Bonuses can be a great tool to incentivize and reward all kinds of employee behavior, from meeting performance goals to referring new workers. However, calculating bonus payments and tax withholdings can be confusing for both employers and employees in the United States. In this guide, we cover the main types of bonuses and explain how to calculate bonus payments and taxes using 2024 rates.
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What is a bond?
A bonus is an additional reward offered to employees on top of their regular salary or wages. Most bonuses are given in the form of money, although some employers also offer non-cash bonuses. There are many different types of bonuses; see the next section for details on the most common bonuses.
Types of bonuses you can give to employees
Non-discretionary bonus
Non-discretionary bonuses are described in the employment contract. As long as the employee meets the requirements, the employer must grant the bonus.
Discretionary bonus
Discretionary bonuses are not described in the employment contract and are therefore awarded at the discretion of the employer. Discretionary bonuses give employers more freedom over how often to offer bonuses and how much money to give to employees.
Sign-in bonus
Signing bonuses, which are one of the most common types of bonuses, are given when a new employee signs their employment contract. These bonuses often function as a recruiting tool and are intended to incentivize candidates to accept the job offer. Signing bonuses can be paid in a lump sum at the start of employment or spread out in paychecks during the first year of employment.
Milestone bonus
Milestone bonuses are essentially performance bonuses. They are awarded when employees or teams reach certain performance goals or metrics, also known as “milestones.”
Annual bonus
An annual bonus is given to employees at the end of a fiscal year. Annual bonuses can be guaranteed, meaning they will be awarded no matter how good or bad the company's performance has been over the past year. These bonuses may also be conditional on the company meeting certain revenue or profit benchmarks.
Retention bonus
Retention bonuses are offered to incentivize key employees to stay with the company for a set period of time; they could be offered during a specific event, such as a merger, acquisition, or other organizational changes. Retention bonuses may also be offered to employees in high-demand, hard-to-replace roles that are more likely to be snapped up by a competitor.
Referral Bonus
Referral bonuses are awarded when a company hires a new employee who is referred by a current employee. Some companies offer a variable referral bonus and award higher payouts for highly competitive and in-demand jobs. Other companies offer a flat-rate referral bonus that does not vary based on the job being filled.
Vacation bonus
Vacation bonuses are typically awarded at the end of the calendar year, around the winter break. Rather than being tied to performance like so many other bonuses, including annual bonuses, vacation bonuses are a sign of gratitude from the company for employees' hard work. Vacation bonuses are typically calculated as a set percentage of each employee's annual salary.
Cash bonus
A cash bonus is a typically small cash bonus that often comes in the form of a gift card that is given to employees “on the spot.” Some popular occasions for earning cash bonuses include celebrating employee birthdays and rewarding excellent customer service.
Non-cash bonus
As the name suggests, non-monetary bonuses do not involve money; examples of non-monetary bonuses include extra paid time off and employee parking spaces.
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How to calculate bonus payment
Bonus pay is usually calculated as a percentage of base salary or gross salary. For example, if an employee earns $100,000 per year and receives a 20% performance bonus, his bonus would be $100,000 x 20% = $20,000. If an employee earns $60,000 per year and receives a 5% vacation bonus, his bonus would be $60,000 x 5% = $3,000.
Some bonuses are offered as a flat fee and do not require any sort of calculation; for example, some companies offer a $500 referral bonus for new employees across the board. Double-check your company's bonus policy to see if bonuses will be a percentage or a flat fee.
How are bonuses taxed?
There are two ways bonuses can be subject to income taxes in the United States: the percentage method and the aggregate method.
With the simplest method, the percentage method, the employer will treat the bonus as separate from the employee's regular salary. All bonds under $1 million will be taxed at a rate of 22%, and all bonds over $1 million will be taxed at a rate of 37%. These bonus payments are often made outside of the regular payroll cycle. Payroll software like Rippling makes it easy for managers to process bonus payments at any time and doesn't charge extra for additional runs, a must-have feature if your company plans to make a lot of off-cycle bonus payments.
The second method, the aggregate method, is a little more complex. With this method, the employer adds the bonus to the salary and pays the employee in a lump sum according to the regular payroll schedule, without specifying the amounts separately. Because the bonus is not set aside as supplemental income, the federal government treats it as regular income and taxes it at the tax rate for your current income bracket.
If you have an upcoming bonus payment and are curious about how much income tax will be withheld through either method, you can use this free bonus tax calculator from TurboTax to see what the difference would be.
Bonuses are also subject to additional withholding for payroll taxes, including Social Security, Medicare, and FUTA (federal unemployment taxes). Additional taxes may be withheld for state income taxes or local taxes. Employers often err on the side of caution when withholding taxes from bonuses, so employees may get a refund after filing their taxes.
How to minimize the tax impact of a bonus
Fortunately, there are a couple of things employees can do to minimize the impact of a bonus on payroll taxes. First, they can contribute to their 401(k) or IRA. If they expect to take a pay cut in the next tax year, they can also ask their employee to postpone the bonus payment until the following year so that it is taxed at the appropriate rate.
