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 to help you as you close out the business year in 2023.
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; and
- 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.
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 2023 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. Put another way, if at the end of year the employee’s paid-out salary plus the nondiscretionary bonuses and incentive payments (including commissions) doesn’t equal at least $35,568, the employer would have one pay period to make up for the shortfall.
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 2023 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.
We would like to remind clients that many states and local jurisdictions will increase their minimum wage rates on January 1, 2024. 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.