How to Calculate Bonus Pay & Taxes (2024 Update)

Giving employees bonus pay can bring massive benefits to your business. Employee bonus pay thanks people for their hard work, shows your appreciation, and incentivizes your team to hit targets, which boosts engagement and productivity.

There’s just one problem: it can be challenging to decide what type of bonus pay will work best for your team,  which bonuses are mandatory, and which are optional. What’s more, knowing your tax obligations is crucial if you pay bonuses, and taxes can always feel intimidating and complicated to a small business owner.

Fortunately, we’re here to help!In this article, we explain bonus pay laws and the tax rate for bonuses in 2024. We also provide information on the different types of bonus pay and how to calculate and pay bonuses and commissions, so you can stay compliant and focus on rewarding your team.

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What is bonus pay?

Bonus pay is additional compensation employees receive on top of their regular salary or wages.

Bonus pay is usually given as a reward for meeting or exceeding performance goals, contributing to business outcomes, or achieving a specific milestone. It can take the form of money, gifts, experiences, or other rewards.

You can reward bonus pay to all your team members or just a few. However, be aware of what you are contractually and legally obligated to do regarding employee bonus pay.

Bonus pay is also known as supplemental pay or income. It can be run through payroll apps or manually using a spreadsheet, but be aware—spreadsheets can be more time-consuming and leave room for error. 

A few different types of bonus pay include:

1. Performance bonus
2. Sign-on bonus
3. Annual bonus
4. Referral bonus
5. Holiday or seasonal bonus

Bonus pay can be a recurring or one-off payment. Some apps, like Homebase payroll, let you calculate both kinds.

Depending on the business, bonuses can make up a substantial portion of your employees’ income. They can also vary significantly based on industry. 

For example, in the US, a retail worker’s average bonus is 2.5% of an employee’s salary. On the other hand, the finance industry sees bonuses of 20%.

What is the difference between a bonus and a commission?

These two types of supplemental pay are similar but have slight differences:

A bonus is an additional payment given to an employee as a reward for achieving specific goals or contributing to the company's success. A bonus is usually paid periodically and is not directly tied to individual sales.

A commission is a payment based directly on the sales or revenue generated by the employee. Commissions are typically earned as a percentage of sales and are paid more frequently, such as monthly or after each sale.

Why Should You Award Work Bonuses?

Bonus pay isn’t required by the Fair Labor Standards Act (FLSA). But many businesses pay it out because of the advantages it offers, including:

• Incentivizing employees to work efficiently and meet targets.
• Encouraging great customer service, which boosts five-star Google reviews and positive word-of-mouth recommendations.
• Helping staff become more emotionally invested in their work and enjoy it more. In fact, workers who get bonuses are 8x more engaged than those who don’t.

Well-managed bonuses show staff you appreciate and value them and their work. And happier employees are also more likely to show up on time, stick to their allotted breaks, and follow internal policies. They’ll probably want to stay at your business for longer, too, which reduces recruitment and training costs.

What is the tax on bonus pay?

The IRS typically sees bonuses as “supplemental” to ordinary wages or pay.

As an employer, it’s your responsibility to calculate taxes accurately and send the correct portion to the IRS, a process also known as tax withholding.

That means they get taxed at a flat rate of 22% (no matter the employee's tax rate) on supplemental wages up to $1 million per year. Over $1 million per year is taxed at 37%.

Most types of bonuses are subject to this rate. That includes gifts, tips, cash payouts, overtime, and commissions.

3 ways to handle bonus payroll taxes

There’s no legal way to pay employees bonuses without taxes. And you have three options for taxing and processing bonus payments:

1. Run separate bonus payroll (“the percentage method”)
2. Include the bonus in your regular payroll run and denote it (“the aggregate method”)
3. Include the bonus in your regular payroll, but don’t denote it (not recommended)

1. Run separate bonus payroll (“The percentage method”).

If you run a separate bonus payroll (as opposed to your regular payroll), employees will get their bonuses on a separate check.

As mentioned above, you’ll have to withhold income tax at a rate of 22% — the flat withholding rate for all supplemental pay under $1 million in the United States. The bonus will also be subject to other regular payroll taxes. For example, state tax, Social Security, Medicare, FUTA, and SUTA.

Read this guide on must-know payroll taxes for small business owners for more information. 

