In December, many employers reward employees with cash bonuses. Bonuses can be great motivators when they are designed to reward employees who meet or exceed their performance goals. Year-end bonuses also contribute to the holiday atmosphere of generosity and gratitude.
But did you know that year-end bonus payments can pose traps for the unwary employer?
We recommend that employers pause before paying those bonuses to make sure they are in compliance with taxation, overtime and retirement plan rules and regulations.
As a reminder, bonuses are taxable or "supplemental" wages, subject to federal and state income tax withholding, Social Security and Medicare taxes.
For federal income tax withholding, if the bonus is combined with regular wages and the employer doesn’t specify the amount of the bonus, the employer withholds federal income tax as if the total payment is a single regular wage payment and uses the normal IRS withholding tables to calculate the amount to withhold.
If the bonus is paid separately (or paid with regular wages but separately specified), the IRS gives employers two choices in how to handle federal income tax withholding (for bonuses less than $1 million):
Most states take a similar approach to state income tax withholding, but employers should check with their state’s tax authorities to confirm the proper treatment of bonuses.
If the bonuses you pay to non-exempt (hourly) employees are “nondiscretionary,” the bonuses can require additional overtime “true-up” payments. Nondiscretionary bonuses are promised to employees to induce them to work more efficiently or to remain with the organization. Examples include:
The U.S. Department of Labor considers most bonus payments “nondiscretionary,” which means that most bonus payments paid to non-exempt employees will affect overtime. Assuming the bonus payments cover more than one pay period, the bonus must be allocated over the periods of time for which it’s payable, and then included in the regular rate for those periods in which overtime was worked. The overtime amount due must be recalculated, and an additional overtime “true-up” payment must be paid.
Discretionary bonuses do not affect overtime calculations, but for a bonus to be considered discretionary, the payment and amount of the bonuses must be at the employer’s sole discretion, and that discretion must be exercised close to the end of the period for which the bonus is paid. A discretionary bonus isn’t paid in accordance with a contract, agreement, announcement or promise that causes employees to expect the payment regularly. For example, if an employer tells employees in June that it intends to pay a bonus in December, the bonus is nondiscretionary. Also, merely telling employees that the employer may refuse to pay a bonus is not sufficient to make the bonus discretionary if, in fact, the employer does not often refuse to pay the bonus.
For employers who moved employees to non-exempt in anticipation of the overtime rules going into effect December 1 (currently pending appeal), it is particularly essential for those employers to understand how their bonus payments can impact their overtime obligations.
The IRS has found that many employers make mistakes when they take (or don’t take) 401(k) contributions from bonus payments, and when they take (or don’t take) the bonuses into account when calculating matching and profit-sharing contributions. Fortunately, you can prevent these mistakes by knowing what your organization’s plan document says about bonuses, and then treating those bonuses correctly for 401(k) plan purposes.
When your organization established its 401(k) plan, it made decisions about which types of compensation should be used when calculating salary deferrals, matching contributions and profit-sharing contributions. Those decisions were documented in the adoption agreement for your 401(k) plan or in the plan document itself if your organization has an “individually designed” plan.
Your organization may have decided to include bonuses in compensation for 401(k) contribution purposes, or it might have decided to exclude them. In addition, your organization may have decided to allow employees to make separate 401(k) elections for bonus payments. If it did so, employees may elect to defer more or less from their bonuses than their regular election would allow them to defer.
As your organization approaches bonus calculation and payment season, your payroll and benefits departments should have a clear understanding of what your 401(k) plan says about bonuses. This can prevent mistaken contributions, which are always time-consuming (and sometimes costly) to fix.
You know what they say: “An ounce of prevention is worth a pound of cure!” We recommend that employers review the compliance obligations associated with bonus payments before they pay bonuses, rather than after.
Sarah provides employer-focused guidance on human resource matters. With an emphasis on employee benefits and the Affordable Care Act, she distils the complexity of employment laws into understandable action items that meet a client’s business goals.
Sarah provides employer-focused guidance on human resource matters. With an emphasis on employee benefits and the Affordable Care Act, she distils the complexity of employment laws into understandable action items that meet a client’s business goals. During previous private practice experience, Sarah handled numerous complex benefit matters, including the transition of benefit plans in large corporate acquisitions, de-risking solutions in pension plans, contested health plan claims, DOL and IRS audits and the implementation of ACA-compliant health plan solutions. Sarah graduated from University of Wisconsin Law School, with a Bachelor of Arts degree from Grinnell College.
A recent survey by the Society for Human Resources Management (SHRM) reported 94% of leaders feel employee engagement is an important or very important workforce challenge. An engaged workforce increases operational income by over 19%, while a disengaged workforce can drain over 34% of an organizations’ operational income. Additional risks of low engagement can be seen in increased turnover, low customer satisfaction ratings and even increased employment litigation.
During the White House’s Summit on Working Families on June 24, 2014, President Obama indicated he was signing a presidential memorandum requiring every federal agency to address flexible work schedules and give employees the right to request such schedules. Absent what could be a dramatic increase in workplace flexibility for federal employees, it is undeniable that the demand for flexibility and work-life balance is on the rise.
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