Bonuses can be an excellent tool to incentivize and reward all kinds of employee behavior, from meeting performance goals to referring new workers. However, calculating bonus payouts and tax withholding can be confusing for both employers and employees in the United States. In this guide, we cover the main types of bonuses and explain how to calculate bonus pay and taxes using the 2024 rates.
A bonus is an additional reward offered to employees beyond their regular wages or salary. Most bonuses come in the form of money, though some employers offer non-cash bonuses as well. There are many different types of bonuses; see the next section below for details on the most common bonuses.
Non-discretionary bonuses are outlined in the employment contract. As long as the employee meets the requirements, the employer must give them the bonus.
Discretionary bonuses are not outlined in the employment contract, and thus are given at the discretion of the employer. Discretionary bonuses give employers more leeway over how often to offer bonuses and how much money to give employees.
Sign-on bonuses, which are one of the most common types of bonuses, are given when a new employee signs their employment contract. These bonuses often function as a recruiting tool and are meant to incentivize candidates to accept the job offer. Sign-on bonuses may be paid out in one lump sum at the start of employment, or spread across paychecks for the first year of work.
Milestone bonuses are essentially performance bonuses. They are given out when employees or teams hit certain performance goals or metrics, AKA “milestones.”
An annual bonus is given to employees at the end of a fiscal year. Annual bonuses may be guaranteed, meaning that they will be given no matter how well or poorly the company has performed in the past year. These bonuses may also be conditional upon the company hitting certain revenue or profit benchmarks.
Retention bonuses are offered to incentivize key employees to stay with the company for a set amount of time; they might be offered during a specific event, such as a merger, acquisition or other organizational changes. Retention bonuses may also be offered to employees in high-demand, difficult-to-replace roles who are more likely to be poached by a competitor.
Referral bonuses are given out when a company hires a new employee who was referred by a current worker. Some companies offer a variable referral bonus, giving out larger payouts for highly competitive, in-demand jobs. Other businesses offer a flat rate referral bonus that doesn’t vary depending on which job is filled.
Holiday bonuses are usually given at the end of the calendar year, around the winter holidays. Instead of being tied to performance like so many other bonuses including annual bonuses, holiday bonuses are a sign of gratitude from the company for the employees’ hard work. Holiday bonuses are typically calculated as a certain percentage of each employee’s annual salary.
A spot bonus is a typically small cash bonus often in the form of a gift card given to employees “on the spot.” Some popular occasions for spot bonuses include celebrating employee birthdays and rewarding excellent customer service.
As the name suggests, non-cash bonuses don’t involve money; examples of non-cash bonuses include extra paid time off and employee parking spots.
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Bonus pay is typically calculated as a percentage of the base salary or gross wages. For instance, if an employee makes $100,000 a year and receives a 20% performance bonus, their bonus would be $100,000 x 20% = $20,000. If an employee makes $60,000 a year and receives a 5% holiday bonus, their bonus would be $60,000 x 5% = $3,000.
Some bonuses are offered as a flat rate and don’t require any kind of calculations to be made; for example, some companies offer a $500 referral bonus for new hires across the board. Double check your company’s bonus policy to see if bonuses will be a percentage or a flat rate.
There are two ways that bonuses may be income taxed in the United States: the percentage method and the aggregate method.
With the most straightforward method, the percentage method, the employer will treat a bonus as separate from the employee’s regular wages. All bonuses under $1 million will be taxed at a 22% rate, and all bonuses over $1 million will be taxed at a 37% rate. These bonus payments are often made outside of the regular payroll cycle. Payroll software such as Rippling makes it easy for administrators to process bonus payouts at any time, and it doesn’t charge extra for additional runs — a must-have feature if your company plans to make a lot of off-cycle bonus payments.
The second way, the aggregate method, is a little more complex. With this method, the employer adds the bonus to the paycheck and pays the employee in one lump sum according to the regular payroll schedule, without specifying the separate amounts. Because the bonus isn’t separated out as supplemental income, the federal government treats it like regular income and taxes it at whatever income bracket tax rate it falls into.
If you have a bonus payment coming up and are curious how much income tax will be withheld through either method, then you can use this free bonus tax calculator from TurboTax to see what the difference would be.
Bonuses are also subject to additional payroll taxes withholding, including Social Security, Medicare and FUTA (federal unemployment taxes). Additional taxes may be withheld for state income taxes or local taxes. Employers often err on the side of caution when withholding taxes from bonuses, so employees may get a refund after they file their taxes.
Fortunately, there are a couple things that employees can do to minimize the payroll tax impact of a bonus. First of all, they can contribute to their 401(k) or IRA. If they expect to take a pay cut in the next tax year, they can also ask their employee to defer the bonus payment until the following year so it will be taxed at the appropriate rate.