Advantages of the Percentage Method

• Easy to calculate as a flat percentage, so it is less error-prone. And if you’re using Homebase payroll to calculate and send tax payments, you’ll spend very little time on the process.
• Employees may prefer it. They'll pay less tax if they’re in a tax bracket equal to or higher than 22%.

Disadvantages of the Percentage Method

• Some employees may not like it. If a worker is in a lower tax bracket, this method could result in over-withholding.

In the above situation, the team member can claim the money back, but they’d probably prefer to avoid the paperwork. Also, getting a bonus now rather than later could make a big difference to their finances.

That’s one of the reasons why the best way to pay employee bonuses is through the percentage method.

Small business payroll software like Homebase can run a bonus payroll quickly and easily. Follow these steps to get started:

1. In your Payroll dashboard, click Payroll Runs on the left dashboard.
2. Under Payroll Actions to the right of the screen, click Run off-cycle payroll.
3. This screen is where you choose which team members to include and the reason for the payroll (like bonuses).
4. Select the pay period and payday and choose whether you want to enter hours manually or import time cards.
5. You can then add time off, other earnings, and tips.
6. Hit Next to review and submit the run. Homebase will make sure that everything adds up correctly for you.

2. Include a bonus in your regular payroll run (“The aggregate method”).

When using the aggregate withholding method, bonuses should be paid through payroll. That means including them alongside your employees’ regular wages but indicating them clearly.

This method is more complicated but still manageable, especially if you have support from your payroll provider or use Homebase payroll.

To calculate your taxes with the aggregate method, take the following steps:

1. Calculate the income tax you need to withhold on the regular pay and bonus combined.
2. Calculate the amount you need to withhold on your employee’s regular wages.
3. Subtract (2) from (1) to get the total tax you must withhold from the bonus.

Imagine you have an employee whose annual salary is $12,500, so around $1,040 per month. That puts them in the 12% tax band.

One month, you give them a bonus of $500.

You’d have to calculate:

• The regular pay and bonus pay added: 1040 + 500 = 1540
• 12% of that total: 1540 x 12% = 184.80
• 12% of the regular pay: 1040 x 12% = 124.80
• The second value subtracted from the first: 184.80 – 124.80 = 60

So, you’d withhold $60 from that employee’s bonus pay.

If you choose to use the aggregate method, Homebase lets you run this kind of payroll easily:

1. In your Payroll dashboard, click Payroll Runs on the left dashboard.
2. Click the green button near the top of the screen that reads Run Payroll or Resume Payroll.
3. On the page that appears, you’ll see a list of your team members.
4. For each team member, you have the option to click +Add under the Other Earnings column.
5. For each team member you want to add a bonus for, hit +Add and enter the dollar amount in the Bonus box.
6. Hit Save or the Enter key.
7. The bonus amount will show up in the Other Earnings column for each team member.
8. Hit Next and Homebase will take care of and check all the calculations.

3. Lump the bonus in with regular wages (not recommended).

Technically, there’s a third option. You could increase your employees’ regular wages and not indicate their bonus. This is sometimes called the gross-up method, which means you withhold taxes on combined wages and bonus pay as though they were all regular pay.

This might seem like an easier option, but it could cause problems for your business and staff, and we don’t recommend it.

The IRS usually treats bonuses as “supplemental wages,” which is why they’re subject to a supplemental withholding rate. So, if you fail to report your employees’ supplementary pay, it leads to incorrect tax withholding.

That means extra paperwork and stress for you and your employees when you have to fix the mistake later. Even worse, it may damage your team’s trust in you.

If at any point you think you’ve overpaid bonuses to an employee, notify the employee immediately and work with your payroll to correct the error. For example, ask the staff member to return the overpaid amount or adjust future paychecks to recoup the difference.

Bonus pay best practices

Bonus payroll needs careful planning and good communication to ensure employees understand what they’re entitled to and what they’re not.

Here are a few bonus pay best practices to follow in your small business:

Ensure fairness and transparency.

Bonuses should be a source of happiness for employees, but they can easily become contentious if they’re not handled carefully.

Above all, prioritize fairness and transparency. That means:

• Offer bonuses that are clearly linked to measurable factors like performance, sales targets, or hours worked.
• Calculate bonuses the same way for all employees.
• Be transparent about how you calculate and pay your bonuses.
• Keep accurate records for tax purposes.

Know how to handle disputes.

Whenever you pay out bonuses, it’s important to be prepared for disputes or issues—for example, if you discover an employee didn’t qualify for what they received. Or maybe someone feels short-changed and wants to challenge you on it.

