Bonuses are a form of supplemental wages, and the IRS defines them as “Wage payments to an employee that aren’t regular wages.” For employers, payroll professionals, and HR teams comparing discretionary vs non-discretionary bonus types, the key difference is this: a discretionary bonus is awarded at the employer’s sole discretion without prior promise or set criteria and is generally excluded from the regular rate for overtime, while a non-discretionary bonus is tied to predetermined criteria employees know about in advance and must be included in overtime calculations.
Additional examples of supplemental wages include commissions, severance pay, awards, prizes, back pay, and retroactive pay increases. This blog article focuses on discretionary and non-discretionary bonuses, the statutory criteria that separate them, examples of each bonus type, how each affects overtime pay, and the payroll implications of classifying them correctly.
When paying bonuses, correctly define the type of bonus. That classification determines whether you include or exclude it from overtime pay calculations, which directly affects payroll accuracy, legal compliance, and employee compensation. Here is a closer look at each type.
Discretionary Bonuses
A discretionary bonus is a variable payment that an employer is not obligated to provide. The following indicators show that a bonus is discretionary:
• The employer gives the bonus without the employee expecting it. • The employer may not tie the bonus to a specific reason or to achieving set goals. • The employer does not disclose the bonus amount, requirements, timing, or announcement 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:
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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;
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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
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Employers do not base the bonus payment on any prior contract, agreement, or promise that would lead employees to expect it regularly.
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Examples of discretionary bonuses can include:
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Bonuses for overcoming a challenge or stressful situation.
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Employers may use offering discretionary bonuses as additional compensation to motivate employees and reward employees for work that exceeds normal expectations.
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A bonus discretionary payment remains subject to the employer’s discretion and can help recognize achievements or mark special occasions.
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Bonuses for going above and beyond typical job duties.
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Bonuses for the employee of the month.
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Bonuses for referring a new employee.
Employers exclude discretionary and non-discretionary bonuses, two common bonus types with different payroll implications, from the regular rate of pay differently when they calculate overtime.
Non-Discretionary Bonuses
A non-discretionary bonus is one where the employer predetermines the criteria for the employee to receive the bonus, unlike a discretionary bonus awarded at the employer’s discretion. There are a few indicators that a bonus is non-discretionary:
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Employees know about and expect the bonus as part of a stated bonus structure that employers offer to reward employees, recognize achievements, or motivate employees without leaving it to later judgment.
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It is expected that certain qualifications be met by the employee, often under a bonus plan or incentive pay plan with objective criteria set in advance rather than a surprise reward.
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The employer sets the criteria in advance and explains how employees meet those requirements to get the bonus, including cases tied to sales targets or meeting sales targets.
According to the U.S. Department of Labor, a non-discretionary bonus is, a nondiscretionary bonus is one that does not meet the statutory requirements of a discretionary bonus.
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examples of nondiscretionary bonuses can include, and employers may award discretionary payments for exceptional performance, company success, or special occasions:
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Bonuses are based on predetermined criteria, such as production bonuses.
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Bonuses for quality and accuracy of work.
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Bonuses are announced to employees in the hopes of getting them to work more efficiently.
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Attendance bonuses.
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Safety bonuses (i.e., going a certain number of days without safety incidents).
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hiring bonuses.
A documented bonus program also helps employers compare bonus options and show when employers offer nondiscretionary bonuses; by contrast, discretionary bonuses are typically unexpected rewards for performance, and when the process feels unfair or inconsistent, morale can suffer.
Non-discretionary bonuses are included in the regular rate of pay when overtime is being considered.
Considerations
To calculate overtime, you must know the regular rate of pay. Under the fair labor standards act, the key difference between the two types of bonuses lies in prior commitment and predictability, so a nondiscretionary bonus is promised in advance and tied to specific measurable goals. To determine this rate, consider the two types of bonuses and apply the correct calculation to ensure compliance with wage and hour laws. Set up the calculations to include or exclude the bonus based on its type:
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Discretionary bonuses are excluded from the employee’s regular rate.
