Have you been sucked down into analysis paralysis trying to select a year-end bonus plan that makes business sense and motivates employees?
Selecting a plan that works best for your organization can be challenging. Should I give a holiday bonus or structure a performance based year-end bonus plan? How much? When? To whom? The choices can be daunting.
Bonuses of any type are simply optional rewards or devices to drive morale or performance. There is no legal obligation to provide them, however, done poorly and inconsistently, they can become an unnecessary legal problem. Balancing how a bonus program will reward your best employees while being non-biased and objective in your decisions is key. Asking yourself the right questions as you structure your bonus plans will help you arrive at an effective and answer:
Budgeting & Planning
- Are bonuses standard in your industry? How would they set you apart or keep up with the competition?
- What can you afford? If you had a great year, what type of bonus would best keep up the momentum? If dollars are tight, where and how will bonuses deliver the best return on investment?
- Are you being consistent and equitable?
If you are choosing performance based programs, use objective criteria and a structure that is consistent to avoid potential adverse impact on different segments of your organization. Your top performers will have an opportunity to receive more rewards with these bonus programs without isolating particular groups, assuming your hiring decisions have produced a diverse workforce across each level of the organization.
- The type of bonus should be appropriate for the performance: e.g., Commissions on Cost Control are best when the employee helps to generate cost savings and can be provided as a percentage for the savings, and incentives for goal attainment related to sales or securing clients help to drive revenue.
Providing clear detail on how the performance will be measured will help to drive the right behaviors, and set expectations to avoid disagreement on the bonus calculation.
- If you are providing spot bonuses, which can include holiday bonuses, have objective criteria to determine who gets what to avoid implications of discrimination. For these type of bonuses, tenure and position levels are effective when there isn’t a consistent measurement of performance to apply otherwise.
- What did you pay last year? Will your bonus decisions this year lift or dampen morale? If times are tough, make sure your employees understand that you are still invested in them and need them to help drive success for future financial benefits. Employees in the know are less likely to make unnecessary and negative assumptions.
Not all bonuses are created equal….
There are significant tax and wage & hour implications to take into consideration when choosing a bonus plan.
Discretionary Bonuses, most commonly referred to as “spot” or “holiday” bonuses, are those bonuses that are not expected and not conditioned upon goal-attainment or performance expectations for individuals. These bonuses serve-up two gifts: a tax deduction for the employer and a lift to employee morale.
These bonuses are best presented as a one-time event to help eliminate assumptions that they will be repeated.
An additional employer consideration is that that Discretionary bonuses may be excluded from overtime pay calculations for those employees covered by the federal Fair Labor Standards Act (FLSA) and state wage & hour regulations as they are not considered part of an employee’s “regular rate of pay”.
Non-Discretionary Bonuses are more closely tied to an employee’s overall compensation plan, and are laid out in detail as a performance based incentive bonus, can be tied to general organizational goal attainment, may be based on anniversaries or other fixed events, or are stipulated as a set bonus payable on a particular date.
The best use of these bonuses are systems that effectively reflect an individual’s impact on the organization’s business goals or results.
Because these are wages that are promised, non-discretionary bonuses must be included when calculating overtime under the FLSA and various state wage & hour laws. Employers needs to be on top of this impact on federal weekly or state daily overtime expenses.
Additional Tax Considerations
While any type of bonus is sure to put a grin on an employee’s face, the realization of their tax implications may be an unwelcome surprise if you don’t educate your employees on your taxation decisions on these supplemental wages.
First and foremost, all employees and employers are subject to taxes on any type of bonus. This includes federal & state income tax, FICA withholding, calculation of unemployment taxes, consideration in social security maximums and the additional Medicare tax.
- When paid as a separate check from regular wages, employers are required to withhold federal income taxes from employees as a flat 25% tax rate, regardless of an employee’s W-4 election amounts. You will want to plan on the impact to your employee’s net checks accordingly.
- When paid in combination with regular wages, employers may withhold through the normal aggregate withholding method, however, the increased gross rate may result in placing employees in a higher tax bracket, effectively increasing their tax percentage for all the wages on the check, which may in fact be more than the 25% flat tax rate depending on the amount of the bonus.
- S Corporations and C Corporations may allow bonuses paid to certain shareholders and owners to be included in business expense deductions. Make sure you speak to your tax accountant in advance to see if your bonus qualifies.
- Your type of business may have grace periods on bonus payments related to the tax year you are claiming them. If year-end numbers need to be calculated to best determine your bonus budget, make sure you understand your deadlines for declaring bonus expenses.
Timing is everything…
If you are paying bonuses near holidays, stop to consider your timing. Will bonuses be best served just prior to the holiday to help with travel or shopping needs? Or will they be a welcome recovery after the fact?
Yet another tax consideration: If you have employee deferred compensation plans or other retirement considerations for your employees, there may be a desire to defer the bonuses payments to future dates to accommodate lower income related tax rates.
If you are locked into non-discretionary, performance based bonus programs, are they best paid in the spring or mid-year so that performance results can be accurately assessed?
Not all organizations can afford bonus programs that do not immediately drive performance results. For those organizations, other types of rewards still show appreciation and motivate employees. Whether you provide paid time off rewards, flexible scheduling, swag or public acknowledgement, you can still take advance of less expensive and traditional methods to bring your staff together.