Your employees are your biggest asset. And, like any good investment, you want to keep them happy and motivated. Enter the discretionary bonus.
It's a way for you to legally reward your employees for their hard work and dedication to the company. But, before you start handing out money and calling it a bonus, you should know a few things about this type of compensation.
Discretionary Bonus Definition
A discretionary bonus is extra money given to your employees as a complete surprise. Unlike a regular bonus, which your employees might earn by meeting or exceeding sales targets or hitting a specific production quota, a discretionary bonus is paid at the employer’s whim.
This means there's no set system for awarding this type of bonus. For instance, you might surprise an employee with a special bonus if they overcame an on-the-job challenge or to celebrate the holidays.
No matter what you call this money, you don’t have to count it toward your employee’s overtime pay rate (if they’re non-exempt, as only non-exempt employees can receive overtime pay) and the government has strict guidelines about them.
To help you get your ducks in a row when gifting extra cash, let's look at those rules more closely.
Discretionary Bonus Requirements by Law
A bonus has to meet these guidelines to be considered discretionary:
- The employer determines whether or not they're going to give a bonus—and the amount of the bonus.
- The bonus isn’t announced beforehand.
- The bonus isn’t listed in the employee’s contract or other agreements. That includes doing or saying anything that would make employees think the bonus will be a regular addition to their pay.
If all these points aren’t met, then it isn’t a discretionary bonus. In that case, it’s considered a non-discretionary bonus according to the Fair Labor Standards Act. As such, it’s included as part of your employee’s regular rate of pay and in overtime pay calculations. That can be a lot of work if you aren’t using a streamlined payroll system like Hourly.
Hourly also makes sure you’re using the right rate of pay to calculate workers’ compensation premiums. In some states, such as California, all bonuses count towards that premium calculation, including discretionary bonuses. In others, such as Tennessee, you don’t add bonuses into workers’ comp wages.
Since all of this is a bit of a hassle (and requires employers to pay a higher rate of pay for overtime), some business owners try to disguise non-discretionary bonuses as discretionary ones. But, the government usually catches on and you’ll get slapped with a bunch of fees, back pay, and other negative effects, so it’s not a risk you should take.
Are Discretionary Bonuses Taxable?
Yes. The bonus money you give your employee is taxable. They need to report it on their taxes and pay the higher bonus tax rate on the extra money.
Discretionary Bonus Examples
Here are some situations where a discretionary bonus might be appropriate:
- Your team overcame a challenging or stressful situation with flying colors.
- An employee went above and beyond their job description.
- It’s the end of the year—and you want to surprise your team with a year-end holiday bonus.
- A couple of employees who aren’t involved in the recruiting side of your company each refer a stellar candidate, and you give them referral bonuses.
- You award a severance bonus that’s not part of the employee contract.
Of course, this isn’t an all-inclusive list. Other legitimate reasons exist. Just be careful when deciding whether something qualifies as a discretionary bonus to avoid misclassifying these funds.
Discretionary Bonuses vs. Non-Discretionary Bonuses
Now you know what a discretionary bonus is. But as mentioned earlier, there's also a non-discretionary bonus.
This type of bonus is given in addition to the employee's regular wages and is usually tied to an employee’s performance. For example, you might award a non-discretionary bonus each time your team meets its sales goals. Commissions and tips also fall under this category since they’re a regular part of the employee’s pay.
If you have any agreement in place about the money, it's no longer given at the sole discretion of the employer. A written or verbal guarantee means it’s an expected bonus, not unexpected—therefore, the bonus would be considered non-discretionary.
So if you tell your employees in March that you're on track for a great year—and if they keep it up, they'll get big rewards in December—guess what? You just spoiled the surprise! And as a result, such bonuses are no longer discretionary.
Similarly, if your employee paperwork mentions a specific bonus, it can’t be discretionary. Any bonuses listed in a collective bargaining agreement, an employment contract, or in other agreements are non-discretionary.
Examples of Non-Discretionary Bonuses
To further clarify, here are some specific examples of non-discretionary bonuses:
- Individual or group production bonuses based on performance goals
- Bonuses for accuracy of work or quality
- Attendance bonuses
- Hiring bonuses
- Safety bonuses
- An expected annual bonus
How to Calculate a Discretionary Bonus
If you want to reward your employees with this type of bonus, you'll need to decide how much to give. You also need to make sure that you don't accidentally violate labor laws in the process.
Here are a few tips for calculating and distributing this type of bonus:
1. Determine How Much Money You Have to Work With
The first step is to figure out how much money you can reasonably afford to give out in bonuses. This will help you avoid overspending and putting your business in financial jeopardy.
