We’re all familiar with the phrase “treat yourself,” but what about treating those around you? As we all know, there’s almost no better feeling than walking into the office in the morning and seeing a box of donuts on the break room table, or going to your desk and seeing a cup of coffee that your coworker picked up for you on their way to work. It’s these little actions that can help make those difficult mornings or days just a little bit easier. As business owners, you’ll often want to perform these kinds of small actions on a larger scale. Of course, this means it won’t be as easy as just stopping by the donut shop on your way to work and picking up some donuts. Going the extra mile for your employees entails, well, just that: going the extra mile. It’s not always easy, especially without the right partners at your side to help you pull it off. Even still, doing those small demonstrations of gratitude can go a long way.
At Payday HCM, we’re very familiar with the importance of going above and beyond, and demonstrating the worth either your employees or your clients have to you. Oftentimes, your employees and your clients feel closer to family than they do coworkers or customers—as such, you want them to feel like family. We receive plenty of questions from our clients all the time about different ways they can make their employees or their own clients feel valued and appreciated. Oftentimes, this involves offering bonuses to their employees. But what is a bonus, and how do you offer one? Moreover, how do bonuses fit within your current payroll structure?
In this article, we’ll be going over bonuses: what they are, how they work, and how you can process bonus payroll runs. We’ll start by covering the basics of bonuses before diving deeper into the tax withholding requirements for bonuses, as well as tips and strategies for delivering bonuses to your employees. By the end of this article, you’ll have the tools you need to deliver a little something extra for all the hard work your employees have put in up to this point.
In this article, you will learn:
What Is a Bonus?
Before we delve into the specifics of paying out bonuses and running a bonus payroll, we’ll first review what a bonus is in general.
Employee Bonuses
Employee bonuses are something that are relatively commonplace within businesses. Luckily, the term “employee bonus” is relatively self-explanatory: essentially, employee bonuses are a form of additional compensation on top of an employee’s regular salary or wage that an employer decides to offer to an employee.
Bonuses can come in all sorts of different shapes and sizes, including cash payments, gift cards, stock options, or other forms of additional compensation added on top of an employee’s typical wage or salary. Bonuses can also be offered for a variety of reasons, including exemplary performance, incentivization of certain behaviors, or meeting certain sales metrics or goals.
Are There Different Types of Bonuses?
Yes, bonuses can vary depending on what they are, as well as why or how they are paid out. Some common types of bonuses include things like:
- Singing bonus: a one-time payment offered to new employees as an incentive for joining a company or business.
- Annual bonus: a bonus awarded once a year, typically dependent on an employee reaching certain goals or milestones.
- Holiday bonus: a bonus offered around a holiday as a reward or thank you for employees’ contributions and hard work.
- Retention bonus: a one-time payment for employees who have remained with a company for a set period of time.
We can also distinguish between discretionary and non-discretionary bonuses. A discretionary bonus is one rewarded to an employee at the discretion of the employer without the employee expecting it—it’s usually not attached to any specific qualifications or goals. A non-discretionary bonus, on the other hand, is one outlined by the employer and is attached to specific goals or expectations.
How Are Bonuses Taxed?
Now that we have a foundational understanding of what bonuses are, we can shift our attention to how these types of compensation are taxed.
Bonuses and Supplemental Wages
When it comes to how bonuses are taxed, they are treated a little differently as compared to regular wages or compensation. The IRS considers bonuses to be supplemental wages, defined as “wage payments to an employee that aren't regular wages.” This includes things like commissions, overtime pay, back pay, and, most importantly for us, bonuses.
These supplemental wages are subject to federal income tax withholding. However, there are two ways an employer can withhold federal income tax on supplemental wages:
- Supplemental wages identified separately from regular wages (percentage): In cases where an employee identifies any supplemental wages, like bonuses, separately from an employee’s regular wages, employers should withhold a flat 22%.
- Supplemental wages combined with regular wages (aggregate): If any supplemental wages aren’t identified separately from regular wages, an employer can withhold taxes on the entire amount as they would with a single paycheck in a regular payroll period.
Supplemental wages, including bonuses, are also subject to any state tax withholding, as well as Social Security and Medicare (FICA) taxes.
Are All Bonuses Taxable?
Any bonuses provided in the form of cash or cash equivalents i.e. gift cards, are subject to tax withholding. However, the IRS does provide some exceptions for things they consider to be “de minimis fringe benefits,” or any benefits that an employee may receive that, for one reason or another, would simply be impractical or unreasonable to account for tax-wise.
Some things the IRS considers to be de minimis fringe benefits include:
- Holiday gifts
- Occasional tickets to events
- Occasional snacks or beverages
Thankfully, the IRS also specifically lists “controlled, occasional employee use of a photocopier” as a de minimis fringe benefit, so no need to worry about getting taxed on all your failed attempts at making copies (although we’re not even sure how exactly taxing something like this would work).
Tips for Paying Employee Bonuses
With our understanding of what bonuses are and how they are taxed, we can now get into tips and strategies for paying your employees bonuses.
Create a Bonus Plan
For any nondiscretionary bonuses, you’ll want to create a detailed bonus plan or policy, outlining things like eligibility, bonus structure (flat rate, percentage of income), timing, and any other details relevant to bonuses you decide to offer. The plan should accurately reflect any metrics or goals that would constitute a bonus.
While there necessarily isn’t a typical bonus rate, a rate of 3 to 5 percent for any clerical or support staff is a good metric when determining a bonus amount. Your bonus rate can then scale as you consider bonuses for managers and executives. Specifics on the bonus rate should be listed in your bonus plan, as well as the impacts of tax withholding on bonus amounts.
Percentage or Aggregate Tax Withholding for Bonuses?
You’ll also need to decide whether or not you’ll utilize the percentage or aggregate method when determining tax withholding for employee bonuses—or, in other words, you’ll need to decide whether you’ll pay out bonuses separately from an employee’s regular wages or in aggregate with their regular wages.
While businesses can opt for either method, identifying bonuses separately from regular wages and running a separate bonus payroll can help to not only ensure your regular payroll continues to be processed correctly and on time, but it can also help verify compliance with the IRS’s tax withholding requirements when it comes to supplemental wages.
Make Sure Your Bonuses Still Feel Like Bonuses
For business owners, rewarding your employees for a job well done at the end of the year can be highly satisfying and rewarding. Whether you’re throwing a company holiday party or providing everyone in the office with gift certificates or gift cards, giving the members of your organization something special can help make all that hard work throughout the year feel all the more satisfying. Of course, if you get caught up in the planning or specifics of these kinds of things, it can often feel like less of a reward and more like a task. The same goes for bonuses: without the proper knowledge on what they are and how they work, paying out bonuses to members of your team can feel like more trouble than it may be worth. With the information provided in this article, though, you can ensure you’re giving your employees the recognition they deserve without creating any extra work.
Ensuring a smooth payout of bonuses at the end of the year for your employees relies on your business having a smooth, preexisting payroll process. But what kinds of strategies can help your business reduce the amount of time you spend on payroll and streamline your payroll processing? Check out our article on five ways to save time by simplifying your payroll process to find out the steps your business can take to reduce the amount of time spent running payroll and increase the efficiency of your processes.
Topics: