Guide to Employee Bonuses

What is a bonus?

An employee bonus is compensation paid in addition to an employee’s regular salary or hourly wage. Bonuses are typically awarded to recognize exceptional performance, incentivize specific behaviors or share company success with employees.

Unlike regular wages, bonuses are generally discretionary payments that can vary based on individual performance, team achievements or overall company results. They can take various forms including cash payments, stock options, gift cards or other valuable compensation beyond standard pay structures.

Why companies offer employee bonuses

Companies implement bonus programs to drive multiple strategic objectives that benefit both the organization and employees. Research shows that bonuses can significantly impact job satisfaction, with studies indicating that workers report higher satisfaction levels when their compensation includes bonus payments, even when total income remains constant.

Some key benefits of employee bonuses include: 

• Motivation and performance enhancement: Bonuses serve as powerful motivators that encourage employees to exceed standard performance expectations. When properly structured, they align individual efforts with company goals, creating a win-win scenario where employees benefit financially while the organization achieves its objectives.
• Employee retention: In competitive job markets, bonuses help retain valuable employees who might otherwise seek opportunities elsewhere. Retention bonuses are particularly effective during periods when competitors are actively recruiting talent.
• Productivity improvement: Well-designed bonus programs can boost productivity by providing clear incentives for employees to increase their output and efficiency. This is especially effective in roles where performance can be measured quantitatively.
• Morale and culture building: Holiday bonuses and discretionary rewards demonstrate appreciation and build goodwill among employees, contributing to a positive workplace culture. The perception of fairness and recognition can significantly impact overall employee morale.
• Talent acquisition: Signing bonuses help companies attract top talent by making offers more competitive and closing gaps between desired and offered compensation.

Common types of employee bonuses

These are some of the most common types of employee bonuses:

• Annual bonus
• Signing bonus
• Discretionary bonus
• Performance bonus
• Retention bonus
• Referral bonus
• Holiday bonus
• Profit-sharing bonus

Annual bonus

An annual bonus is awarded to an employee once per year. The bonus amount is typically based on the employee’s annual base salary or a set percentage for the department or position. Most companies assign a target bonus that each employee is eligible to receive at the end of the year. The employer awards the full annual bonus if the employee meets specific goals and the company or department meets its performance goals.

Signing bonus

A signing (or sign-on) bonus is a one-time payment an employer or recruiter pays a new employee. Its purpose is to convince an individual to join a company. Employers use a signing bonus when they’re trying to lure a top employee or executive away from a competitor, outbid another company’s competing offer, or close the gap between the employee’s desired salary and the company’s offered salary. Signing bonuses often come with a contractual requirement that the employee stay with the company for a minimum period.

Discretionary bonus

A discretionary (or spot) bonus is awarded to an employee for various reasons, such as demonstrating exceptional performance or achieving a specific employee performance goal. This bonus is typically given at the whim of the employer or manager to show gratitude for something the employee has done. Discretionary bonuses are usually unexpected by the employee because they are not included in the employment contract. The bonus can be monetary, a gift or some other form of compensation.

Performance bonus

Performance bonuses are merit-based rewards tied directly to an employee’s achievement of specific goals, metrics or performance standards. These bonuses are typically outlined in employment agreements and are earned when predetermined criteria are met, making them different from discretionary bonuses.

Retention bonus

A retention bonus is a reward given to an employee for remaining with the company for a set period. It can be used to encourage high-performing employees to stay with the company amid a competitive job market or to retain a valuable employee who has received a job offer from a competitor. Typically, a retention bonus is given as a one-time payment instead of a raise. 

Referral bonus

A referral bonus is given to reward current employees for helping to attract and recruit new employees. The bonus is typically paid after the new employee joins the company and performs their job duties for some length of time. The referral bonus amount depends on several factors, such as the type of role and how hard it is to fill.

Holiday bonus

A holiday bonus is typically awarded around recognized holidays, such as Christmas and Hanukkah. Its goal is to thank and reward employees who have contributed to the company’s success. A holiday bonus is often tied to the performance of both the overall company and the individual employee. It can often help to boost employee loyalty and create goodwill.

Profit-sharing bonus

A profit-sharing bonus provides employees with a percentage of the company’s profits. The award is calculated using the company’s earnings during a specific period. Employers award this bonus to employees when the company realizes a profit. Some portion of pretax profit is placed into a pool for distribution to eligible employees according to their salary and title. The profit-sharing bonus can comprise cash or stocks.

Bonus structures explained

Understanding different bonus structures is essential for creating effective compensation programs that align with business objectives and employee expectations.

Flat vs. percentage-based bonuses

• Flat rate bonuses: These provide a fixed dollar amount to all eligible employees regardless of their salary level. While simple to administer, flat rates may not reflect the varying contribution levels across different positions.
• Percentage-based bonuses: These calculate bonus amounts as a percentage of an employee’s annual salary or the department’s total compensation. This approach ensures fairness across different salary levels and is more commonly used for annual bonuses. For example, setting a bonus at 5% of yearly wages ensures proportional rewards for employees working different periods.

Commission structures

A commission is a bonus based on the amount of money or revenue a sales team member earns from facilitating sales. The commission amount is defined in the sales commission structure, which describes how the employer will pay salespeople for each sale. 