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Employers offer nondiscretionary bonuses through a bonus plan or incentive pay plan with objective criteria employees must meet, and for non exempt employees they are included when figuring the regular rate of pay.
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For exempt employees, these bonus rules generally do not change overtime calculations because they are not typically entitled to overtime compensation under the FLSA.
See example calculations below. These bonuses provide predictable financial incentives tied to measurable goals such as sales targets, attendance benchmarks, production quotas, or even hiring bonuses and similar incentive payments.
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:
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$500.00 Regular wages ($10.00 hourly rate x 50 hours) +
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$50.00 Overtime wages ($10.00 hourly rate x 0.5 half-time OT premium x 10 OT hours) +
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$500.00 Discretionary bonus =
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$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 for a nonexempt employee.
The right bonus structure or bonus program should clearly explain eligibility and payout rules.
Calculate total gross wages:
First, under the Fair Labor Standards Act and wage-and-hour laws, overtime for a nonexempt employee depends on the employee’s regular rate of pay.
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$500.00 Regular wages ($10.00 hourly rate x 50 total hours worked) +
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$500.00 Non-discretionary bonus =
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$1,000.00 Total compensation the employee earned for the pay period
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$1,000.00 / 50 (total hours worked, including straight time hours) =
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$20.00/hr Regular rate of pay
These rules help ensure compliance and proper overtime compensation for non-exempt employees, while exempt employees generally are not subject to the same overtime calculation.
Calculate overtime wages:
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Regular rate is based on the amount the employee earned for the week and the employee’s total compensation before overtime is calculated.
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$20.00/hr regular rate of pay (based on 50 straight-time hours before calculating overtime hours) x 0.5 half-time OT premium x 10 OT hours =
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$100.00 Overtime wages
Continue with the calculation:
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$500.00 Regular wages +
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$100.00 Overtime wages +
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$500.00 Non-discretionary bonus =
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$1,100.00 Total gross wages employer pays
The regular rate of pay should always be considered when calculating overtime hours. 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.
FAQs
What is a discretionary bonus?
A discretionary bonus is a payment that an employer chooses to give without prior promise or set criteria. Employees do not expect it, and the employer decides the amount and timing.
What is a non-discretionary bonus?
A non-discretionary bonus is a payment based on predetermined criteria that employees know in advance. It is typically tied to performance, attendance, or production goals. It can also include a year end bonus for nonexempt employees or referral bonuses when participation is voluntary and limited in scope. While employers may award discretionary bonuses for exceptional contributions or company-wide success.
Do discretionary bonuses count toward overtime?
No. Employers exclude discretionary bonuses from the regular rate of pay when calculating overtime because they are not guaranteed or expected. Unlike bonus payments such as a year end bonus or referral bonuses when the rules and payout conditions are announced in advance.
Do non-discretionary bonuses affect overtime pay?
Yes. Employers must include non-discretionary bonuses in the regular rate of pay when calculating overtime. This can increase the total overtime wages owed; such bonuses are typically known or expected in advance and may be tied to set criteria. By contrast, discretionary bonus payments are excluded from the regular rate of pay when they are not guaranteed or expected, but bonuses promised under a collective bargaining agreement must be included.
How do bonuses affect payroll calculations?
Bonuses affect payroll calculations by changing the regular rate of pay used to calculate overtime. Bonus payments must be included in that rate unless a specific exclusion applies. Non-discretionary bonuses increase the regular rate, while discretionary bonuses do not. This is why employers should set clear rules for awarding bonuses based on specific circumstances; retention bonuses, for example, may be used during major transitions or critical projects. Bonuses required under a collective bargaining agreement are generally not treated as discretionary for overtime purposes.
Resources
2022 IRS Publication 15 (Circular E), Employer’s Tax Guide
Department of Labor Fact Sheet #56C.
Pincus Schiff is a payroll software specialist at Friday App, where he helps businesses simplify payroll, stay compliant, and automate their workflows. He writes about payroll best practices, compliance, and the latest in workforce technology.
