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Employee Bonus Guide: Everything to Know from Types to Tax

By:
Ryan Shank

Employee bonus programs are a great way for businesses to incentivize high-performance achievements. Bonus structures are tied to operational benchmarks as a way to encourage employees to exceed expectations and reap financial gain.

We're going to cover 12 types of bonuses in this guide, so you're better equipped to choose the correct compensation package for your employees and company goals.

Key takeaways:

  • A retention bonus is given as a means to "retain" key employees.
  • Signing bonuses are paid to employees when they first sign up or join an organization.
  • Discretionary bonuses are given 'on the spot' for a job well done.
  • Profit sharing is when eligible employees are awarded a portion of company profits.
  • Retirement plans, discounts gym memberships, and wellness programs are types of non-cash bonuses.

12 Types of Bonuses You Can Offer (& When to Offer Them)

Employee bonuses are a powerful tool for attracting and retaining top talent, motivating performance, and building a positive company culture. But with so many different types of bonuses available, choosing the right one and implementing it effectively can seem like a challenge.

Here are a couple of statistics to keep in mind regarding bonuses:

  • 53% of employees say employer benefits contribute to increased productivity levels and overall job satisfaction.
  • Lever reports that 46% of workers say salary or bonuses are the biggest motivator for staying at their current company. While flexible hours and upskilling opportunities were 21% and 8% respectively.
  • 75% of employees are more likely to stay at a company based on the bonuses on offer.

Let's dig a little deeper to reveal the effect bonus payments have on employees, your business, and the workforce.

1. Profit Sharing Bonus

  • A profit sharing bonus structure is when a percentage of a company's profits are split among eligible employees once predetermined benchmarks have been met.
  • The calculation of each profit share is based on a set formula. When calculating profit distributions, consider various factors, such as employee's salary, length of service, and business financial health.
  • Profit sharing is great to use if you want to engage and motivate employees. This translates to higher productivity, company loyalty, and increased job satisfaction - and attracts top talent.
  • A profit sharing bonus can be structured in two ways:
  • Reward employees with a portion of business profits (e.g. cash bonus)
  • Defer profits to employee retirement plans (e.g. 401k)

See how to calculate profit sharing bonuses on ShareWillow's website and take advantage of our free profit sharing template!

2. Performance Bonuses

  • Give performance bonuses based on employee performance. This is a form of variable bonus pay and is not always guaranteed.
  • These types of employee bonus programs can be structured in various ways:
  • Sales bonus - incentivizes individuals or teams to exceed sales targets
  • Project-based - given to employees who have completed key projects ahead of schedule
  • Use this compensation plan to boost positive behavior, enhance accountability and ownership of work, and provide targeted motivation.

3. Commission Bonuses

  • This type of employee bonus program directly ties sales performance with cash incentives. Implement commission structures to reward sales personnel for reaching sales targets.
  • Commission bonuses can be individual or team bonuses and structured in the following ways:
  • Percent-based - say 5% or 10% of the closing deal amount an employee or team brings in.
  • Flat rates - give a set amount - say $600 - regardless of total sales income.
  • Tiered - increase bonuses at designated milestones.
  • This employee bonus program is not limited to large, high-end corporations but is commonly used in businesses of all sizes.

4. Spot Bonus

  • Give spot bonuses "on the spot" for exceptional performance on a specific task.
  • Reward employees who go above and beyond on a particular project or situation.
  • For instance, you own an events company and your New Year's bash is a roaring success. You might feel that your event manager deserves an incentive for their excellent job execution. This impromptu bonus is usually a once-off thing, used as a 'pat on the back' for a job well done.

5. Signing Bonuses

  • A signing bonus can be beneficial in competitive job markets or for positions with highly specialized skills because it provides an additional incentive. 
  • Offer a signing bonus to new employees when they join your organization - these are given upon hire and aren't based on performance.
  • Use signing bonuses to attract and retain top talent by offering upfront incentives. This will motivate employees and improve job satisfaction, fostering long-term loyalty and a positive company culture geared toward success.
  • Take Walgreens' signing bonus, for example - some pharmacists can receive up to $75,000!

6. Referral Bonuses

  • Implement referral bonus plans, whereby you reward employees who have nominated successful new hires.
  • This is a great employee bonus program to use; leveraging your current employees' network base to find qualified candidates for various positions.
  • Usually, there are restrictions tied to these payouts - typically 2 to 3 months -, as the new employee needs to complete their probation period.