Ways to avoid and address issues regarding bonus pay include:

• State your policy for resolving future possible bonus pay issues in your contracts.
• Check the legal rules or requirements that apply to your business.
• Always explain your thought process and actions clearly and fairly.

For example, you may not be able to request that an employee pay back their bonus (or deduct it from their future paychecks) unless that possibility is stated upfront in their contract.

You may also not be able to avoid paying non-discretionary bonuses if they’re stated in an employee contract. Nor can you dismiss someone to avoid paying bonuses. Doing so may give the staff member cause to sue you for wrongful termination.

You should also clearly state which bonuses are discretionary and which are not, as well as the exact requirements needed for a payout. This can avoid ambiguities in the future.

Bonus pay tax rates 2024 by state

Taxes on bonuses can differ based on where you live. Generally, both the employer and the employee have tax responsibilities. For employees, bonuses are considered income and need to be taxed, similar to their regular salary.

The employer usually takes care of deducting the taxes from the bonus amount and sending them to the government on behalf of the employee. Different places may have specific tax laws on bonus pay, like higher tax rates or special rules.

It’s a good idea to check with a tax professional or look up the tax laws in your area to understand how bonuses are taxed and any important rules you should know.

Alabama

Alabama’s state tax imposes a 5% rate on bonuses. These specified rates are applicable when bonuses are disbursed separately from regular salary. Conversely, combining a bonus with a regular salary alters the tax treatment, potentially changing the applicable tax rates since the aggregate is considered a single payment for taxation.

Alaska

Alaska imposes no state income tax, so no state taxes are deducted from bonuses. This means an employer in Alaska will only withhold federal taxes at the specified rates for bonuses, with no state tax considerations.

Arizona

Arizona imposes a flat state income tax rate of 2.5% on all earnings, including bonuses. These taxation rates are calculated on the bonus’s total amount before any deductions are made. 

Arkansas

Starting from January 1, 2024, Arkansas will implement a new withholding rate of 4.4% for supplemental income like bonuses, down from the prior 4.7%. This adjustment pertains only to state taxes on such income, excluding federal taxes, which remain at 22% for bonuses up to $1 million and 37% for those exceeding this amount.

California

For 2024 in California, bonuses and stock options fall under supplemental income and face a 10.23% tax rate. Other forms of supplemental pay are subject to a 6.60% tax rate.

Colorado

Colorado maintains a universal income tax rate of 4.4%, applicable to all earnings, including bonuses. When bonuses are issued separately from regular wages, they are taxed at these federal rates alongside the state’s 4.4% rate. For instance, a $1,000 bonus in Colorado would attract $220 in federal tax and $44 in state tax, totaling $264 in taxes, leaving the recipient with $736.

Connecticut

Connecticut does not set a distinct supplemental withholding rate for bonuses. Employers must apply the aggregate method, incorporating the bonus into the employee’s gross wages from the most recent pay period to calculate state income tax. 

The 2024 adjustments in Connecticut’s income tax rates include a decrease to 2% for the first $10,000 of income for single filers ($20,000 for married filing jointly) from the previous 3%. Income beyond this up to $40,000 for singles ($80,000 for married couples) is taxed at 4.5%, reduced from 5%. Tax relief is limited for those earning above $150,000 (single) or higher for married couples, with the top tax rate at 6.99%. 

As such, a bonus tax rate in Connecticut for 2024 relies on the individual’s total income within these brackets, contrasting with federal bonus taxation at flat rates of 22% for up to $1 million and 37% for higher amounts.

Delaware

Delaware has no state supplemental rate. Withhold state income tax as if the total of the supplemental and regular wages were a single wage payment for the regular payroll period,  unless the payment is deferred compensation, in which case it’s taxed at 5%.

Florida

This state has no state income tax or supplemental rate.

Georgia

In Georgia, bonus pay tax rates are determined by the employee’s annual salary. The tax rates on supplemental wages, like bonuses, are set as follows: 2.0% for earnings under $8,000; 3.0% for $8,000 to $10,000; 4.0% for $10,000.01 to $12,000; 5.0% for $12,000.01 to $15,000; and 5.49% for amounts over $15,000. These rates, applicable to bonuses paid separately from regular wages, are in addition to federal and other payroll taxes.

Hawaii

In Hawaii, bonuses do not have a distinct tax rate at the state level but are taxed according to the same rates as other forms of income. The state’s income tax structure is progressive, with rates from 1.4% to 11% over 12 brackets based on income levels.

Idaho

The state imposes a sales tax of 6.00%, with local jurisdictions able to add up to a 3.00% additional sales tax. This results in an average combined state and local sales tax rate of approximately 6.02%.

Illinois

Bonuses in Illinois fall under the category of supplemental income and incur federal as well as state taxes. The state imposes a uniform tax rate of 4.95% on all forms of income, bonuses included, meaning your bonus will attract this state tax rate alongside federal taxation.

Indiana

Indiana applies a 3.23% tax rate on supplemental wages, including bonuses. The Indiana Department of Revenue mandates that withholding for these one-time or irregular payments be calculated without exemptions.

Iowa

In 2024, Iowa imposes a 6.0% tax rate on supplemental income, encompassing bonuses, commissions, and overtime. This distinct taxation, separate from that of standard salary, is managed in two ways: the percentage method, which deducts a set rate directly from supplemental earnings, and the aggregate method, which merges these earnings with regular pay within a pay period, applying tax rates in accordance with the employee’s W-4 form.

Kansas

For 2024, bonuses in Kansas are subject to a supplemental state tax rate of 5%, which is levied on top of any federal taxes that may apply. This particular rate deals exclusively with the taxation of bonuses within the state.

Kentucky

In 2024, Kentucky has set its individual income tax at a rate of 4.0%, showing a decrease from the rate in the previous year. The state applies this rate uniformly under its flat tax system, which means the same rate is used for all income brackets, including bonuses. Unlike federal returns, Kentucky permits itemized deductions on state returns but does not provide for standard or personal exemptions.

Louisiana

Louisiana does not apply a specific supplemental tax rate for supplemental wages such as bonuses. Instead, it taxes these earnings at the same standard income tax rates applicable within the state. This policy places Louisiana among those states that, while imposing an income tax, do not differentiate tax rates for supplemental earnings​.

Maine

For 2024, bonuses paid in addition to usual salaries in Maine will incur a 5% supplemental tax. This specific rate is relevant when bonuses are distributed independently of regular pay. Income earned beyond bonuses falls into various tax brackets, with the highest bracket taxed at 7.15% for incomes exceeding $54,450 for individual taxpayers and $108,900 for joint filers.

Maryland

For bonuses, Maryland integrates a 5.75% state bonus tax rate with local tax rates to determine the total tax liability.

Massachusetts

This state does not assign a unique supplemental tax rate for bonuses, adhering instead to its regular income tax framework.

Michigan

Michigan treats bonuses the same as regular income, without a separate supplemental tax rate.

Minnesota

A 6.25% supplemental tax rate is applied to bonuses in Minnesota, reflecting a distinct policy towards supplemental wages.

Mississippi

Mississippi follows the same protocol as Massachusetts and Michigan, applying its standard income tax rules to bonuses without a separate rate.

Missouri

Missouri designates a 4.8% tax rate for bonuses, aligning with states that implement specific rates for supplemental income.

Montana

Bonuses in Montana are subject to a 5.0% supplemental tax rate. 

Nebraska

Nebraska also enforces a 5.0% tax on bonuses, showing a consistent method of handling supplemental earnings.

Nevada

With no state income tax, Nevada does not impose any tax on bonuses or other income at the state level.

New Hampshire

Similar to Nevada, New Hampshire’s lack of state income tax means bonuses are not taxed at the state level.

New Jersey

New Jersey treats all wages the same for tax purposes, not setting apart bonuses with a unique tax rate. It adheres to its overall income tax rules that apply universally to wages.

New Mexico

In New Mexico, a specific 5.9% rate is applied to bonus payments, showcasing a deliberate policy to manage supplemental wages distinctively.

New York

New York taxes bonus payments at a significant rate of 11.7%, highlighting its policy to levy a higher tax on supplemental wages.

North Carolina

A 4.6% tax rate on bonuses is enforced in North Carolina, demonstrating its policy to treat supplemental wages differently from regular income for tax purposes.

North Dakota

With a 1.5% tax rate on bonuses, North Dakota adopts a gentler approach to the taxation of supplemental earnings compared to other states.

Ohio

Ohio mandates a 3.5% withholding rate on supplemental wages, such as bonuses and commissions, following specific state regulations​​.

Oklahoma

In Oklahoma, a 4.75% rate is applied to supplemental wages​​.

Oregon

Oregon’s supplemental wages, including bonuses, are taxed at an 8% rate​​.

Pennsylvania

Pennsylvania treats bonus payments like regular income, adhering to its overall income tax rules without a separate rate for supplemental pay​​.

Rhode Island

Rhode Island imposes a 5.99% tax rate on bonus payments, illustrating its specific taxation policy for supplemental earnings​.

South Carolina

For bonus or supplemental wages, South Carolina adheres to the regular income tax protocols, eschewing a separate supplemental tax rate.

South Dakota

Given the absence of state income tax, South Dakota does not levy taxes on supplemental or bonus wages at the state level.

Tennessee

Tennessee, lacking a state income tax, does not tax supplemental or bonus wages at the state level.

Texas

Texas, aligning with South Dakota and Tennessee, does not impose state income tax, thus exempting supplemental or bonus wages from state-level taxation.

Utah

Utah applies its regular income tax procedures to bonus or supplemental wages, without a separate tax rate for these earnings.

Vermont

For bonuses or similar payments, the supplemental tax is calculated as 30% of the federal withholding amount for general supplemental wages. If it falls under a nonqualified deferred compensation plan, the rate is 6%.

Virginia

A supplemental tax rate of 5.75% is applied to bonuses and other supplemental wages.

Washington

The state does not impose a personal income tax, so bonuses and similar payments are not subject to a supplemental tax rate.

West Virginia

Supplemental tax rates are adjusted according to annual gross salary, with rates varying within specific salary brackets: Under $10,000 is taxed at 2.36%, $10,000-$25,000.01 at 3.15%, $25,000.01-$40,000 at 3.54%, and $40,000.01-$60,000 at 4.72%

Wisconsin

The state sets its supplemental tax rates based on the annual gross income, applying different rates across various salary bands: Under $12,760 is taxed at 3.54%, $12,760-$25,520 at 4.65%, $25,520.01-$280,950 at 5.30%, and over $280,950 at 7.65%.

Wyoming

As there is no personal income tax in Wyoming, there is no supplemental tax rate for bonuses or similar payments.
Learn more about payroll taxes by state in this helpful guide.

Laws on bonus pay: Key facts for compliance

Bonus payroll is governed by federal and state laws, so it’s important to stay compliant with the rules and regulations to avoid any legal consequences. 

Laws to be aware of:

• FLSA
• Equal Pay Laws
• State Laws
• Contractual obligations (e.g., employment contracts and company policies)

Employer responsibilities

As an employer, you are responsible for running bonus payroll effectively. 

• Create and document clear bonus structures: Outline what employees need to do to achieve a bonus and outline discretionary and nondiscretionary bonuses to avoid legal disputes.
• Review bonus policies: Regularly review bonus policies to ensure they comply with federal and state equal pay laws.
• Stay up to date on state laws: Review state-specific regulations often to make sure you comply with any changes in the law.

Employee rights

Employee rights vary depending on federal and state laws, employment contracts, and company policies. But as general guidance, employees have the right to:

• Non-discriminatory bonus distribution: Pay your employees fairly without discrimination and ensure that you follow the Equal Pay Act (EPA). 
• Earned bonuses: If you state in a contract or company policy that you will pay a bonus, employees have a right to receive that bonus.
• Transparent bonus information: Employees must have access to documented information outlining the criteria and objectives for receiving a bonus at work.

As an employee, you might wonder what to do if a bonus wasn’t reported and you haven’t received your bonus. If this happens, notify your manager or HR department. Remember to keep all related documentation, such as pay stubs or communication about the bonus, to help resolve any discrepancies.

What are different types of bonus pay?

Types of bonus pay for small business owners fall into two distinct categories:

Discretionary bonuses

A discretionary bonus is a special type of bonus pay given by an employer to an employee as a reward for their exceptional performance or contributions. Unlike regular bonuses, it’s not guaranteed or based on specific criteria, but rather at the employer’s discretion.

Some examples include:

• Cash gifts for the holidays
• On-the-spot, one-off bonuses for exceptional work
• Rewards-based performance bonuses

Non-discretionary bonuses

A non-discretionary bonus is a type of bonus pay that an employer is obligated to give to an employee based on specific criteria or conditions. Unlike discretionary bonuses, which are given at the employer’s choice, non-discretionary bonuses are typically outlined in a contract or company policy.

These bonuses are given when certain goals, like reaching sales targets or completing a project on time, are met.

​​They may include:

• End-of-year bonuses
• Signing bonuses
• Referral bonuses
• Sales commissions
• Goal-based performance bonuses

Bonus pay methods: How to deliver the dollars

When it comes to payout methods for bonuses, there are various ways that small business owners can show their gratitude and appreciation for staff members. 

Payroll

Use a small business payroll system to distribute bonuses easily without having to doy manual calculations yourself.
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Running bonus payroll is a simple and convenient method because the bonus is treated as part of an employee’s usual salary and follows the same deductions and taxes. This ensures employees receive the bonus along with their regular pay, making it easier to manage their finances and taxes.

Cash

Another way to pay bonuses is to give them in cash. This is a more immediate way of handing money to your staff and showing them your appreciation. It may also feel more tangible because employees can actually see and feel the money.

However, when you pay bonuses this way, they’ll still be subject to the same tax rules as when you do it with an electronic payroll process. So cash bonuses can end up being a hassle for both employees and employers.

Stock options as a bonus

Offering employee stock options (ESOs) means giving team members shares in your business. Staff can buy shares at a set price rather than the (usually higher) market rate. That means they’re likely to make money if they sell their shares later on.

If your company is doing well, offering ESOs is a good form of compensation. It can also incentivize staff to stay longer as they may want to wait until their ESOs mature or the share price rises before selling.

Giving more shares the longer an employee stays with the company can also boost retention.

Gift cards

Gift cards reward employees with a voucher for a specific brand or product type. They may be more personal and can even send a powerful message.

For example, if you give employees a gift card for a wellness day or a massage at a local spa, you’re encouraging them to take a break, which could be a very welcome surprise.

However, this option may be risky because:

• It may be difficult to know what to get an employee, especially if you don’t know them well.
• Some staff, especially if they’re struggling financially, may prefer money to a gift card so they have more choice of what to spend it on.
• It may increase employee frustration if the gift card is for a brand or item they don’t like or won’t use.
• Bonuses are typically worth more than gift cards (for example, $1,000 vs. $100). As a result, gift cards might seem like tokens to some employees.

However, gift cards may be a great option for your business if you can’t afford to give sizable bonuses but still want to show your appreciation. They may also work well for smaller businesses where managers know their employees better.

Gifts

Offering team members gifts is another option. However, they carry a lot of the same risks as gift cards.

Giving gifts in a business setting may also blur boundaries between personal and professional relationships and create a sense of indebtedness. In extreme cases, it may also put you on the wrong side of bribery laws, especially if the gift is of high value.

Gifts also shouldn’t be confused with regular supplies that employees need and should be given anyway. That might include a computer, technical support, safety equipment, or a car fuel allowance.

However, when chosen carefully, gifts can be a nice touch. Some ideas are:

• A bottle of wine during the holiday season (or a non-alcoholic option)
• Pizza for the whole team for Friday lunches (including options for special dietary needs)
• A group meal paid for by management to celebrate a productive quarter
• A high-value watch to thank an employee for their many years of service

How to calculate bonus pay

Small businesses use different methods to calculate bonus pay based on their industry and specific business. Here are some common ones:

Bonus pay as a sales commission

Business owners use this method to reward salespeople. The bonus amount is calculated by multiplying the total sales made by a pre-determined bonus percentage.

For example, if an employee makes  $10,000 in sales and the bonus or commission rate is 5%, the calculation would be: $10,000 x 0.05 = $500.

Bonus pay as a percent of salary

This method is used for managers, team leaders, or department heads who determine bonuses based on a percentage of each employee’s salary. The calculation involves multiplying the employee’s salary by the bonus percentage.

For example, if an employee earns $50,000 per year and the bonus percentage is 3%, the calculation would be: $50,000 x 0.03 = $1,500.

Sign-on bonus pay

Sign-on bonuses are typically flat rates given to new hires. If the bonus is paid in increments over a contract period, you divide the bonus amount by the contract length.

For example, if the sign-on bonus is $1,000 and the contract length is five months, the calculation would be: $1,000 / 5 = $200.

Discretionary bonus pay calculation

As a bonus pay example, let’s say you have a small retail store.

You have three full-time and two part-time employees, so five in total. Your full-time staff each work 35 hours a week. Your part-time staff each work ten hours a week.

Your bonus budget is $5,000 in total.

To keep your bonus payments fair, you calculate the following:

1. Everyone’s total hours: 35 + 35 + 35 + 10 + 10 = 125
2. The bonus amount divided by that number: 5000 ÷ 125 = 40. (Each hour worked = $40)
3. The full-time workers’ hours multiplied by this rate: 40 x 35 = 1400
4. The part-time workers’ hours multiplied by this rate: 40 x 10 = 400

So, you’d give your full-time workers $1,400 each and your part-time workers $400 each.

This is a more accurate reflection of each employee’s contribution to your business and is much less likely to cause resentment than if you simply divide $5,000 by five.

Non-discretionary bonus pay calculation

Calculating non-discretionary bonuses isn’t the same as calculating discretionary bonuses. You need to use other formulas.

For one-off non-discretionary bonuses, you might decide on a suitable amount for the situation, your business size, and your industry. For example, salons might pay $1,000 for each employee referral that stays a customer for at least six months.

For recurring non-discretionary bonuses based on employee tenure, role, and performance, you have to get each individual’s data for every criterion and multiply their average monthly salary by those numbers.

Non-discretionary bonus pay calculation example

Let’s say you run a small cafe with one manager. Cafe policy encourages higher sales by offering a non-discretionary bonus based on monthly sales targets. For example:

• Manager base salary: $3,000 per month.
• Monthly sales target: $20,000 in sales.
• Bonus rate: 5% of sales exceeding the target.
• Emma's sales performance: $25,000 in sales for the month.

Then, use the following calculation:

1. Determine the base monthly salary: $3,000
2. Calculate the nondiscretionary bonus:some text
   • Sales achieved: $25,000
   • Sales target: $20,000
   • Sales exceeding the target: $25,000 - $20,000 = $5,000
     Bonus = $5,000 x 0.05 = $250

This means your manager will receive $3,250 in compensation ($3,000 + $250 = $3,250).

How to pay bonus pay

Follow these twelve steps to run effective small business bonus payroll:

1. Decide what bonuses you offer: Determine the types of bonuses you want to offer, such as performance-based, holiday, or hiring bonuses. Consider your company's goals, business outlook, and employee motivation when choosing bonus types.

2. Create criteria for getting a bonus: Establish clear and measurable criteria that employees must meet to qualify for each type of bonus. Ensure this aligns with your company's objectives and is communicated clearly to employees through policies, training modules, and employee handbooks.

3. Budget it out: Calculate the total cost of the bonuses and make sure they fit within your company’s budget. Don’t forget to factor in federal and state taxes and other payroll-related expenses to avoid overspending.

4. Validate and get approval: Present the bonus plan to relevant stakeholders or managers for approval and ask for their feedback to make any last-minute changes or improvements.

5. Draft up documentation: Document the bonus program, including eligibility criteria, dollar amounts, schedule, and any other relevant details. This documentation should be clear and accessible to both employees and management.

6. Create a bonus program: Develop a formal program outlining how bonuses will be administered. Include the process for evaluating employee performance, bonus distribution timelines, and progress tracking methods.

7. Identify who meets the criteria: Review employee performance data to identify which employees or staff members meet the criteria for receiving a bonus. Make sure that the evaluation process is fair and consistent.

8. Decide how to deliver bonuses: Determine whether bonuses will be paid as a lump sum, added to regular payroll, or delivered through another method, such as gift cards or stock options. Consider tax implications and what will contribute to employee happiness.

9. Process payroll: Make sure that all necessary information is entered correctly into the payroll system. Use Homebase to calculate the appropriate withholding for taxes and other deductions.

10. Pay bonuses out: Distribute the bonuses to employees. Ensure that payments are made on time and that employees know the bonus details in their paycheck. Make yourself available for any questions or feedback. 

11. Keep a record: Maintain detailed records of all bonus payments, including amounts, recipients, and the criteria they meet. These records are essential for tax purposes and future reference.
    
    
12. Collect bonus program feedback: After bonuses have been distributed, gather feedback from employees and management on the effectiveness of the bonus program. Use this feedback to make improvements for future bonus cycles.

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FAQ

How does bonus pay work?

Bonus pay is an additional payment that some employers give their employees. It’s a way to reward exceptional performance, meet specific goals, or show appreciation. Bonus pay can come in different forms, such as cash, gift cards, or stock options. The bonus amount can vary depending on factors like individual achievements, company profits, or sales targets.

Some bonuses are discretionary, meaning the employer decides who gets them, while others may be based on specific criteria. Bonus pay is typically given on top of an employee’s regular salary and is subject to taxation according to the applicable laws.

