Bonus payments are a hugely popular — and effective — way to boost your employee compensation strategy. When done right, they are a powerful motivation, helping your company to retain top talent and develop a more engaged workforce.
But before you can hand them out, there are some important things to consider. For instance, what kinds of bonus payments can you actually offer? What are the differences between them? And what are the legal and tax implications for both you and the recipient?
In this article, we’ll discuss how to give bonus payments to employees, and explore some of the different types you can offer. We’ll also cover some important considerations for implementing an incentive program, and some of the tax implications you should bear in mind.
What are bonus payments?
Bonus payments are a form of compensation that employees receive on top of their regular salary or wages. They’re often tied to specific criteria or performance metrics (like meeting sales targets) and can take various forms, such as cash bonuses, stock options, or extra paid time off.
Why offer bonus payments to employees?
Your company isn’t obligated to offer bonus payments. However, implementing an incentive program shows employees that you value their hard work — and are willing to reward exceptional performance. This is more likely to improve productivity and boost retention.
When bonuses are tied to team performance or project outcomes, this can incentivize employees to work together toward a common goal. This, in turn, helps bring teams together and fosters creative thinking.
Types of bonus payments
Most people associate bonuses with small brown envelopes that are handed out at the end of a successful year. But bonuses can come in many shapes and forms.
Here are some of the most popular:
Performance-based bonuses
Performance-based bonuses are awarded to employees who meet certain performance goals or targets. Common examples include one-time cash bonuses or cash equivalent gifts.
For example, let’s say your company is working on a major software development project. You might implement a performance-based incentive program that rewards developers who reach important milestones while meeting all quality standards. These types of bonuses can motivate and incentivize employees to do their best work.
Sales bonuses
Some companies pay commissions to reps for each sale they make. But they can take it even further by offering additional bonuses for those who meet or exceed sales goals.
For example, a sales rep could receive a 3% increase in their salary and a $3,000 year-end bonus for meeting expectations. Alternatively, they may receive a 5% increase in salary and a $10,000 year-end bonus for exceeding expectations.
Profit-sharing bonuses
Some companies offer profit-sharing bonuses in which they distribute a percentage of quarterly or annual profits to eligible employees. These can be one-off cash payments or stock options.
For example, Home Depot has a profit-sharing plan called Success Sharing, which motivates associates to deliver better customer experiences.
Holiday bonuses
Holiday bonuses are typically awarded to employees during holidays or occasions like Christmas or New Year’s. These types of bonus payments differ from year-end bonuses and can come in the form of cash payments, extra paid time off, or other perks.
Sign-on bonuses
For some roles — especially those that are difficult to fill — companies may offer a sign-on bonus. These bonuses can be used to create a more attractive compensation package and entice prospective employees to join.
For example, post-COVID, with many airlines struggling to hire enough staff, United Airlines offered a $15,000 sign-on bonus to part-time ramp agents in Denver (with contingencies, such as 12 months in the role).
Referral bonuses
Referral bonuses are another bonus payment given to employees who refer candidates to open positions. Companies can attract potential candidates, and employees can receive a financial reward for their contribution to the hiring process.
Referral bonus amounts can vary depending on what openings are available and how difficult they are to fill. For example, companies may offer higher employee bonuses for in-demand positions, like information security professionals, software developers, and data analysts.
Considerations when implementing bonus and incentive programs
When setting up bonus programs, there are a few things to keep in mind, and some best practices to follow.
Align the bonus with your company’s goals
Before you implement an incentive program, it’s important to establish clear objectives for it. For instance, what are the goals behind it? How does it relate to your company’s strategic objectives?
As a starter, your incentives should be aligned with your company’s values and goals. This ensures your employees are working toward a bonus payment that pushes the desired outcomes forward.
For example, let’s say one of your company’s strategic goals is to increase customer satisfaction. In this case, you could implement a program where customer service reps earn a bonus based on their customer satisfaction survey scores.
Alternatively, if your company values collaboration, you could offer team bonuses instead of individual incentives.
Choose a bonus type and establish the eligibility criteria for it
Choose a bonus type that fits your goals, and decide on its structure.
For example, let’s say you want to offer a sales bonus. One way to structure it would be to offer reps a 5% salary bonus for hitting 125% of their quarterly target.
Determine the eligibility criteria and make these requirements clear so that employees know what they need to do to qualify. Are you offering the bonus to certain departments only? Or is it available to the entire company? Ensure that you are crystal clear about the details, and that there’s no room for confusion or debate.
Ensure fairness and transparency
It’s important to avoid any favoritism or bias when giving bonus payments to employees. The process for awarding bonuses should be objective and applied consistently.
If you’re offering a holiday bonus, for instance, it’s a good idea to offer it to everyone. Employees with more seniority may get a bigger bonus. However, if some individuals hear that others got a bonus while they didn’t, they may resent that decision and choose not to remain with the company for much longer.
Communicate the bonus to employees
Clear communication is essential to the success of any incentive program. Make sure to communicate bonuses that employees can earn and how they’re awarded.
You could even help employees track and monitor their progress toward the bonus so that they know how close they are to earning it.
Monitor and evaluate your incentive program
Sometimes, bonuses can have an adverse effect. For example, let’s say that you decide to offer an attendance bonus, thinking this will increase productivity. However, after a period of evaluation, you realize that the levels of absenteeism are actually worse. The reason? The incentive has made absenteeism an acceptable behavior, with good attendance worthy of extra recognition.
This is an extreme example, but it illustrates that incentive programs shouldn’t be set in stone. Regularly monitor and evaluate the effectiveness of all your programs, and ensure that they are having the desired effect in line with your company goals.
Be sure to also gather feedback from your employees. This can help you determine if the bonuses are working or not, and allow you to adjust course if necessary.
What are the tax withholding requirements for bonus payments to employees?
This depends on the tax withholding laws in the employee’s country, but most tax authorities consider bonuses to be taxable income in one way or another.
Example: The US
In the US, the Internal Revenue Service (IRS) considers bonuses taxable income, meaning your employees must pay taxes on them. These include federal and state income taxes, as well as other taxes for Social Security and Medicare.
There are two methods you can use to calculate tax withholdings when giving bonus payments to employees:
The percentage method
This method involves withholding a flat 22% of the bonus and adding the rest to the employee’s wages as normal. It’s the most straightforward of the two options, but it has some drawbacks.
Employees in a lower tax bracket have their bonuses taxed at a higher rate, but they may get a refund when they file. On the other hand, employees in a higher tax bracket may have to owe more when they file.
The aggregate method
With this method, your employee’s bonus is added to their regular paycheck, and federal income tax is withheld based on the total amount. You can use Publication 15-T to determine how much you should withhold.
The aggregate method is the more accurate of the two, but the process is more complicated.
Note that some states have different withholding requirements for employers. For example, if your company is based in Oregon, you must withhold an additional 8% for state tax. That’s on top of the 22% normally required for supplemental income.
To learn more about your tax withholding obligations in the US, check out our US State Explorer tool .
Managing bonuses with Remote
Bonus payments can play a key role in shaping your company’s compensation strategy. This strategy can help you attract skilled workers, retain talent, and improve productivity.
However, dealing with the implications of bonus payments can be challenging, especially if you have team members in different locations.
Remote ensures that, when you provide bonuses to your people, all tax withholdings are calculated correctly in full compliance with relevant laws and regulations — no matter where your team members are based.
To learn more about how we can simplify your bonus payments and management — and to see how else we can help you attract and retain top talent — speak to one of our friendly experts today .
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