Employee bonuses are additional financial payments given to employees beyond their regular compensation or wages. These rewards are often used to recognize exceptional performance, incentivize desired behaviors, or share company success with the workforce.
For business leaders and HR professionals, designing an effective bonus program starts with a clear grasp of the various types of bonuses and their strategic applications. By aligning these with company size, industry benchmarks, budget constraints, and organizational objectives, employers can create a system that fuels growth and enhances employee satisfaction.
What Are the Different Types of Employee Bonuses?
Here’s a breakdown of the most common types of bonuses employers can offer:
Annual bonus
An annual bonus is a performance-based reward given to employees at the end of the fiscal year. Usually, the bonus is calculated as a percentage of the employee’s base salary and is often tied to individual and company performance metrics. Annual bonuses serve as an incentive for employees to meet or exceed their goals throughout the year. The amount can vary significantly based on the company’s financial performance, the employee’s position, and their individual contributions.
Signing bonus
A signing bonus, or sign-on bonus, is a one-time payment offered to new employees as an incentive to join the company. It’s often used to attract top talent, especially when competing with other offers from other organizations or when trying to bridge the gap between a candidate’s desired salary and the company’s offer. Signing bonuses may come with contractual obligations. For example, the employee may be required with the company for a minimum period before receiving the bonus.
Discretionary bonus
A discretionary bonus, sometimes called a spot bonus, is an unexpected reward given to employees for exceptional performance or achievements. These bonuses are not contractually guaranteed and are awarded at the employer’s discretion. They can be monetary or non-monetary (e.g., gifts or extra time off) and are used to show appreciation for an employee’s efforts or to motivate specific behaviors.
Retention bonus
A retention bonus is a financial incentive offered to key employees to encourage them to remain with the company for a specified period. It’s common to use them during times of organizational change, such as mergers or acquisitions, or to retain valuable employees in a competitive job market. To a large extent, retention bonuses are paid as a lump sum after the agreed-upon period has elapsed.
Referral bonus
A referral bonus is given to employees who successfully recommend new hires to the company. Such a bonus incentivizes employees to help with recruitment efforts by leveraging their professional networks. The bonus amount often depends on factors such as the position being filled and how difficult it is to recruit for. Payment is made after the new hire has been employed for a certain period.
Holiday bonus
A holiday bonus is a reward given to employees around major holidays, often at the end of the year. It’s seen as a gesture of goodwill and appreciation for the employee’s contributions throughout the year. Holiday bonuses may be tied to company performance or individual achievements, but they can also be a fixed amount or percentage of salary given to all employees regardless of performance.
Profit-sharing bonus
A profit-sharing bonus is a form of compensation where employees receive a portion of the company’s profits. The amount is usually based on the company’s overall financial performance and can be distributed annually or quarterly. This type of bonus aligns employee interests with company success, giving them a literal stake in the business, and can serve as a powerful motivator for improving overall business performance.
Commission
A commission is a performance-based bonus awarded to sales team members, calculated based on their sales revenue. The specifics of how commissions are paid are outlined in the company’s sales commission structure, which defines the payment method for each sale.
Here are some common commission structures:
- Base salary plus commission: Employees receive a fixed salary along with a percentage of their sales revenue as commission.
- Flat commission: A set payment is provided for completing specific tasks or achieving certain goals, regardless of the sale amount.
- Quota-based commission: Employees earn a commission for reaching predefined sales targets or quotas.
- Territory commission: Payment is based on the total sales volume within a designated territory rather than individual transactions.
- Straight-line commission: Commissions are calculated as a percentage of the sales quota achieved, with higher earnings for exceeding the target.
Tiered commission: As sales milestones are reached, the commission rate increases, incentivizing higher performance.
What Are the Various Criteria for Employee Bonuses?
Employee bonuses can be based on various criteria, each designed to incentivize specific behaviors or outcomes. Here are some common factors used to determine bonus eligibility and amounts:
Performance-based criteria
Individual performance: Individual criterion focuses on an employee’s achievements, often measured against predetermined key performance indicators (KPIs) or goals.
Team performance: Bonuses may be tied to the collective success of a team or department, encouraging collaboration and shared responsibility.
Company-wide performance: Some bonuses are linked to overall organizational success, such as meeting annual revenue targets or profit margins.
Time-based criteria
Tenure: Long-serving employees may receive bonuses as a reward for their loyalty and continued contributions to the company.
Annual bonuses: These are awarded at the end of the fiscal year, often based on a combination of individual and company performance.
Specific achievement criteria
Project completion: Bonuses are awarded for successfully finishing important projects or meeting critical deadlines.
Sales targets: Relevant for sales roles, these bonuses are tied to reaching or exceeding sales quotas.
Customer satisfaction: Bonuses are based on positive customer feedback or maintaining high service quality standards.
Skill development criteria
Skill acquisition: Rewards are given to employees who acquire new skills or certifications that benefit the organization.
Innovation: Bonuses are awarded to employees who contribute new ideas or create new products that drive company growth.
By incorporating a mix of these criteria, companies can create a comprehensive bonus structure that aligns with their goals while motivating employees across various aspects of their work.
Employee Bonuses and Taxes: What Employers Need to Know
Employee bonuses are subject to taxation, and employers and employees must understand the tax implications. Here’s an explanation of how bonuses are taxed:
Taxation of employee bonuses
Employee bonuses are considered taxable income and are subject to various taxes, including:
- Federal income tax
- State income tax (where applicable)
- Social Security tax
- Medicare tax
Employer responsibilities
Employers must account for bonuses when calculating:
- Federal and state unemployment taxes
- Social Security maximum contributions
- Medicare tax
Withholding methods
When paying bonuses, employers have two main options for withholding federal income tax:
- Aggregate Method: The bonus is added to regular wages, and withholding is calculated based on the total amount.
- Flat Rate Method: A flat 22% is withheld from the bonus for federal income tax.
Special considerations
If an employee is exempt from regular tax withholding, the employer must still account for the bonus when calculating withholding:
- Add the bonus to the employee’s regular pay.
- Calculate the withholding based on the new total.
- Withhold the calculated amount from the combined pay.
Employee implications
Employees should be aware that:
- Bonuses will increase their total taxable income for the year.
- The additional income may push them into a higher tax bracket.
- If insufficient taxes were withheld, they may owe additional taxes when filing their annual tax return.
To manage the tax impact of bonuses, employees can consider:
- Increasing 401(k) contributions to offset the additional taxable income.
- Adjusting their W-4 form to increase withholding throughout the year.
- Setting aside a portion of the bonus to cover potential additional taxes owed.
Understanding these tax implications helps both employers and employees properly manage and plan for bonuses, ensuring compliance with tax laws and avoiding unexpected tax bills.
A well-implemented bonus program is a strategy capable of positively impacting both individual performance and organizational success. Beyond the numbers, bonuses communicate recognition and inspire a deeper connection to the company’s mission.
When employers thoughtfully invest in their workforce through tailored incentives, they create an environment where employees feel motivated to achieve more, ultimately advancing company-wide aspirations.
Ensure your employees are supported throughout the year to meet their goals for bonuses by providing career coaching, leadership training, and workshops aligned with their skill development and organizational objectives. INTOO’s wide range of programming led by expert coaches can help every member of your workforce. Contact us to learn more.
INTOO staff writers come from diverse backgrounds and have extensive experience writing about topics that matter to the HR and business communities, including outplacement, layoffs, career development, internal mobility, candidate experience, succession planning, talent acquisition, and more.
