According to Bank of America’s Fall 2017 Small Business Owner Report, 35%of small businesses plan to offer year-end bonuses. These bonuses are an important way to retain good employees, especially during this increasingly tight job market. The size of these bonuses varies by industry and company, as well as the way they are figured (tied to performance or a flat amount) and when they are paid to employees (this year or next). Here are 5 things to know about year-end bonuses.
1. Be fair, be clear
Unless an employee has an employment agreement spelling out any required bonus, it’s within the company’s discretion to give a year-end bonus. These holiday-time rewards are an expression of gratitude by the employer for a job well done. Companies want employees to be happy about receiving bonuses and not grumble that payments to some workers are unfair. Consider:
- Giving all employees the same type of bonus (e.g., a week’s wages).
- Fixing bonuses to performance. Be sure that employees understand how this works.
- Paying bonuses based on longevity with the company (e.g., a dollar amount per year of employment).
2. Pay what you can afford
Not every small business is giving bonuses this year. But with profits up for many companies, it may be easier this year than in recent years to give bonuses. Because bonuses are discretionary, companies don’t have to put themselves in the red just to be generous at holiday time. But with that said, don’t overlook the real cost of giving. In addition to the gross amount of the bonus, don’t ignore:
- Employer’s payroll taxes. Depending on what the total payments to the employee for the year have been, the employer share of FICA can be 7.65% of the bonus amount (e.g., $765 on a $10,000 bonus).
- Employee benefits keyed to compensation (e.g., employer contributions to a company’s qualified retirement plan)
3. Factor in payroll taxes
Bonuses are taxable compensation subject to income tax withholding and FICA. They’re treated as supplemental wages. This means employers can:
- Lump the bonuses in with regular pay and figure withholding in the usual way
- Withhold at a flat 25% (no other rate is allowed). However, for bonuses over $1 million (not likely in a small business), the flat withholding rate is 39.6%.
The rules for payroll taxes on bonuses are in IRS Publication 15.
4. Withholding for the additional Medicare tax
If a year-end bonus puts taxable compensation to an employee over $200,000, the employer must withhold for the 0.9% additional Medicare tax on earned income. This is so regardless of the employee’s marital status or whether he or she will ultimately owe this tax when the income tax return for 2017 is filed.
5. Declare now, pay later?
Calendar-year companies that are on the accrual method of accounting can declare year-end bonuses by December 31 and pay them later. As long as bonuses to rank-and-file employees are paid by March 15, 2018, they’re deductible on the 2017 return. But bonuses to owner-employees have different rules. For S corporations, bonuses aren’t deductible in most cases until actually paid (i.e., when owners have to include the bonuses in their income).
Are you a Santa or a Grinch? At this time of the year, small business owners can show appreciation and generosity to their staff in ways other than bonuses. Consider giving employees time off, closing the office, increasing compensation for the coming year, or any other tangible or intangible benefit you can offer at holiday time. A big, genuine thank you is always welcome.