A young woman sits at a table and looks at an unfolded paper in her hands with a big smile on her face. The table in front of her holds an open laptop, an open envelope, several other papers, and a notebook and pen. The room in the background has neutral gray walls; behind the woman are a three-legged lamp and a shelf holding several potted plants.
Employee bonuses can range from 3–5% of annual pay for support staff to a mid-double-digit percentage of pay for executives. — Getty Images/fizkes

As employees reevaluate workplaces and positions, small businesses must develop innovative ways to engage and retain them. Employee bonuses, also known as variable compensation, can be tied to performance or given as gifts. Indeed, 79% of organizations surveyed by Payscale offered "some form of variable pay" in 2021.

When it comes to employee bonuses, you have several options, including individual, team-based, or company-wide awards. Plus, you can offer them on the spot, at the end of the year, or after workers meet certain objectives. Use these tips to implement bonus pay at your small business.

Explore the types of employee bonuses

An employee bonus is any compensation above a worker's hourly wage or base salary. You have quite a bit of flexibility regarding the timing of the payment, who you give bonuses to, and whether the bonus is percentage-based or a flat feet. Companies may use different bonus strategies depending on their goals and industry.

Employee bonuses can be tied to:

  • Sales goals.
  • Employee or customer referrals.
  • Work anniversaries.
  • Discretionary or on-the-spot gifts.
  • Individual, team, or company performance.
  • Holidays.
  • Business profits.

Your bonus plan can show employees gratitude after a year of service or motivate them to achieve role-related objectives. Alternatively, you can use bonuses based on your business profits to help staff feel personally invested in your organization. And your bonus doesn't need to be cash. Consider employee gift ideas like stock options, gift cards, vacation days, or subscriptions.

[Read more: Tailor-Made Benefits: Keeping Employees Happy Means Customizing Benefits]

Understand the tax implications

IRS Publication 15 provides guidance regarding payroll taxes and bonuses, known as supplemental wages. Variable compensation (cash or otherwise) is an employee benefit, subject to Medicare, Social Security, and FUTA (unemployment) taxes. Bonuses for services rendered count as an expense on your business taxes for the year you paid them out. But there are exceptions—review IRS guidance on de minimis fringe benefits to learn more.

An effective bonus strategy clearly describes the process for giving variable compensation.

You can include the bonus with regular wages or pay it separately. If you put the bonus on an employee's regular paycheck, you withhold taxes based on the total amount. Conversely, you can pay a stand-alone bonus and withhold the 22% supplemental rate. Calculate the bonus yourself, or consider consulting with your accountant or tax advisor to learn how bonuses affect company and employee taxes.

Define your bonus payout structure

According to Investopedia, "A typical payout structure is 3% to 5% of annual salary for clerical and support staff. Managers might receive payments in the low double-digit percentage range, with executives in the mid-double-digit range." However, one-time bonuses could also be a flat rate.

When considering an amount, remember to factor in employee taxes. For instance, if you reward everyone with a $100 bonus paid separately, you'll withhold $22 and cut a $78 check. Fit Small Business provides a thorough guide for calculating and paying taxes on bonuses.

[Read more: Small Business Employee Benefits: Everything You Need to Know]

Put it in writing

An effective bonus strategy clearly describes the process for giving variable compensation. For example, if you're incentivizing your sales team, you may use measurable key performance indicators (KPIs). In contrast, a bonus as a form of profit sharing should define how and when it's calculated. Don't forget to review tax consequences for team members in different income brackets and encourage them to speak to human resources for more information.

Your bonus plan should discuss the following:

  • Employee eligibility: Outline the types of employee (full-time, part-time, or role-related) eligible for bonuses. Also, mention any restrictions, such as needing to be with your company for a certain amount of time.
  • Bonus structure: Describe the payout structure, whether it's a flat rate or a percentage of income. If you use a tiered plan, show how you define the tiers and the rate per tier.
  • Timing: Let your team know when bonuses appear on their paycheck or when you'll cut a separate check. Your method may differ for annual bonuses versus discretionary compensation.
  • Bonus-specific details: Explain why you give an employee bonus and how staff can earn it. Include measurable performance standards or actions that result in a reward.

CO— aims to bring you inspiration from leading respected experts. However, before making any business decision, you should consult a professional who can advise you based on your individual situation.

To stay on top of all the news impacting your small business, go here for all of our latest small business news and updates.

CO—is committed to helping you start, run and grow your small business. Learn more about the benefits of small business membership in the U.S. Chamber of Commerce, here.

A message from
Attract & retain top talent at your business with a 401(k) plan
Offering a retirement plan does more than just prepare you and your employees for a secure financial future – it can also help you attract and retain top talent. Fidelity’s new 401(k) plan designed for small businesses like yours has simple plan choices and fewer administrative burdens, so you can spend less time managing a 401(k) and more time focusing on running your business.
Get Started
Published November 01, 2022