Employee compensation involves more than an employee’s initial salary when they join a company. Total compensation can include overtime, on-call pay, special project pay, bonuses, raises, benefits and stock options (or other investment options). For example, some businesses offered bonuses to employees who worked during the COVID-19 pandemic.
Any compensation in excess of an employee’s base salary or hourly wage can be categorized as employee bonuses or bonus pay. We’ll explain the various bonus types and how to implement and structure employee bonuses.
These are some of the most common types of employee bonuses:
An annual bonus is awarded to an employee once per year. The bonus amount is typically based on the employee’s annual base salary or a set percentage for the department or position. Most companies assign a target bonus that each employee is eligible to receive at the end of the year. The employer awards the full annual bonus if the employee meets specific goals and the company or department meets its performance goals.
A signing (or sign-on) bonus is a one-time payment an employer or recruiter pays a new employee. Its purpose is to convince an individual to join a company. Employers use a signing bonus when they’re trying to lure a top employee or executive away from a competitor, outbid another company’s competing offer, or close the gap between the employee’s desired salary and the company’s offered salary. Signing bonuses often come with a contractual requirement that the employee stay with the company for a minimum period.
If you’re recruiting employees in a specific state or city, you may be obligated to abide by wage transparency laws during the recruitment process.
A discretionary (or spot) bonus is awarded to an employee for various reasons, such as demonstrating exceptional performance or achieving a specific employee performance goal. This bonus is typically given at the whim of the employer or manager to show gratitude for something the employee has done. Discretionary bonuses are usually unexpected by the employee because they are not included in the employment contract. The bonus can be monetary, a gift or some other form of compensation.
A retention bonus is a reward given to an employee for remaining with the company for a set period. It can be used to encourage high-performing employees to stay with the company amid a competitive job market or to retain a valuable employee who has received a job offer from a competitor. A retention bonus is typically given as a one-time payment in lieu of a raise.
A referral bonus is given to reward current employees for helping to attract and recruit new employees. The bonus is typically paid after the new employee joins the company and performs their job duties for some length of time. The referral bonus amount depends on several factors, such as the type of role and how hard it is to fill.
A holiday bonus is typically awarded around recognized holidays (such as Christmas and Hanukkah). Its goal is to thank and reward employees who have contributed to the company’s success. A holiday bonus is often tied to the performance of both the overall company and the individual employee. It can often help to boost employee loyalty and create goodwill.
A profit-sharing bonus provides employees with a percentage of the company’s profits. The award is calculated using the company’s earnings during a specific period. Employers award this bonus to employees when the company realizes a profit. Some portion of pretax profit is placed into a pool for distribution to eligible employees according to their salary and title. The profit-sharing bonus can comprise cash or stocks.
A commission is a bonus based on the amount of money or revenue a sales team member earns from facilitating sales. The commission amount is defined in the sales commission structure, which describes how the employer will pay salespeople for each sale.
These are some of the most common types of commission structures:
Consider the following factors when you’re developing an employee bonus structure:
Follow these strategies to structure your employee bonus plan:
Bonuses can be given per employee or per team or department.
Employees must pay taxes on bonuses because they’re considered employee benefits and part of an individual’s wages. Taxes include federal and state income taxes, as well as Social Security and Medicare taxes.
Employers must include bonus pay when calculating federal and state unemployment taxes, the Social Security maximum and the Medicare tax. If the employer pays the employee bonus with their regular wages, they must withhold the federal income tax for the total amount. If the employer pays a separate employee bonus, they should do one of the following:
If the employer does not withhold taxes from the employee’s paycheck due to exemptions, the employer must add the bonus to the employee’s paycheck and calculate the withholding based on the total amount.
Employers receive a business tax deduction for bonus payments to employees. Bonus payments fall under the “payments to employees” category, provided the bonus is for services rendered (i.e., not a gift).
Among smaller companies (100 or fewer employees), year-end bonuses are the most common, while larger companies favor cash profit-sharing bonuses.
Payroll services can ease the administrative and accounting headaches that often accompany bonuses. The best online payroll companies can include bonuses and commissions in employee paychecks, accommodate discretionary bonuses, deduct the correct payroll taxes and withholding amounts, and even advise you when bonus-triggering events occur.
Here are some of the best payroll platforms to consider for managing bonuses:
Jennifer Dublino contributed to this article.