Some employers use bonuses to reward and recognize high performers, especially during the holiday season. If you award bonuses, here are some overtime and tax rules to consider:
Under the federal Fair Labor Standards Act (FLSA), non-exempt employees must receive one and a half times their “regular rate of pay” for all hours worked over 40 in a workweek (“overtime”). Some states require overtime in additional circumstances. When calculating an employee’s regular rate of pay, employers must include nondiscretionary bonuses.
What is a Nondiscretionary Bonus?
A nondiscretionary bonus is announced to employees in advance typically to encourage them to work more efficiently and/or to remain with the company. With this type of bonus, employees expect that if they meet certain criteria (such as attendance or productivity targets), they will get a bonus. Examples include bonuses for meeting set production goals, retention bonuses, and commission payments based on a fixed formula. Most bonuses are considered nondiscretionary. By contrast, discretionary bonuses aren’t announced or promised in advance (and do not need to be included when calculating overtime). For example, if you decide at the end of the year to surprise employees with a bonus, this would generally be considered a discretionary bonus.
How to Calculate Overtime with a Nondiscretionary Bonus:
If the nondiscretionary bonus is earned over a single workweek: Add the bonus to the employee’s regular earnings when determining the regular rate of pay for that week.
Example: A non-exempt employee is paid $10 per hour, works 50 hours, and receives a $100 nondiscretionary productivity bonus for that week. To calculate overtime:
Step 1: Calculate total straight-time. ($10 hourly rate x 50 hours worked) + $100 bonus = $600
Step 2: Calculate regular rate of pay. $600 straight-time pay divided by 50 hours worked = $12
Step 3: Calculate overtime premium pay. $12 regular rate of pay x .5 x 10 overtime hours = $60
Note: Since the straight-time earnings have already been calculated for all hours worked (see Step 1), the employee is entitled to an additional 10 hours of overtime pay, calculated at one-half the regular rate of pay.
Step 4: Calculate total compensation for week. $60 overtime pay + $600 straight-time pay = $660
If the bonus is earned over a series of workweeks: Include the bonus in the regular rate of pay in all overtime weeks covered by the bonus period. If necessary, you may temporarily disregard the bonus in computing the regular hourly rate until you know the bonus amount. Then, apportion it back over the workweeks of the period during which the employee earned the bonus.
Example: If an employee receives a $2,600 bonus for meeting certain annual goals, divide $2,600 by 52 weeks ($50/week). Add the $50 to the employee’s regular earnings in each workweek the employee worked overtime to figure out the employee’s regular rate of pay and overtime due for that week. For any workweek in which the employee worked overtime, you would then need to make catchup payments for the difference between what you paid the employee in overtime at the time and what the employee is entitled to now that the bonus is known.
Bonuses are generally considered supplemental wages and are subject to federal taxes as well as certain state taxes. For federal taxes, bonuses up to $1 million are typically taxed at a flat rate of 25 percent (a higher percentage for amounts over $1 million). Keep in mind that many types of bonuses are considered taxable by the IRS. For example, cash, a gift certificate, gift card, and similar items that can easily be exchanged for cash are typically considered taxable wages, regardless of the amount (see IRS Publication 15-B). However, if an employer gives a turkey, ham, or other item of nominal value for the holidays, it is generally not considered income.
Bonuses can be an effective and efficient way to drive productivity and employee engagement. If you administer bonuses, ensure that your bonus program complies with all applicable federal, state, and local rules.