7. Holiday Bonus

  • Say "thank you" to your team at the end of the year with a holiday bonus. These are usually given at the end of the fiscal year or around holiday times.
  • Based on Upflip findings, 71% of Christmas bonuses are cash incentives, with 80% of employees confirming boosted morale.
  • Holiday bonuses are often a set amount and are implemented once your business profitability has been reviewed.

8. Retention Bonuses

  • Retention bonuses are a popular tool used by U.S. companies to incentivize employees to stay with the organization.
  • Give these bonuses to current employees, especially during critical periods like mergers, acquisitions, or significant projects. By doing so, you're building trust, respect, and a culture of appreciation.
  • The amount of a retention bonus can vary, depending on your employee's role, seniority, and your company's financial resources.
  • It's used to retain staff and is often a once-off payment, outside employees' base salary.
  • Wage increases, paid time off (PTO), or extra holiday income are examples of such bonus structures you can use.

9. Non-Monetary Bonus

Sometimes the best rewards go beyond a paycheck. Get creative with a blend of monetary and non-monetary benefits to form your overall employee compensation packages. This diversity caters to your team's interests, preferences, and needs.

Non-financial employee incentive ideas include:

  • Employee of the month awards
  • Paid time off (PTO) or extra vacation days
  • Flexible scheduling
  • Healthcare benefits
  • Wellness programs - such as gym memberships or spa treatments
  • Mobile device contracts

10. Stock Options/Equity 

  • If you're a new startup (or tech company), allocate an equity bonus structure to your team.
  • Allow employees to purchase company stock at a reduced rate, which can be highly lucrative as your business expands.
  • However, profit sharing offers similar benefits without the complexities of managing stock options.

11. Annual Bonus

  • Year-end bonuses reward individuals or teams, based on your company's success and financial health. It's additional compensation over their base salary but is not a guarantee.
  • These are typically cash bonuses given to staff members who contributed throughout the fiscal year to meet business benchmarks.
  • Use it to foster a collaborative spirit amongst workers to rally together to increase your business's bottom line.
  • The average American annual bonus is 5.6% of an employee's salary.

12. Discretionary Bonus

  • Give discretionary bonuses at your (or a manager's) discretion.
  • These are typically given based on criteria that may not formally be defined, such as showing appreciation, acknowledging employee efforts, or celebrating company value champions!
  • While it's great to reward employees for notable hard work, a discretionary bonus is not recommended. Due to the nature of "criteria", some employees may not fully understand this incentive and see it as unfair or biased.

Now that we've covered various bonus structure examples, let's discuss bonus calculations for employees in the next section.

How to Calculate Employee Bonuses

After those 12 employee bonuses, we bet you can't wait to learn how to calculate bonuses for employees, right?

Here's how you do it:

Determining Bonus Amounts 

  • Individual: Use pre-defined metrics like exceeding sales targets, achieving project milestones, or improving customer satisfaction ratings. Assign point values for each metric, and calculate the bonus based on individual scores.
  • Example: Multiply an employee's total sales by the pre-established commission rate (e.g. 5%) [$2,000 x 5% = $100].
  • Team: Assess team performance against collective goals, factoring in individual contributions and ensuring fairness. Consider metrics like project completion, cost savings, or exceeding team targets.
  • Company-wide: Analyze overall company performance against financial goals, profitability milestones, or industry benchmarks. Calculate a bonus pool based on success and distribute it proportionally to employee salaries or another pre-defined method.
  • Example: Divide 10% of your net profit amongst employees.

Bonus Payout Schedules: How to Make Bonus Payments to Employees

Payment schedules vary depending on the types of employee bonuses you offer:

  • Annual: Typically paid at the end of the fiscal year or before the holiday season.
  • Profit sharing: This can be paid quarterly, bi-annually, or once a year.
  • Performance: Usually paid quarterly or at the end of a set evaluation period.
  • Commission: Paid regularly, such as once a month.
  • Spot/discretionary: Awarded immediately (at the manager's discretion).
  • Signing: Paid upfront when joining a company or after signing an employment contract.
  • Referral: Paid after the new hire completes a probation period (e.g. after 90 days).
  • Holiday: Distributed around major holidays like Christmas, Thanksgiving, or Hannukkah.
  • Retention: This can be paid upfront, in installments, or upon achieving specific milestones.

