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How Job Bonuses Work

job bonuses

Job bonuses can be pleasant surprises for hard workers and enticing considerations for job seekers. But can there be any drawbacks? Any red flags? Unfortunately, there are. It depends on the bonus structure and whether your employer understands what they’re promising. If they get it wrong or don’t communicate with you effectively, you could be surprised to find that your bonus comes at a cost.

What Are Job Bonuses?

Job bonuses can comprise a significant part of an employee’s compensation package. It’s well-known that finance, law, investment banking, and sales professionals rely on hefty job bonuses. But did you know that radiologists, on average, enjoy an extra $48,000 each year in bonuses, too?

Investopedia defines job bonuses as financial compensation that is above and beyond the normal payment expectations of its recipient. The website summarizes that:

  • Bonuses may be awarded by a company as an incentive or to reward good performance.
  • Companies have various ways they can award employee bonuses, including cash, stock, and stock options.

Job bonuses can take any number of shapes and sizes. The most common are:

Signing bonuses: A one-time payment to help entice a highly sought-after job candidate to take a job offer.

Retention bonuses: An employer may choose to reward a retention bonus to a longtime employee or one that they fear may be ready to jump ship.

Annual or holiday bonuses: This common type is given annually, and the amount is usually determined by any combination of the employee’s salary base, their individual performance, and/or the organization’s success that year.

Spot bonuses: These motivational tools are usually spur-of-the-moment, surprise rewards for a job well done.

Milestone bonuses: Strategically outlined performance- or metrics-based rewards for achieving certain goals or milestones. These are more commonly called incentives, and the difference can be profound (which we’ll discuss later).

Referral bonuses: Hires referred by other employees stay 70% longer than other hires. That’s why employee referral programs have become popular. The average bonus? About $2,500.

Profit-sharing bonuses: Profit-sharing bonuses are usually a percentage of the company’s profits over a set period of time. Delta Airlines is famous for its generosity in this area. This year, Delta employees received 6% of their annual pay.

Commissions: These aren’t job bonuses exactly, but they operate in a similar way. “Commissions complement a base salary and are very clearly defined at the top of the year through a sales commissions structure,” as Glassdoor points out.

Are Bonuses Guaranteed?

There are two ways to categorize most job bonuses, as Indeed does here: discretionary (not guaranteed, often a pleasant surprise) and nondiscretionary (guaranteed, usually incentive-based, and outlined in an employment contract). Understanding the differences is critical because the category your bonus falls into determines if it’s taxed and whether you have a legal right to receive it.

A spot bonus, for instance, is discretionary. It’s usually not outlined in an employment contract and is not guaranteed. In other words, you have no legal right to it. Milestone bonuses or incentives, on the other hand, are often nondiscretionary. They’re often well-defined in an employment contract, as in, “If you achieve X, you will receive Y.”

“The key difference between a bonus and an incentive is that bonuses are typically given out in response to short-term goals, or as a gift after the fact. While incentives are typically given out in response to long-term goals and are often communicated and set in place in advance,” explains incentive platform provider ourlinQ.

An employer might be legally obligated to follow through on a nondiscretionary bonus or incentive. However, as the Muse covers, it can be challenging to hold their feet to the flames.

How Taxes Enter the Picture

The IRS generally taxes job bonuses as “supplemental wages.” As Bankrate explains, “The IRS will expect its cut of any bonus you receive. Even if you receive your bonus in cash, gift cards, a vacation, or some other benefit, you’ll generally have to pay taxes.”

It’s true: “Stuff” can be taxed, too. Unless specifically excluded, even prizes or awards given to employees are taxable, the IRS states. “The exception to this rule is if your bonus can qualify as an employee achievement award,” says Bankrate, adding that tangible personal property and awards under $1,600 in value may also be excluded.  

How those taxes get paid can get awfully tricky, especially when there are thousands of dollars involved. NerdWallet’s Sabrina Parys explains two main ways an employer usually pays out a monetary bonus: the percentage method (typically separate from your paycheck) or the aggregate method (usually lumping it with your regular wages into one paycheck). There are pros and cons to each, and depending on your tax bracket and the reward amount, each could affect your tax obligation in different ways.

The bottom line, says Parys, “is that neither the aggregate nor the percentage method is an exact science. Regardless of the calculation method, keep an eye on your total withholdings for the year if you get a bonus. If you have a sense for what your total income will be, you can tinker with your W-4 and adjust your withholding to get out ahead of things before tax time.”

Those who receive hefty job bonuses will often have tax-advantage accounts set up to help absorb the hit or may even defer the bonus to the next tax year. “Because this can be a tricky strategy to navigate, make sure to consult a tax professional to ensure it’s the right call for your financial picture,” Parys adds.

Job bonuses can be terrific icing on the cake, but don’t rely on them so heavily that you can’t afford to live without them. Instead, plan ahead, read between the lines, ask questions (your recruiter can help), and enjoy the rewards when they come.