Bonuses are a form of supplemental wages, and the IRS defines them as “Wage payments to an employee that aren’t regular wages.” Additional examples of supplemental wages include commissions, severance pay, awards, prizes, back pay, and retroactive pay increases. This blog article will focus on discretionary and non-discretionary bonuses and payroll implications around each type of bonus.
When paying out bonuses to employees, its important to correctly define the type of bonus being paid out. Depending on which type it is, the bonus will either be included or excluded from overtime pay calculations. Let’s break them down further.
Discretionary Bonuses
A discretionary bonus is a variable payment that the employer isn't committed to providing. There are a few indicators that a bonus is discretionary:
- The bonus is given to the employee without the employee expecting it.
- There may not be a specific reason why the bonus is given. The bonus is not attached to an employee’s achievement of reaching goals.
- The amount, requirement, timing, and announcement of the bonus should not be disclosed in advance.
According to the U.S. Department of Labor, all of the following statutory requirements must be met for a bonus to qualify as discretionary:
- The employer has the sole discretion, until at or near the end of the period that corresponds to the bonus, to determine whether to pay the bonus;
- The employer has the sole discretion, until at or near the end of the period that corresponds to the bonus, to determine the amount of the bonus; and
- The bonus payment is not made according to any prior contract, agreement, or promise causing an employee to expect such payments regularly.
- Examples of discretionary bonuses can include:
- Bonuses for overcoming a challenge or stressful situation.
- Bonuses for demonstrating exceptional performance that is not awarded under other specified criteria.
- Bonuses for going above and beyond typical job duties.
- Bonuses for employee of the month.
- Bonuses for referring a new employee.
Discretionary bonuses are excluded from the regular rate of pay when overtime is being considered.
Non-Discretionary Bonuses
A non-discretionary bonus is one where the employer predetermines the criteria for the employee to receive the bonus. There are a few indicators that a bonus is non-discretionary:
- Employees know about and expect the bonus.
- It is expected by the employee and requires that certain qualifications be met.
- The employer sets the criteria in advance and explains how the employee can meet those requirements to get the bonus.
According to the U.S. Department of Labor, a non-discretionary bonus is, a non-discretionary bonus is one that does not meet the statutory requirements of a discretionary bonus.
- Examples of non-discretionary bonuses can include:
- Bonuses based on predetermined criteria, such as production bonuses.
- Bonuses for quality and accuracy of work.
- Bonuses that are announced to employees in the hopes of getting them to work more efficiently.
- Attendance bonuses.
- Safety bonuses (i.e., going a certain number of days without safety incidents).
Non-discretionary bonuses are included in the regular rate of pay when overtime is being considered.
Considerations
In order to calculate overtime, the regular rate of pay must be known. To determine this rate, consider the two types of bonuses so the calculations are done correctly. The calculations should be set up to either include or exclude the bonus based on which type it is:
- Discretionary bonuses are excluded from the regular rate of pay.
- Non-discretionary bonuses are included in the regular rate of pay.
See example calculations below.
Example 1: Employee works 50 hours for the week with a regular pay rate of $10.00/hr. The employee also received a $500 discretionary bonus. The regular rate of pay would be $10.00/hr since the bonus is discretionary.
Calculate total gross wages:
- $500.00 Regular wages ($10.00 hourly rate x 50 hours) +
- $50.00 Overtime wages ($10.00 hourly rate x 0.5 half-time OT premium x 10 OT hours) +
- $500.00 Discretionary bonus =
- $1,050.00 Total gross wages
Example 2: Employee works 50 hours for the week with a regular pay rate of $10.00/hr. The employee also received a $500 non-discretionary bonus. The regular rate of pay would be $20.00/hr since the bonus received is non-discretionary.
Calculate total gross wages:
First, we need to figure out the regular rate of pay so overtime can be calculated.
- $500.00 Regular wages ($10.00 hourly rate x 50 total hours worked) +
- $500.00 Non-discretionary bonus =
- $1,000.00 Total regular wages
- $1,000.00 / 50 (total hours worked) =
- $20.00/hr Regular rate of pay
Calculate overtime wages:
- $20.00/hr Regular rate of pay x 0.5 half-time OT premium x 10 OT hours =
- $100.00 Overtime wages
Continue with calculation:
- $500.00 Regular wages +
- $100.00 Overtime wages +
- $500.00 Non-discretionary bonus =
- $1,100.00 Total gross wages
Regular rate of pay should always be considered when calculating overtime. The types of additional earnings paid to an employee will directly affect the regular rate of pay. The payroll product must either allow the employer to enter a regular rate of pay (when it differs from the regular pay rate) or calculate the regular rate of pay as part of gross wage calculation.
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