A simple way to calculate the amount of everyone's bonus is to take the total number of funds available and divide it by the number of employees you have.
2. Consider the Company's Performance
When deciding how much to give, think about how well the company performed overall. If you had a banner year, you might be able to give out larger bonuses than usual. But if profits were down, you'll need to be more conservative.
3. Avoid Violating Labor Laws
When distributing bonuses, be careful not to violate any labor laws. For example, you can't give out bonuses that are based on illegal criteria like race, religion, or gender.
4. Consider One of These Calculation Methods
If you prefer a more formal approach, there are a few different ways to calculate discretionary bonuses. Here are three of the most common:
- The percentage method: With this method, you multiply an employee's wages by a certain percentage. For example, you could give each employee a bonus that's equal to 5% of their annual salary.
- Percentage of sales: With this method, you calculate bonuses as a certain percentage of total sales. For example, you could give each employee a bonus that's equal to 0.5% of the company's total sales for the year.
- A set amount per sale: With this method, you give each employee a set amount of money for every sale they make. For example, you could give each employee a $50 bonus for every sale they bring in or simply divide the amount of money you want to give by the number of sales made by the employee.
No matter how you choose to calculate bonuses, make sure you're consistent. You don't want to make it look like you’re playing favorites. So whether you pick one of the systems above or come up with one on your own, adhere to your plan. That way, your personal feelings about your team members don’t come into play.
Make Sure to Record Your Bonuses
The best way to avoid any legal issues is to keep track of why you gave each employee the bonus you did. That way, if anyone comes back and says they didn’t get a bonus just because you didn’t like them, you’ll have documentation to refer to that explains why you awarded the bonuses you did.
Discretionary Bonus Checklist
Again, there are a lot of rules about these types of bonuses. If you’re unsure whether a bonus you plan to give an employee would fall under the discretionary bonus umbrella, here’s a quick checklist to help you determine if it meets the criteria:
- Is the bonus a surprise?
- Was it given to recognize exceptional performance?
- Was it given at your discretion and not tied to specific eligibility criteria?
- Are you the only person determining the bonus amount?
- Have you made no prior contract or agreement with your employees about the bonus?
If you can’t answer yes to all of these questions, it doesn’t legally qualify as a discretionary bonus.
If you still aren’t sure if the money you’re giving is discretionary or not, speak to a professional accountant or lawyer who’s familiar with your company and the FLSA rules. They can accurately classify your bonuses so you don’t break any laws—and can save you the time, money, and hassle of having to deal with a misclassification down the road.
Is It Discretionary? Common Scenarios to Help You Figure It out
As you can imagine, discretionary bonuses are a bit of a gray area. To help you wade through the differences, see if you can determine whether the following scenarios qualify as discretionary or non-discretionary bonuses.
You give your employees $100 bonus payments at the end of each workweek to "boost morale" and encourage employee retention.
Is this discretionary?
No. Since the retention bonus is given regularly and isn’t a surprise, you need to count this money towards your employees' regular gross pay and calculate it in your workers’ comp premiums and overtime pay.
The holidays are coming! Reviewing financial records, you realize that the company performed well this year. So naturally, you want to share the wealth, giving each employee a surprise $500 holiday bonus.
Is this discretionary?
Yes, since it's a surprise and not tied to any specific criteria your staff knew about in advance.
Your graphic designer is getting married next month. You want to help make it extra special, so you give her a $1,000 bonus to put towards her dream event.
Is this discretionary?
Yes. Money given as gifts on holidays, weddings, or other special occasions may be excluded from the regular payment—as long as you don't tie the amount of money you give to the number of hours worked or the employee's productivity.
You've noticed some attendance problems lately, so you give your employees a $100 bonus every week they don't miss any hours.
Is this discretionary?
No. Your employees have to earn an attendance bonus by showing up to work. It’s not given at your discretion since they know what they have to do to get this money.
You decide to start offering group performance bonuses where every time the team reaches its production goal, everyone gets a $50 bonus. You also throw in a few other ways for individual employees to earn more based on their specific performance during each bonus period.
Is this discretionary?
Nope. Your team knew about it in advance, and the cash is clearly tied to specific factors in your incentive pay plan.
Show Your Employees You Care
Discretionary bonuses are a great way to show your employees how much you appreciate their hard work. You just want to make sure you're classifying them correctly!
Otherwise, you’ll be miscalculating your employee wages, which can really impact overtime pay and workers’ compensation premiums—and could get you in legal trouble.