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Bonuses can be a great tool to motivate and reward a variety of employee behaviors, from meeting performance goals to referring new employees. However, calculating bonus payouts and withholding taxes can be confusing for employers and employees in the United States. In this guide, we cover the main types of bonuses and explain how to calculate bonuses and taxes using 2024 tax rates.
What is the bonus?
A bonus is an additional reward that an employee receives in addition to their regular wages or salary. Most bonuses are in the form of cash, but some employers offer non-cash bonuses as well. There are many different types of bonuses; see the next section for details on the most common bonuses.
Types of Bonuses You Can Offer to Employees
Non-discretionary bonuses
Non-discretionary bonuses are set out in the employment contract and the employer is required to pay the employee the bonus as long as the employee meets the requirements.
Discretionary Bonus
Discretionary bonuses are not set out in the employment contract and are therefore awarded at the employer’s discretion. Discretionary bonuses give employers greater freedom in how often and how much they award.
Signing Bonus
Signing bonuses are one of the most common types of bonuses and are given to new employees when they sign an employment contract. These bonuses are often used as a recruiting tool and are intended to motivate candidates to accept a job offer. Signing bonuses can be paid as a lump sum upon joining or in installments over the salary of the first year of employment.
Milestone Bonus
Milestone bonuses are essentially performance bonuses that are paid out when an employee or team reaches certain performance goals or targets, also known as “milestones.”
Year-end bonuses
Annual bonuses are paid to employees at the end of the financial year. Annual bonuses may be guaranteed, meaning they are paid regardless of how well or poorly the company performed over the past year. These bonuses may also be conditional on the company meeting certain revenue or profit benchmarks.
Retention Bonus
Retention bonuses are designed to incentivize key employees to stay with the company for a certain period of time; they may be awarded during specific events, such as mergers, acquisitions, or other organizational changes. Retention bonuses may also be awarded to employees in high-demand, hard-to-replace positions, which are more likely to be poached by competitors.
Referral Bonus
Referral bonuses are given when a company hires a new employee who was referred by a current employee. Some companies offer variable referral bonuses, with higher bonuses for highly competitive, high-demand jobs. Other companies offer a flat-rate referral bonus that doesn’t vary based on which position is being filled.
Holiday Bonus
Holiday bonuses are usually paid around the end of the year, around the winter holidays. Unlike other bonuses (including year-end bonuses), holiday bonuses are not tied to performance, but are a thank you from the company for the hard work of employees. Holiday bonuses are usually calculated as a percentage of each employee’s annual salary.
Spot Bonus
A spot bonus is a small cash bonus given to an employee “on the spot,” usually in the form of a gift card. Some common occasions for spot bonuses include celebrating employee birthdays and rewarding outstanding customer service.
Non-cash bonuses
As the name implies, non-cash bonuses do not involve money; examples of non-cash bonuses include extra paid time off and employee parking spaces.
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How to calculate bonus
Bonuses are usually calculated as a percentage of base or gross salary. For example, if an employee makes $100,000 per year and receives a 20% performance bonus, their bonus would be $100,000 x 20% = $20,000. If an employee makes $60,000 per year and receives a 5% holiday bonus, their bonus would be $60,000 x 5% = $3,000.
Some bonuses are fixed amounts that don’t require any calculation; for example, some companies offer a $500 referral bonus to all new employees. Check the company’s bonus policy carefully to see if the bonus is based on a percentage or a fixed amount.
How are bonuses taxed?
In the United States, there are two ways to levy income tax on bonuses: the percentage method and the total amount method.
Using the most straightforward method, the percentage method, the employer will treat the bonus separately from the employee’s regular salary. All bonuses below $1 million will be taxed at 22%, and all bonuses over $1 million will be taxed at 37%. These bonuses are usually paid outside of the normal payroll cycle. Payroll Software Rippling, for example, makes it easy for administrators to process bonus payments at any time, with no additional charges for additional runs—a must-have feature if your company plans to make a lot of off-cycle bonus payments.
The second method, the roll-up method, is a little more complicated. In this method, the employer adds the bonus to the payroll and pays it to the employee in a lump sum in the normal manner. payrollSince the prize money is not separately listed as supplemental income, the federal government treats it as regular income and taxes it according to the income bracket it falls into.
If you are about to receive a bonus and want to know how much income tax you can deduct using these two methods, you can use this Free Bonus Tax Calculator from TurboTax to see what the difference is.
Bonus also requires additional Payroll Tax Taxes are withheld, including Social Security, Medicare, and federal unemployment taxes (FUTA). State income or local taxes may also be withheld. Employers tend to be careful about withholding taxes on bonuses, so employees may receive a refund after filing their taxes.
How to minimize the tax impact of your bonus
Fortunately, there are steps employees can take to minimize Payroll Tax First, they can contribute to a 401(k) or IRA. If they anticipate a pay cut in the next tax year, they can also ask employees to defer bonus payments until the following year so they can be taxed at the appropriate rate.
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