We all know that employees love bonuses. They increase job satisfaction, make employees happy, improve performance, and can help you hire better people; but there’s a lot to know about how employee bonuses work.
Here are some things that you’ll need to know that we cover in this article.
- Bonus Basics
- What are the types of bonuses you can give to employees?
- How does Calculating employee bonuses work?
- What are the factors for receiving a bonus?
- How do bonuses work with payroll?
- How are bonuses taxed?
Overwhelmed? Keep reading and you won’t be.
A bonus is a sum of money given to an employee in addition to their usual compensation and benefits.
You may have heard the term “incentive pay” and wondered, “What’s the difference between incentive pay and bonuses?” Bonuses and incentive pay are very similar but are used in slightly different ways. So what is incentive pay?
Incentive pay is additional pay or some sort of compensation that is awarded for accomplishing predetermined goals.
Still don’t see the difference? Here’s an analogy.
A bonus is like giving a fish to a dolphin after it does a triple backflip through a hoop, even though it wasn’t expecting the fish. Incentive pay is like telling a dolphin that if it does a triple backflip through a hoop, you’ll give it a fish.
In other words, a bonus is an unexpected reward. Incentive pay is an anticipated or motivational reward.
What are the types of bonuses you can give to employees?
Wait, so why am I paying my people extra?
Easy, because they’re doing good work for you, you like them, and you want them to like you too.
Bonuses can be based on whatever metrics you please, but here’s a list of some popular ones.
- Goal/Achievement bonus: Team or individual
- Gainsharing: You made us $X, here’s part of that back for your good work
- Milestone bonus: You made it 6 months! Congrats!
- Referral: Employee referrals are a great way to hire
- Holiday bonus: Gift, everybody gets one
- Year-End: Usually performance-based
- Commission: The more you sell, the more you’ll make
- Retention bonus: We like you, please don’t leave
- Sign-on bonus: Please join our team!
- Periodic: Quarterly/annual, basically just to say, “We still like you!
How does calculating employee bonuses work?
You could use a flat-rate style bonus for pretty much any of these, and those don’t require any calculations. All you have to do is pick a number and pay up.
Other bonus types require a tiny little bit of math. Don’t worry! The math is super easy, but here are a couple of calculators with formulas to make them even easier.
Commissions-based bonuses are pretty much the same calculation. The only difference is that instead of using a percentage of an employee’s salary, you’ll use a percentage of a sale amount. Here’s the formula.
(Sale amount * % of sale you want to pay as a bonus)/100
That’s pretty much all of the math you’ll need for calculating how much of a bonus to pay employees.
What are the factors for receiving a bonus?
There are as many factors for receiving a bonus as there are types of bonuses. Some factors are passive on the employee’s part. For example, you’ll probably get a holiday bonus no matter how good of an employee you are.
Most bonuses, however, are somehow tied to performance. What qualifies you for these performance-based bonuses depends entirely on your role. If you lay bricks, you may get a bonus for laying bricks faster than expected.
If you’re a salesman, you’ll probably get a commission as a percent of the sales you make, and if you sell a lot one month, you may get a bonus on top of that.
If you’re a highly-valued employee, your employer may just give you a bonus because they don’t want to lose you.
There are a lot of factors for receiving a bonus, but you have to keep in mind that there are very few ways to guarantee a bonus. Unless a predetermined bonus is written into your offer letter, then your employer doesn’t have to give you one.
How do bonuses work with payroll?
A bonus is a form of employee compensation, so it has to go through payroll. Here’s how that works.
There are two ways to do it, and both ways have different effects on how the bonus is taxed. Here are your options:
- You can lump the bonus into the employee’s usual paycheck.
- You can pay the bonus separately from the usual paycheck.
The bonus may be more impactful for the employee if it’s paid separately, but that’s up to you.
Let’s look at how bonuses are taxed.
How are bonuses taxed?
Bonuses are subject to income tax, but they’re taxed a bit differently than salary. Bonuses are taxed at a flat rate of 22% up to the first $1 million, and 37% after the first $1 million.
So if you received a $1.5 million bonus separate from your usual paycheck, first, you’d have a little celebration, then you’d do some tax math. You’d take $220,000 out of the first million for taxes (.22 * 1,000,000), then $185,000 out of the $500k after that (.37 * 500,000).
So, you’d get to take home $1.095 million of your $1.5 million bonus.
The other option is for the employer to include the bonus with the employee’s typical paycheck. If they do that, then the bonus would be taxed along with the rest of your income.
Any difference between the tax you paid on the bonus with your paycheck and what you would have paid with the 22% and 37% rates will be corrected with a tax refund or bill.
In the end, everybody gets their full bonus and pays the correct taxes. Still, employees might prefer to get their take-home bonus amount all upfront. This can all be a bit complicated, but if you don’t want to worry about it, you don’t have to! EddyHR’s payroll service can take care of it for you.
Bonuses are a great way to motivate employees, show your appreciation, retain great talent, and win great talent. If strategically used, bonuses can accomplish those ends very effectively.
Now you know the basic types of bonuses you can offer, what behavior deserves a bonus, how to calculate bonuses, and how bonuses are taxed. That makes you well-equipped to attract, motivate, and keep amazing people at your company.