Nervous about end-of-year bonuses, overtime, and payroll taxes? Many employers reward and recognize high performers with a bonus, especially toward the end of the year. If you award bonuses, there are several overtime and tax rules to consider. Here’s an overview of some of these rules to help you as you close out the business year in 2024.
Bonuses and Overtime Pay
Under the Federal Fair Labor Standards Act, employers must pay nonexempt employees overtime at one and a half times their “regular rate of pay” for all hours worked over 40 in a workweek. When calculating an employee’s regular rate of pay, employers must include nondiscretionary bonuses. What is a nondiscretionary bonus?
Most bonuses are considered nondiscretionary under the FLSA and therefore must be included in the regular rate of pay calculation, including those:
- Based on a predetermined formula such as individual or group production goals
- Bonuses for quality and accuracy of work
- Bonuses to induce them to work more efficiently
- Attendance bonuses
- Safety bonuses
These bonuses are nondiscretionary because the employee knows about and expects the bonus, and it’s based on defined terms. The fact that the employer has the option not to pay the bonus doesn’t make the bonus discretionary. We can help you calculate overtime with a nondiscretionary bonus, there is an easy formula to use! Remember, many states have their own laws requiring a different formula for bonuses.
Note: If the nondiscretionary bonus is earned over a single workweek, the bonus is added to the employee’s regular earnings for that workweek when determining the regular rate of pay. However, if the bonus is earned over a series of workweeks, the prorated bonus must be included in the regular rate of pay in all overtime weeks covered by the bonus period. If the calculation of the bonus is deferred over a period longer than a workweek, the employer may temporarily disregard the bonus in computing the regular rate until the amount of the bonus can be determined.
In other words, the employer would pay compensation for overtime at 1.5 times the hourly rate until the bonus can be determined. Once the amount of the bonus can be ascertained, it must be apportioned back over the workweeks of the bonus period. The employer must then recalculate the regular rate of pay for each overtime workweek in the bonus period and pay the overtime premium pay due on the bonus.
Bonuses and Overtime Exemption
The FLSA allows for exemptions from the overtime requirements for certain employees who work in administrative, professional, executive, highly compensated, outside sales, and computer professional jobs. Make sure your employees classified as “exempt” meet the salary-level test, the salary basis test, and the duties test. Federal law has permitted employers to use nondiscretionary bonuses, incentive payments, and commissions to satisfy up to 10% of the federal minimum salary requirement for the administrative, professional, and executive exemptions, as long as these forms of compensation are paid at least annually.
As 2024 comes to a close, make sure you’ve satisfied this requirement. Employers may make one final catch-up payment no later than the next pay period after the end of the year if the bonus, incentive payment, or commission ends up being less than anticipated.
Note: Some states have their own rules for exemption from overtime that don’t allow employers to apply bonuses toward meeting the minimum salary requirement. Therefore, to maintain the overtime exemption under state law, these employers must satisfy the state’s requirement with a salary alone.
Tax Withholding On Bonuses
If you do plan to provide a bonus this year, remember that bonuses are generally considered supplemental wages and are subject to federal taxes as well as certain state taxes. For federal taxes, when an employee receives $1 Million or less in supplemental wages during 2024 and those wages are identified separately from regular wages, the flat withholding rate is 22%. Over $1 million, the withholding would be 37%.
Keep in mind, many types of bonuses are considered taxable by the IRS. For example, cash, a gift certificate, gift card, and similar items that can easily be exchanged for cash are typically considered taxable wages, regardless of the amount (see IRS Publication 15-B). However, if an employer gives a turkey, ham, or other item of nominal value for the holidays, it’s generally not considered taxable income.
Bonuses can be an effective and efficient way to drive productivity and employee engagement. If you’re paying out bonuses, make sure that your bonus program complies with all applicable federal, state and local rules. If clients have any questions concerning payroll, they should consult Victoria Jackson, V.P. of Sales at TFG’s Your Payroll Solutions. “Tori” can be reached at 561-209-1108, or vjackson@yourpayrollsolutions.net.
