Employees are now starting to receive bonuses from their employers instead of getting a raises as reported by the Washington Post. The two main reason for this is: first, bonuses are easier to stop than a continuing pay raises and second, they have an immediate positive effect on employees. Although bonuses are an awesome way to give incentives to employees, it’s important that you know the tax implications your business and your employees will face once you start to hand them out.
How Bonuses Work
A bonus is given to an employee for a specific and special reason as a one-time or annual payment. Aside from your salary or hourly rate of pay for the year, you will be given an additional payment which is the bonus. The decision on who receives a bonus, the amount, and when it is paid is up to you. If you’re an employee, you can include a bonus into your employee’s regular paycheck or you can give a separate check for a more impactful effect.
Bonuses may also come in a contractual form including sales bonuses for salespeople or sometimes for performance awards. Another type of bonus given to a team of employees who met a specific sales or production goal is called a special holiday bonus. It can also be given as a sign of gratitude for a good overall yearly profitability.
How to deduct employee bonuses as a business expense?
It is best to pay bonuses to employees if you have extra cash and is expecting to make a good profit for this year. You don’t just receive a tax deduction for these benefit expenses, you also get much goodwill from employees especially during holidays.
Setting up the bonus as a one-time event will be a great way to avoid any expectation of yearly bonuses. The truth is when we do something once, people come to expect it. But when you do something twice, it is no longer a privilege but an employment right.
Bonuses fall under the category of “payments to employees” and is, therefore, a deductible business expense. If you decide to give bonuses to selected people, make sure you are clear as to why you did this. You can try giving a bonus base on performance-related reason.
How do bonuses to employee/owners work?
Bonuses given to employee/owner qualifies as a business expense can, therefore, be deducted depending on some circumstances. Here’s an example:
How do bonuses as taxable income to employees work?
Employee bonuses are considered as an employee benefit and are always taxable. The federal and state income taxes and FICA taxes must be withheld by the employee. Bonus amounts in calculating unemployment taxes must also be included as well as the Social Security maximum, and the additional Medicare tax.
Discretionary vs Non-Discretionary Bonuses
The employer can decide to have the bonuses discretionary or non-discretionary. The difference must be understood carefully since non-discretionary bonuses may be required in calculating overtime pay.
If a bonus is not expected, it is considered as discretionary. If you give an employee a performance every end of the year and you don’t give it every year, it’s considered as discretionary. You can only consider holiday bonuses as discretionary even if they are given every year when the IRS says so.
Bonuses imposed on the employer are considered non-discretionary bonuses. They are given by a union contract, employment contract, or as a bonus that employees expect (except for the holiday bonus noted above). Signing bonus (for signing a contract) are considered non-discretionary.
Non-discretionary bonuses must be included to weekly gross pay for overtime purposes for hourly employees and for exempt employees who are qualified for overtime. If you want to know more about how to calculate bonuses and overtime, check The Department of Labor website for more information.
