November 15, 2017

Employee Bonuses 101: Everything You Need to Know

Written by
Rachel Fenton
Tags: Accounting HR

There is a lot to be aware of when it comes to bonuses. From who receives them, to who signs the check, it’s important to establish a standard process that clearly outlines each and every step along the way. Small HR teams have a lot on their plate already, so bonus season can seem even more time consuming and chaotic. To help, we’ve compiled four essential elements to consider when setting up a bonus system.

1. Timing

Bonus cadence can take a variety of forms. There have been cases made for annual, semi-annual, holiday, and even spot bonuses. To determine your bonus schedule, start by considering your overall goal. What do you want bonuses to achieve? Performance bonuses, for example, may be linked to your company’s talent review cycle and reward high-performers. Alternatively, an end-of-the-year bonus that is determined by your company’s overall revenue that year helps employees share in the company’s success. Branding an end-of-year bonus as a holiday bonus is yet another way to make employees feel valued and appreciated for another year of hard work.

ALSO READ: Bonus Time: Using Performance Metrics for Payouts

2. Decision-Makers

Your bonus process should clearly delineate who’s responsible for deciding who will receive a bonus and for how much. While it’s payroll’s job to cut the checks, it may take someone outside of the HR team to provide a holistic view of employee performance.

If using a performance-based model, consider allocating bonus money to departments based on overall performance as a team, and then give the manager discretion to divide it up amongst individual employees. However, even in this scenario, HR should have the ultimate say in reviewing and approving the proposed bonuses.

In some companies, everyone receives the same bonus. In others, the amount is determined by a formula relative to the employee’s salary and performance. Decide from the get-go what role leadership, managers, and HR will have in the decision-making process so that you aren’t blindsided by complaints once bonuses are distributed.

3. Taxation

Bonuses are considered supplemental wages by tax authorities and are taxed much more heavily than a regular paycheck. Be sure to communicate this to employees so that they are not surprised to see that their bonus or commission has been cut almost in half. Take note that there are two acceptable methods for handling these taxes:

  • The more simple approach applies a federal flat rate (25 percent, as of 2017) to the bonus. In addition to this rate, other taxes like Social Security, Medicare, and any local supplemental taxes will also need to be deducted from the payment.
  • The more complex aggregate approach is sometimes preferred by employees in lower income tax brackets. This method is best described in steps:
    • Add the bonus amount to employee’s most recent paycheck
    • Take the sum and determine what the regular federal withholding amount would be
    • Subtract the usual withholding amount from the combined withholding amount
    • Withhold the difference from the bonus

Both methods are permissible by the IRS. The simpler percentage based model typically results in a higher payout to the employee and less confusion for HR.

4. Performance

Oftentimes, bonuses are distributed based on employee performance. However, this is not as cut and dry as it may sound. Performance can be a very subjective measure, so ensure that your management team is aligned on how they define a high performer. Once you reconcile discrepancies in management styles, establish a quantifiable method to help you derive the bonus amount from an employee’s performance.

Performance bonuses can be individual or company-based. If the company achieves overall business goals, everyone in the company may be entitled to a bonus. Other times, performance bonuses may be divvied up at the department or individual level. This affects the timing as well, as overall company bonuses would likely line up with the end of the year versus performance bonuses with the timing of the review cycle.

Alternatively, many companies have taken to separating compensation and bonus cycles from the actual performance review cycle. Though performance and compensation are inextricably linked, the excitement or disappointment around monetary incentives can distract from the focus of performance reviews.

Final thoughts

While bonuses are a great way to boost employee morale and retention, ensure you have the right process in place to send them out with confidence. Be prepared to answer employee questions about why they received a certain bonus or why half of the amount went toward taxes. Thorough planning and follow-through set you on the right track to a great bonus season—whenever that may be.


This post by Rachel Fenton originally appeared on The Namely Blog.