The Benefits of Offering Employee Bonuses [for Employers]

A well-structured compensation package is a powerful strategy to align company objectives with team interests. Here's what rewarding employee bonuses can do for your business:

Increased Employee Motivation and Productivity

  • Bonuses directly tie rewards to performance, creating a tangible incentive for employees to go above and beyond.
  • Setting clear bonus criteria and celebrating achievement fosters a sense of ownership and purpose, motivating employees to strive for individual and team goals.
  • This translates to increased engagement, higher quality work, and boosted productivity across the board.
  • Consider the positive cycle: achieving goals earns bonuses, which fuels further motivation and goal-setting.

Improved Employee Retention

  • In today's competitive job market, retaining valuable employees is crucial. Bonuses offer a powerful tool to combat this issue.
  • When employees feel recognized and rewarded for their efforts, they're more likely to stay loyal and engaged.
  • Competitive, well-structured bonuses demonstrate your commitment to your workforce, sending a clear message that their performance is valued and appreciated. This fosters a sense of security and job satisfaction.

Enhanced Company Culture

  • When employees see colleagues being rewarded for exceeding expectations, it fosters a collaborative and performance-oriented atmosphere. Additionally, bonuses can be used to recognize teamwork, shared achievements, and company-wide successes.
  • This positive support builds trust, strengthens employee relationships, and fosters a culture of respect and appreciation.
  • A strong company culture, in turn, attracts and retains talent, boosts morale, and fuels innovation.

How to Create Effective Employee Bonus Policies

Follow this guide for employee bonus structure success.

Setting Clear Criteria

  • Define clear Specific, Measurable, Achievable, Relevant, and Time-bound (SMART goals) for performance-based bonuses.
  • Explain how individual, team and overall company performance contribute to bonus eligibility, calculations, and payout terms.
  • Consider using tiered systems to determine bonus amounts based on performance milestones.
  • Share bonus criteria well in advance, giving employees ample time to understand and align their efforts.

Communicating the Policy

  • Make it accessible by including bonus policies in employee handbooks or online portals.
  • Use clear language to avoid any misunderstandings or possible legal disputes.
  • Hold meetings, such as webinars and board meetings, to clearly explain the policy and address any concerns.
  • Keep communication open by encouraging employees to ask questions about the policy through designated channels.

Regularly Reviewing and Updating the Policy

  • Gather feedback from employees and management through surveys.
  • Analyze the impact of the policy on key metrics like employee motivation, retention, and performance.
  • Be flexible and adjust policies to align with the economic climate and your evolving business goals.
  • Stay informed about best practices in bonus programs.
  • Keep compliant to ensure your policy adheres to relevant legal and tax regulations (which we'll cover next).

Understanding the Tax Implications of Employee Bonuses  

Understanding how tax brackets affect employee bonus programs is crucial to staying aligned with federal and state tax regulations. Here's a quick breakdown:

Taxation of Bonuses

  • Whether it's performance bonuses or annual bonuses, all monetary incentives are subject to tax.
  • Bonuses are classed as "supplementary" wages, which are taxed in line with federal, Social Security, and Medicare taxes.
  • The Internal Revenue Service (IRS) charges supplemental wages at a flat rate of 22% tax (up to $1 million), regardless of the recipients's tax bracket.
  • If bonuses exceed $1 million, the withholding rate increases to 37%.

Reporting Bonuses on Tax Returns

  • Employers file employee bonuses on an employee's W-2 form (in the first box), for the year bonuses are received.
  • If bonuses are included in yearly wages, it's the employer's responsibility to deduct taxes (charged at a normal income rate of 22%).

Tax Planning for Bonuses

  • Employees can explore tax planning to mitigate the tax impact on bonuses.
  • This includes adjusting withholding allowances or making contributions to tax-deductible accounts such as 401 k plans.
  • Taxes should be carefully considered by both employers and employees. Consulting with a tax professional is advised to ensure compliance with tax laws.
  • For more info, you can refer to IRS guidelines on supplemental wages and the taxation of bonuses.

Offer your People an Attractive Employee Bonus Scheme with our Profit Sharing Template

If you're a business owner who's ready to implement an effective employee bonus program, let ShareWillow simplify the process for you.

Forget complicated systems of the past and download our free profit sharing template today. Enjoy automated, efficient, and effective software like never before, and kiss your bonus tracking headaches goodbye.

ABOUT THE AUTHOR

Ryan is the founder of ShareWillow. He's passionate about helping businesses create incentive plans that motivate and reward employees. He previously built and sold PhoneWagon.

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