It's always a good idea to give your hardworking employees holiday gifts and bonuses. In fact, in a global study by the ADP Research Institute, one-off bonuses — like holiday or merit bonuses — were found to be the highest-ranked reward to employees in multiple countries if they didn't receive a pay raise. So while holiday bonuses are clearly valuable to workers, employers must be mindful that these financial offerings can have overtime and tax implications as well as create conflicts of interest. If you decide to give your employees bonuses and gifts this season, review these guidelines to help ensure your holiday giving is compliant.
Types of bonuses
Bonuses can usually be separated into two types: discretionary and nondiscretionary. Think of a discretionary bonus as an award an employer gives on a case-by-case basis to recognize achievement — the employee receiving a discretionary bonus didn't have to meet any type of quota or condition to receive it. On the other hand, non-discretionary bonuses are awarded to an employee based on meeting a particular quota or condition — the employee receiving a non-discretionary bonus did have to meet a quota or condition to receive the bonus.
Non-discretionary bonuses are usually announced well in advance to encourage greater work efficiency or retention. Discretionary bonuses, like holiday bonuses, are the kind many employers give out to employees a kind of surprise gift.
When calculating overtime under the Fair Labor Standards Act (FLSA), employers need to remember that nonexempt (usually hourly) employees must receive overtime for all hours worked over 40 in a workweek, and nondiscretionary bonuses must generally be included in a nonexempt employee's regular rate of pay. This means that nondiscretionary bonuses are added to the total amount of earnings for that period, and then total amount of earnings is then divided out over the total amount of hours worked to get a new regular rate of pay (RROP). The new RROP is used to recalculate wages owed for overtime during that period.
Related holiday bonus reading: What is the difference between overtime, holiday and regular pay?
What if a nondiscretionary bonus is earned over a single workweek?
In this scenario, you should add the bonus to the employee's regular earnings for that week and make sure you or your payroll platform recalculate the amount owed for any overtime hours worked by the employee. You can use a payroll calculator to recalculate wages owed for overtime if necessary, but your payroll platform will likely do this automatically. It's still a good idea to understand how overtime recalculations are made just in case you need to check for accuracy.
How to recalculate pay after a nondiscretionary bonus is paid
If an employee works a 40-hour week at a rate of $25 per hour, receives a $250 discretionary bonus, and worked three hours of overtime that week, the amount of pay owed for the three overtime increases based on the nondiscretionary bonus.
In that 40-hour pay period paid at $25 per hour, the employee earned $1000 for regular hours, and $112.50 for three overtime hours ($25 x 1.5 = $37.50 OT rate). So, the employee was already paid $1112.50 for that pay period. To calculate what additional wages are owed for the overtime, divide the total bonus ($250) by the number of hours worked in the period (43) to get the hourly increase: $250.00 / 43 = $5.82. Then multiply the total number of overtime hours worked in the pay period by one-half of the hourly increase. One half the hourly increase = $5.82 / 2 = $2.91. So the additional pay owed to the employee for the three hours of overtime is 3 hours x $2.29 = $8.73.
What if the bonus is earned over a series of workweeks?
In this case, you should include the bonus in the regular rate of pay for all overtime weeks covered by the bonus. For example, if an employee receives a $2,600 annual bonus, you should divide the amount by 52 weeks, resulting in a weekly amount of $50. Then, add the $50 to the employee's regular earnings in each workweek the employee worked overtime. Then divide the total bonus for that week by the number of hours worked in that week to get the hourly increase. Once you have the hourly increase, multiply it by .5 to get the additional amount owed per overtime hour. Then multiple the additional amount owed per overtime hour by the total amount of overtime hours that week. Do this for each week overtime was worked and add the amounts together to get the total owed for all overtime weeks throughout the year.
Most payroll systems will automatically calculate this increased rate of overtime based on the new RROP when a nondiscretionary bonus is paid out through the system, but it's still a good thing to be aware of so you can check to make sure it's correct, helping ensure you won't be liable for underpaying employers and violating FLSA.
Taxes and payroll
Bonuses are supplemental wages so they are subject to federal and state taxes. For federal tax purposes, bonuses up to $1 million are taxed at a flat rate of 25 percent.
Many types of bonuses — such as gift cards and gift certificates — are considered taxable by the IRS if they can be easily exchanged for cash. However, holiday turkeys or other items of nominal value are generally not considered income.
Conflicts of interest
Vendors may give your employees gifts, and employees may want to do the same for their clients. However, since gifts can raise concerns about conflicts of interest, you should prepare written guidelines about giving and receiving gifts. Set a nominal value on acceptable gifts. Also, if you work with foreign officials, you may be subject to anti-bribery laws. Make sure your employees know your policies and are trained to comply.
1. Review your budget
Determine if your business has the necessary funds to pay holiday bonuses and how much you can afford to put toward these gifts. Remember, bonuses don't have to be extravagant: Gift cards or an extra paid day off are great ways to show appreciation.
2. Set clear criteria to determine bonus eligibility
You may want to determine bonus eligibility using certain criteria, for example, seniority or performance throughout the year. Just be sure to communicate bonus criteria and apply it consistently.
3. Manage employee expectations
Make sure you communicate to employees that a holiday bonus is awarded at the company's discretion and is not an entitlement.
Holiday gifts and bonuses are a powerful way for you to show how much you appreciate your employees and the hard work they put in throughout the year. Following these guidelines can help you stay compliant and avoid any conflicts of interest as you show your appreciation.
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