As the year comes to a close, it is important to consider employee compensation and how much each employee has earned over the year. While some employers do not offer bonuses for varying reasons, it is important for any business, regardless of employee size, to recognize the potential to reward high-performing employees.
Whether employers have existing compensation plans or are interested in creating new ones, it is important to know the basics of year-end bonuses and how they integrate with your existing payroll processes.
What is a Year-End Bonus?
A year-end bonus is exactly what it suggests: a monetary bonus delivered to the employee at the end of the year in addition to regular wages or salaries.
Types of Year-End Bonuses
Year-end bonuses may take on many forms and may be centered around a variety of different goals to be achieved across the workforce. However, particular types of bonuses fall into two primary categories.
Year-End Discretionary Bonus
The key distinction of a discretionary bonus is that the amount is determined by the employer and is provided at the employer’s discretion.
These bonuses happen outside any planned bonus schedule. This is why they are a popular choice at Year End. For instance, discretionary holiday bonuses are quite common. The bonus amount can also vary.
Some examples of year-end bonuses that can be discretionary include:
- Holiday bonuses
- Employee of the Month or spot bonuses
- Retention bonuses
- Severance bonuses
Because these bonuses are unplanned, discretionary bonuses are not recorded with normal pay. They act similarly to gifts to employees and, therefore, are not a part of the pay rate or salary. Discretionary bonuses are also typically not counted towards wages for things such as overtime thresholds.
Year-End Non-Discretionary Bonus
On the other hand, non-discretionary bonuses are woven into an employee’s pay. These bonuses are awarded for the completion of planned objectives communicated to the employee to drive productivity and often set career and development goals. Goals may also be centered around achieved results for the company, such as a sales goal.
Some examples of year-end bonuses that can be non-discretionary include:
- Attendance bonus
- Safety bonus
- Hiring bonus
- Work-related bonuses
- Individual or group work
- Quality and or accuracy
- Employee profitability
- Sales goal
Non-discretionary bonuses to be rolled out to high-earning employees must have goals set in place to be achieved in order to qualify. Non-discretionary bonuses ARE counted towards wages for things such as overtime thresholds.
When are Year-End Bonuses Paid?
Before considering when year-end bonuses should be paid out, it is important to evaluate if they can be supported financially.
Often, employers will determine a percentage to calculate in tandem with an employee’s salary to determine the amount.
Important to note is that non-discretionary bonuses should have a fixed amount that is communicated to the employee at the time the goal is given. Amounts for discretionary bonuses can be determined at the employer's discretion, as the name would suggest.
When are Year-End Bonuses Paid Out?
Once the bonus amounts have been determined, employers need to find the best time to pay them out.
Typically, as the name suggests, year-end bonuses are paid towards the end of the year between the months of November or December.
Lately, however, many businesses are shifting towards an even later pay date than traditionally expected. Some businesses, for example, now choose to pay out year-end bonuses between January and February. The reasoning behind this is to help alleviate the employee’s tax liability for the end of the year so that the employee may plan accordingly for the next tax year.
How are Year-End Bonuses Taxed?
How a year-end bonus is taxed depends on a few key factors.
Generally, bonuses are considered supplemental income and are considered taxable. However, there are still specific requirements that can determine how taxes are withheld.
Bonuses are subject to the same income tax liabilities as regular wages and salary earnings. As such, the following withholdings apply to year-end bonuses:
- Federal and state tax rate
- Social Security tax on all income plus bonuses dependent on the Social Security limit that may be taxable ($168,600 earnings limit in 2024 and $176,100 earnings limit in 2025)
- Medicare tax including additional Medicare tax
Payroll Taxes on Standalone Year-End Bonus Checks
While the above generally holds true, if year-end bonuses are separated from standard payroll and are issued as a standalone check, employers will have to calculate tax withholdings to the bonus separately.
A common withholding method for standalone year-end bonuses is to use 22% as the withholding rate. This rate is generally used if the standalone year-end bonus is less than or equal to $1 million. In cases where a standalone year-end bonus is over $1 million, the exceeded amount is taxed at a 37% withholding rate.
Get Help With Managing Year-End Bonuses
Properly planning and organizing year-end bonuses is an integral part of providing employees with seamless payroll and compensation management.
Payroll software can simplify how year-end bonuses are paid when incorporating them with employee wages or salary. Having a payroll system that can automate year-end bonus payments as well as maintaining tax compliance helps streamline a year-end bonus schedule.
Compensation Management Software can help uncover industry trends in compensation and is a valuable tool for evaluating budgets to determine if and what bonuses can be awarded, particularly for discretionary bonuses. The same tools can also help to determine how much non-discretionary bonus rewards can or should be.
Contact us to learn more about the solutions we offer for your year-end bonus strategy.