These are some of the most common types of commission structures:

• Base salary plus commission: Combines a fixed income with performance-based rewards, providing financial security while incentivizing sales performance. This structure is common in industries with longer sales cycles.
• Straight commission: Compensation is entirely commission-based with no base salary. Employees earn a percentage of the revenue they generate, though this approach provides no income guarantee.
• Tiered commission: Commission rates increase as salespeople meet higher performance goals, rewarding top performers with escalating rewards.
• Territory volume commission: The employee is paid for sales across a territory, rather than for an individual sale.
• Revenue-based commission: Salespeople receive a portion of the money they generate, often used for high-value products or services.
• Profit-based commission: Commission is determined by deal profitability rather than just revenue, promoting focus on profitable sales.

Milestone and deferred bonuses

• Milestone bonuses: These are awarded when employees reach specific achievements or complete particular projects. These can be particularly effective for long-term projects or professional development goals.
• Deferred bonuses: These bonuses, such as equity shares or stock options, tie employee rewards to long-term company performance and help reduce the risk that incentive compensation will increase costs without corresponding profits.

Equity-based bonuses

Stock options and equity shares provide employees with ownership stakes in the company, aligning their interests with long-term business success. These bonuses can be particularly valuable in growth-oriented companies where stock appreciation provides significant value.

Tax and compliance considerations

Employees must pay taxes on bonuses because they’re considered supplemental wages and part of an individual’s taxable income. The IRS classifies bonuses as “supplemental wages,” which are subject to specific withholding rules that differ from regular payroll taxes.

Employer tax obligations

Employers must include bonus pay when calculating federal and state unemployment taxes, the Social Security maximum and the Medicare tax. Employers have two main methods for calculating withholding taxes on bonus payments:

• Percentage method (flat rate): The employer identifies the bonus as separate from regular wages and applies the flat percent withholding rate. For 2025, the federal withholding rate for supplemental wages is 22 percent for bonuses up to $1 million. If an employee receives a bonus exceeding $1 million, the first million is taxed at 22 percent, while amounts above $1 million are subject to a 37 percent withholding rate.
• Aggregate method: If the employer does not withhold taxes from the employee’s paycheck due to exemptions, the employer must add the bonus to the employee’s paycheck and calculate the withholding based on the total amount using standard payroll tax tables.

Tax benefits for employers

Employers receive a business tax deduction for bonus payments to employees. Bonus payments fall under the “payments to employees” category, provided the bonus is for services rendered, such as not a gift. 

“Some businesses may prefer to give employees cash or gift cards, but this can negatively impact both parties if discovered by taxing authorities,” Marcus Dillon, certified public accountant and president of Dillon Business Advisors, told us. “Properly paying bonuses ensures clarity for all parties regarding total compensation.”

Best practices for designing a bonus program

Creating an effective bonus program requires strategic planning that balances business objectives with employee motivation and fairness. 

Align bonuses with business goals.

Identify the business goals you’ve set for your organization and the steps required to achieve them. Different goals will require various investment levels. A bonus structure attached to business goals can help you attract and retain top talent. The pay mix should vary by job level, with larger bonus components for higher-level positions.
“Aligning compensation with business goals also helps employees feel more invested in the organization’s performance,” said Dillon. “When incentives are easily calculated by both employees and employers, it provides clarity on the goals being met and how team members can benefit.”

Ensure fairness and transparency.

To ensure fairness and transparency, create a written document outlining the employee bonus plan’s details. Give all employees this information so they understand how and why bonuses are given. Provide details on the bonus types in your plan, why they exist and how employees can earn these bonuses, especially if a bonus is tied to a specific outcome. 

“Make it easy to understand and avoid using accounting jargon employees may not be familiar with,” said Rey Ramirez, co-founder of Thrive HR Consulting.

Consider important key factors.

There are several key factors for you to consider when designing your bonus program, such as financial constraints, industry trends and employee preferences. 

• Financial constraints: Bonuses require budget planning. Some companies might have many assets but lack cash reserves; others might have funds tied up in specific projects. Various financial constraints will determine how much you can give in bonuses.
• Industry trends: Businesses should track industry trends before creating a bonus structure. Companies should attempt to match bonuses their competitors or others in the marketplace offer their employees. Some employers might have to give higher bonuses to keep top employees from searching for work elsewhere in a competitive job market.
  “If you are losing employees and candidates due to paying below market, bonuses can have a real impact,” said Ramirez. “If the market demands a bonus for a role or industry, not providing the opportunity will make it difficult to attract and retain talent.”
• Employee preferences: Consider asking employees which types of bonuses they prefer. Use their input to choose a bonus structure that will motivate employees to achieve higher performance goals.

Balance short-term and long-term rewards.

Effective bonus programs should include both immediate recognition for exceptional performance and long-term incentives that encourage employee retention and sustained performance. Consider implementing a mix of spot bonuses for immediate achievements and annual or deferred bonuses for longer-term goals.

Celebrate bonuses.

Openly celebrate bonuses to motivate employees. You might consider holding lunches, team events or one-on-one meetings to acknowledge accomplishments and recognize everyone involved. 

“Expressing appreciation and highlighting how the collective effort led to the opportunity to share business profitability in the form of a bonus is important,” said Dillon. “I also recommend listing bonuses as a separate line item on pay stubs to highlight the bonus compensation and provide another way to celebrate the achievement.”

Casey Conway and Jennifer Dublino contributed to this article. Source interviews were conducted for a previous version of this article.