Posted by The TaxAdvocate Group, LLC

Tax Implications of Year-End Bonuses

Tax Implications of Year-End Bonuses

According to the Washington Post, many employers pay workplace bonuses instead of pay raise. Bonuses are easier to stop than a steady increase in pay and have an immediate positive impact on workers. Employee bonuses are great incentives for workers, but be sure to first consider the tax implications to your company and your employees before you even offer them.

How Bonuses are Paid

Just to be clear, for some special purpose, a bonus is a special one-time or annual payment to an employee. The bonus is an additional payment in excess of the year's salary or hourly pay rate. You can choose who gets a bonus, the amount of a bonus, and when it is given. You may place a bonus in the regular paycheck of an employee, but for extra effect, offering a separate check is also good.

Incentives, such as sales incentives for salespeople, can be contingent, or they can be for achievement awards. Another form of incentive is a special holiday bonus for a group of employees who have achieved a specific goal of sales or production or overall annual profitability.

Deduction of Compensation for Jobs as a Business Expense

If you've got some cash and expect to make a profit this year, then it is indeed the perfect time to give bonuses to your employees. You also get a lot of goodwill from workers, especially around the holidays, in addition to receiving a tax deduction for these benefit expenses.

Announce the bonus as a one-time event, so your employees won't expect to receive bonuses every year. It's funny how people come to expect it again when you do something once. Others see it as a job right when you do it twice, not just a luxury.

Bonuses are deductible business expenses in the "payments to employees" category. If you give bonuses to some employees and not to the others, make sure that you have a clear rationale for that difference. For example, you might want to offer performance-related incentives, which are linked to evaluations. Susan Heathfield, Human Resources Expert, has an excellent article on granting employee incentives to help you think about this method carefully.

Employee / Owner Rewards

Employee/ owner incentives are a legitimate business expense and under certain circumstances can be deducted. For example:

S Corporations can deduct bonuses for shareholders and owners as long as at the time the bonus is paid, they own their shares.

Those shareholders/ owners who have a 50 percent or higher stake at the time the bonus is paid can be withheld by C Corporations.

Bonuses are not considered deductible costs for single ownerships, partnerships and Limited Liability Companies (LLCs) because the IRS considers owners/ partners/ members to be self-employed. It is a situation in which more tax deductions will arise from running a company and at the same time being an employee of your own company.

Bonuses for Employees as a Taxable Income

Employee bonuses as an employee benefit are always taxable. Federal and state income taxes and FICA (Social Security and Medicare) contributions must be withheld. Benefit payments may also be included in the calculation of unemployment taxes, full social security, and extra Medicare tax.

Bonuses and Overtime

Incentives may be discretionary (at the employer's discretion) or non-discretionary. Knowing the difference is crucial, as non-discretionary incentives may need to be included in the measurement of overtime pay.

When not anticipated, a bonus is discretionary. It is discretionary if you give a performance bonus to an employee at the end of a year, and you don't give it every year. The only exception is that the IRS states that even if they are offered every year, holiday bonuses can be discretionary.

Non-discretionary bonuses are those levied on the employer through a union contract, employment contract, or as an incentive that workers receive (except for the above-noted holiday bonus). 

In addition to weekly gross pay, non-discretionary bonuses must be added for overtime purposes for hourly employees and for exempt employees eligible for overtime. Let's say the pay for the week for an employee, including the non-discretionary bonus, is $650, and the employee's overtime worked 3 hours. The daily rate of pay for the employee is $15.11. The bonus for overtime is 50% or $7.56 an hour. The gross overtime bonus for the three overtime hours is $22.67, which for a total of $672.67 is added to the regular pay. Further guidance on how to determine incentives and overtime is available from the Labor Department.

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