Do employers pay taxes on bonuses?

Yes, employers may pay taxes on bonuses. When employers give bonuses to employees, they’re responsible for withholding the necessary taxes from the bonus amount. This means that employers need to deduct a portion of the bonus as taxes and send it to the government on behalf of the employee.

The specific tax withholding rate is determined by the tax laws and regulations of the jurisdiction. By fulfilling their tax obligations, employers make sure that the required taxes are paid, helping to fund government services and programs.

Are holiday bonuses taxed?

Yes, holiday bonuses are taxed as they’re considered compensation. However, they’re taxed at a different rate than regular pay, so you need to process them differently.

How are year-end bonuses taxed?

If you include a year-end bonus as part of a standard payroll check, you should treat it the same as regular taxable income. If you choose to include year-end bonuses on separate checks, they’ll be taxed at a flat rate of 22%.

What is the difference between overtime pay and a bonus?

Overtime pay is a nondiscretionary bonus. It’s mandatory to pay, and employees are entitled to it based on the number of overtime hours they clocked in during a workweek. On the other hand, many bonuses are discretionary, meaning they’re optional. They’re offered as an incentive for exceptional employee performance.

Is a bonus better than a pay raise?

From a business perspective, yes, bonuses may be more beneficial than pay raises in some cases. Bonuses are variable as they’re often based on employee performance or specific results. That means, unlike pay raises, you can reduce them if your budget decreases.

Are there disadvantages to handing out bonus payments?

Yes, there are some disadvantages to handing out bonus payments. Once you’ve introduced bonuses, employees may expect them even if you don’t have the budget. This may lead to lower morale and staff feeling disappointed if you can’t deliver.

Does a w3 include bonuses?

Yes, a W-3 form includes bonus pay. The W-3 form summarizes all W-2 forms submitted by an employer, including total wages, tips, and other compensation, including bonuses. Ensuring that all bonus payments are accurately reported on both the W-2 and W-3 forms is important.

Does a w2 include bonuses?

Yes, a W-2 includes bonuses. Any bonuses you receive are taxable income and will be included in Box 1 of your W-2 form and your regular wages. The taxes withheld from your bonus will also be reflected in the W-2.

What do I do if a bonus wasn't reported?

If a bonus wasn’t reported, you should take immediate action to correct the error. First, verify your payroll records to confirm the mistake. Then, the employee will be issued a corrected W-2 form (known as a W-2c) and will submit the corrected information to the IRS. Additionally, the employee should be informed of the corrections and provided with the updated tax forms.

Are relocation bonuses taxed?

Yes, relocation bonuses are subject to taxes. Like other bonuses, they are considered supplemental income and subject to federal income tax, Social Security, Medicare, and other state and local taxes. Employers typically withhold a flat rate of 22% for federal income tax on bonuses, including relocation bonuses.

When are quarterly bonuses paid?

Quarterly bonuses are typically paid at the end of each quarter. This means payments are usually made in March, June, September, and December, depending on your company’s fiscal calendar. However, the payment date may vary based on company policy or specific employee agreements.

What is the difference between bonus pay and commission?

Bonus pay is a discretionary or non-discretionary payment given to employees as a reward for meeting certain performance criteria or achieving company goals. It is typically a one-time payment. Commission, on the other hand, is a payment structure where employees earn a percentage of the sales they generate. Unlike bonuses, commissions are usually a regular part of an employee's pay structure and are directly tied to sales performance.

What is an STI bonus?

An STI bonus, or Short-Term Incentive bonus, is a performance-based bonus awarded for achieving specific short-term goals, typically within a fiscal year. STI bonuses reward employees for meeting or exceeding objectives that contribute to the company’s short-term success, such as quarterly or annual targets. These bonuses are often tied to individual, team, or company performance metrics.

Bonus vs. double bonus: What’s the difference?

A bonus is an additional payment given to an employee on top of their regular salary, usually as a reward for meeting performance goals or company success. A double bonus refers to a bonus that is either twice the normal amount or structured so that the employer covers the taxes, effectively doubling the net bonus the employee receives.

Are relocation bonuses taxed?

Yes, relocation bonuses are taxed. They are treated as part of your regular income, so they are subject to federal and state income taxes, and Social Security and Medicare taxes. The bonus will be included in your W-2 form, and your employer will typically withhold taxes from the payment.