Essential Elements for an Employer’s Bonus Plan

by | Aug 21, 2025 | Employee Management

Ten Essential Elements for an Employer’s Bonus Plan

Bonus plans can be a great way to incentivize employee work performance. They can also create problems if not set up correctly.

When structuring an employer’s bonus plan it is critical to ensure the plan is clear, comprehensive, legally compliant, and communicated to employees (preferably in writing). Below is a list of Ten Essential Elements for an Employer’s Bonus Plan.

  1. Purpose and Scope of the Bonus Plan
  • Clearly state the objectives of the bonus plan (e.g., incentivize performance, reward loyalty, align employee interests with company goals).
  • Define which employees or employee groups are eligible to participate (e.g., all staff, management, executives, select teams).
  1. Type of Bonus
  • Specify whether the bonus is:
    • Discretionary: Awarded at the employer’s sole discretion, with no expectation or guarantee.
    • Non-Discretionary: Based on pre-established criteria or agreements, creating an expectation of payment if conditions are met.

Just because you say it is “discretionary,” does not make it so. If there are expectations of payment based on certain events happening (employee performance, company performance, longevity of employment, etc.), then it is non-discretionary.

  1. Eligibility Criteria
  • Detail the requirements for employees to qualify for the bonus, such as:
    • Minimum tenure or employment status (e.g., must be employed on a specified payout date or at year-end).
    • Performance metrics, attendance, safety records, or other measurable factors.
  • Address eligibility in cases of resignation, termination (voluntary or involuntary), or during leaves of absence.
  1. Bonus Calculation Formula
  • Provide a clear, objective formula for calculating the bonus, including:
    • Performance targets (individual, team, or company-wide).
    • Thresholds (e.g., billable hours, sales targets, profitability goals).
    • Percentage of salary, flat dollar amounts, or pool-based distributions.
  • State whether the bonus is prorated for partial periods of employment.
  1. Payment Timing and Method
  • Specify when bonuses will be paid (e.g., quarterly, annually, upon project completion).
  • Indicate payment method (e.g., lump sum, payroll deposit).
  • Will some portion of the bonus be advanced, subject to a “clawback” provision?
  1. Plan Administration and Discretion
  • Identify who is responsible for administering the plan and making determinations (e.g., HR, executive committee).
  • Reserve the employer’s right to interpret, amend, or terminate the plan, and describe the process for any changes.
  • Include any internal appeal rights, if applicable.
  1. Impact on Other Compensation and Benefits
  • Clarify whether the bonus is included in calculations for overtime, retirement contributions, or other benefits, in compliance with wage laws. Most non-discretionary bonuses are a wage that must be included in determining an hourly employee’s “regular rate of pay” for overtime purposes. Consult with counsel to discuss how this should be handled.
  • Address potential ERISA implications if the bonus plan could be construed as a retirement or deferred compensation pl
  1. Tax Withholding and Deductions
  • State that all bonuses are subject to applicable tax withholding and deductions.
  1. Communication and Documentation
  • Require written acknowledgment by employees of the plan terms.
  • Ensure the plan is distributed to all eligible employees and is accessible for review.
  1. Legal Disclaimers and Compliance
  • Include language to ensure compliance with all applicable federal, state, and local employment laws.
  • Avoid ambiguous terms (e.g., “active employment”) that could be challenged in court.
  • If applicable, specify that the plan does not create an employment contract or guarantee employment.
  • Identify when and how the company can discontinue the bonus plan, and how that will impact partially earned bonuses.

These Ten Essential Elements are a good beginning toward a compliant, enforceable and clear bonus plan. When implementing the bonus plan, companies should consider additional issues such as:

  • Qualitative Performance Metrics: Consider including non-financial metrics such as client satisfaction, leadership, or mentoring contributions.
  • Tiered or Career-Stage Bonuses: Tailor bonus structures to different levels of seniority or job rol
  • Regular Feedback and Transparency: Outline how employees will receive feedback on their progress toward bonus criteria.
  • Plan Review and Updates: Establish a regular review process to keep the plan aligned with company goals and legal requirements.

A well-drafted bonus plan should be clear, objective, and legally compliant, minimizing ambiguity and legal risk while motivating employees and supporting company goals. Consulting with experienced employment counsel is recommended to tailor the plan to your specific business and jurisdiction.

The Nuddleman Law Firm helps employers create proper bonus and commission plans and represents employees who are owed wages. Robert Nuddleman frequently conducts training for companies regarding common wage and hour pitfalls, including the failure to properly document and pay bonuses and other incentive compensation plans. If you have questions about your compensation plans, contact the Nuddleman Law Firm.