 overtime earnings
Add the regular earnings and overtime earnings together to get the employee’s total wages.
$441.60 + 132.48 = $574.08
You would give the employee $574.08 in total wages.
For more information on how bonuses affect overtime wages, visit the U.S. Department of Labor website.
Taxes on bonuses
There are a few ways to calculate federal income tax on bonuses. You can find these in the supplemental wages section of IRS Publication 15 (Circular E), Employer’s Tax Guide.
If you pay the bonus with the regular wages and don’t specify the amount, withhold federal income tax on the total wages as you normally would.
But if you give a separate bonus check or combine bonus pay with a paycheck but specify the amount, there are a couple of ways you might withhold federal income tax. You can use one of the following methods if you withheld income tax from the employee’s regular wages in the current or preceding calendar year:
- Percentage method: Withhold a flat supplemental tax rate of 22%
- Aggregate method: Use the IRS income tax withholding tables to calculate federal income tax on bonus wages paid concurrently with or separately from regular wages
Bonus payments are also subject to withholding for Social Security tax, Medicare tax, state income taxes, and local income taxes. Many states use a supplemental tax rate. You will also have to pay any employer payroll taxes on the bonus.
Tax gross-up
If you want an employee to receive a certain bonus amount after you subtract payroll taxes, you will have to gross-up the bonus. When you do a bonus gross-up, you increase the total bonus amount. This way, the employee will receive the exact amount you want them to get after taxes.
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This article is updated from its original publication date of 5/2/2012.
This is not intended as legal advice; for more information, please click here.
