Many employers pay year-end bonuses to employees. Paying and receiving bonuses can have unintended consequences, including tax consequences, if not handled properly. From a wage and hour perspective, there is a difference between a discretionary bonus and a non-discretionary bonus. An example of a discretionary bonus is a Christmas bonus, where the employee doesn’t know whether he or she will get a bonus, or how much it will be. A discretionary bonus is not considered a wage as long as the employer has the discretion whether to provide the bonus and how much the bonus will be. If, on the other hand, the employee or the company has to meet certain goals, or if the bonus is based on identifiable criteria, then the bonus is non-discretionary and becomes a wage. Even if a non-discretionary bonus has some discretionary aspects (e.g., supervisor subjectively determines employee’s “contribution” to a project), if the employee has some measurable goals she or he can achieve to earn the bonus, it is considered a wage.
It is important to keep discretionary bonuses discretionary and separate from non-discretionary bonuses. Since a non-discretionary bonus is a wage, that means an employee who earned overtime wages during the bonus-earnings period may be entitled to an overtime premium on the bonus. Non-discretionary bonuses should be in writing. Although the law does not require written bonus plans–at least not yet–it is important to clearly spell out what has to happen in order for the employee to earn the bonus. Smart employers also consider what happens if an employee leaves the employment after having achieved the necessary goals, but before the bonus is paid out.
So, are year-end bonuses discretionary or non-discretionary? That depends on how the bonus is set up. If the employer decides to give the employee some money at the end of the year as a way to show the employer’s appreciation or as a gift, but the employer has not set any expectations that the employee is entitled to the bonus, then the bonus is most likely a discretionary bonus. On the other hand, if the employer tells the employee that it will pay the employee a bonus based on billable hours, or number of widgets made, or possibly even company profitability, then if the employee (or the company) achieved the goals then the bonus is likely a wage.
Regardless of whether the year-end bonuses are discretionary or non-discretionary, they are taxable income. I am not qualified to advise anyone on tax issues, so speak with your CPA or payroll specialist about year-end bonuses.
The following is from an article written by BenefitMall, a payroll and benefits company. Full disclosure: I use BenefitMall for my running my payroll–even an employment attorney knows it’s easier to use an outside payroll service–and I’ve referred BenefitMall to a number of my clients. Putting aside any professional relationship, I thought they had some really good things to consider. Enjoy
Year-End Tips for Handling Bonus Payments
Each year companies reward employees with bonuses for their hard work. This reward is an addition to expected yearly wages and is handed out as either cash or non-cash. Regardless of what the bonus is, employers must withhold income taxes. To help you ease your way into the new year with less stress than necessary, take a look at the bonus payment tips below for information on year-end tax preparations.
1. Coordinate Payroll Schedules – Make sure your payroll is run in chronological order. Specifically, don’t run a payroll with a check date that comes before a payroll with a check date that has already been processed. Also, run your bonus payroll on a separate day than your regularly scheduled payroll, so that two payrolls are not being processed on the same day.
2. Employee Tax Brackets – Consider the employee’s tax bracket when giving bonuses. Check out these easy to use Payroll Calculators to determine tax-withholding information. There are various formulas to choose from:
- Percentage Method Bonus Calculator – Calculates federal withholdings using a 25 percent rate for bonuses paid up to one million dollars, and a 39.6 percent rate or the highest rate of income tax for the year for bonuses paid in amounts more than one million dollars.
- Aggregate Method Bonus Calculator – This method calculates bonuses as a part of standard payroll. While the employee may have more money withheld initially using this formula, more will be returned during tax season.
- Gross Pay Calculator – The employee receives the full bonus pay. The gross amount of the bonus is determined using the calculator and then the tax is added to the net pay.
Be sure to account for all local, state and federal taxes regardless of what formula is used. And equally important, make sure bonus pay is included in your payroll and W-2s.
3. Federal Tax Liability Threshold – To avoid penalties, be sure to account for the tax liability threshold. Employers should report and deposit taxes of payroll deposit periods that meet or exceed $100,000 to the IRS on the first business day after the check date.As you continue to prepare for the end of the year and the start of 2016, we hope that you find these tax tips helpful. BenefitMall understands how much time and energy is put into handling year-end payroll tasks. To make sure your company remains compliant with standard tax regulations, please visit our Year-End Site at BenefitMall.com/YearEnd for more valuable payroll resources.
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