With the end of Q4 just around the corner, year-end bonuses are top-of-mind for many businesses and their employees. As a small business owner, it can be challenging to know how to strike the right balance between wanting to show appreciation for your staff and not breaking the bank. Here’s what you need to know about calculating year-end employee bonuses for your SMB.
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What is an employee bonus?
According to the U.S. Department of Labor, bonuses are additional funds paid to employees on top of their regular wages. Under the Fair Labor Standards Act (FLSA), employees’ regular wages encompass their total compensation for services rendered and hours worked. As such, bonuses are separate from an employee’s regular pay rate.
Employers are not obligated to award bonuses; if they choose to do so, many factors, including how much employees receive and when, are at the employers’ discretion.
What business factors should be considered for employee bonuses?
There are many factors to consider when determining whether to award bonuses, including potential tax implications and the overall impact they may have on your company’s bottom line.
Financial impact
Since payroll is one of the most expensive aspects of running a business, developing a bonus strategy beforehand is vital. Consider running a cash flow and profit analysis to see how awarding bonuses will impact your profit margins. From there, you can determine if your business has enough cash flow available to sustain the additional compensation for your workforce.
Tax implications
In addition to affecting your business’s cash flow, employee bonuses could have potential tax implications. Bonuses are supplemental wages, typically including compensation for unused sick or personal time, commissions, and overtime.
As supplemental income, bonuses are subject to income tax withholding and Federal Insurance Contributions Act (FICA) payments. For example, if you awarded your staff a $1,000 bonus, as an employer, you’re responsible for paying 7.65% ($76.50) to each employee’s Social Security and Medicare funds.
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Year-end bonuses come with additional tax deduction complications to be mindful of — specifically whether bonuses paid during the new year are deductible from the tax year your employees earn them or during the new tax year when you make the actual payments.
[Read more: Tax Deductions for Small Businesses]
Company policy on bonuses
Your company bonus policy should outline the eligibility criteria, the bonus payment schedule, and how bonus amounts are calculated. Your policy may also stipulate requirements for other types of bonuses, such as sign-on bonuses, performance bonuses, and annual bonuses.
Communicate your policy with employees, and make it readily available for reference in an employee handbook or on a company intranet resource. This can help manage employee expectations and increase motivation.
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In addition to year-end bonuses, businesses may choose to reward their employees with bonuses at other times.
How to calculate year-end employee bonuses
There are three options for calculating year-end employee bonuses:
Salary percentage bonus
When using the salary percentage structure for calculating bonuses, follow these steps:
- Calculate your employee’s salary.
- Determine the percentage increase you wish to award as a bonus.
- Multiply your employee’s salary by the percentage increase.
For example, if your employee makes $100,000 per year and you wish to award a 5% bonus, you would multiply $100,000 by 0.05 for a total of $5,000.
Sales commission bonus
If your employee’s bonus is based on sales commission, you need to know the total sales amount and the bonus percentage to calculate the total. For example, if your employee made $20,000 in sales and your company offers a 5% commission, here’s how to calculate their bonus: $20,000 x 0.05 = $1,000.
Performance bonus
A performance bonus, similar to a sales commission bonus, is awarded based on individual, team, or overall company performance. The payment can be structured as a percentage of the employee’s salary, a lump sum, or a variable pay plan — which could be a cash payment or some other reward, such as a trip or gift.
Other types of employee bonuses
In addition to year-end bonuses, businesses may choose to reward their employees with bonuses at other times, including:
- A sign-on when starting a new role, typically to attract highly qualified candidates to the position.
- As part of a severance package.
- As a referral bonus for helping onboard new talent.
- To celebrate years of service to a company.
- To celebrate the end-of-year holiday season, although this is more common outside of the United States.
- As options that give the employee a stake in the company.
[Read more: Looking to Give Your Employees Bonuses? Here's What You Need to Know]
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