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How To Account For Holiday and Year End Bonuses

Are you paying year-end bonuses or considering non-cash alternatives?

The end of a year brings many things - time with family, holiday cheer, winter activities, gifts, and the potential holiday or year-end bonus to be paid to employees. While bonuses are in no way a requirement, they can increase morale amongst employees which in turn may increase productivity, engagement, and more. If your business is in a position to consider providing bonuses to your employees, there are a few things you should know.


Bonuses are considered compensation.

Just like regular payroll, bonuses are subject to income tax, Social Security and Medicare taxes, and Federal Unemployment tax. However, bonuses are considered to be supplemental wages and are generally subject to the flat withholding rate of 22% (2021). While there are other methods of determining the tax rate for bonuses paid, the flat rate method is the most straightforward. Keep in mind the actual tax owed by employees on their personal return could be more or less than 22% flat rate. It is important to keep in mind that the 22% rate is likely to be higher than your employees’ normal withholding rate, which can often be a source of confusion. If your employees are worried about the higher tax rate you can remind them that come tax time, the IRS treats bonuses just like regular income. If the tax withholding on their bonus was higher than necessary, that overpayment will lower the overall tax owed or be included in their refund. There are other considerations should your company have a 401k plan as the bonus could be subject to employee and employer deferrals.


You can also pay bonuses to independent contractors.

Maybe your business utilizes the work of independent contractors rather than employees. If you do decide to pay a bonus to independent contractors be sure that you distinguish the bonus from any employment bonus. For example, rather than a holiday or year-end bonus you can make “incentive payments” to independent contractors for renewing their contract, early completion of a project, or achieving certain set goals for a project. If you are going to pay an incentive to an independent contractor, be careful that the terms of the payment do not make the contractor appear to be a full-time employee. This past blog article discusses the tests that need to be passed when it comes to the employee vs. independent contractor distinction.


Incentives paid to independent contractors are included on their 1099-NEC at the end of the year as part of their total compensation.


Consider alternatives to cash bonuses.

Not all businesses are in a position to pay out cash bonuses to employees. If year-end or holiday bonuses aren’t in the cards this year consider offering special perks such as extra time off or flexible hours over the holidays. These types of perks can still serve well to let your employees know that they are appreciated.


Bonuses to employees are tax deductible business expenses.

In general, bonuses paid to employees are deductible as “payments to employees” by the employer. For example, you may put cash in with the holiday card for your company event but remember to gross up the amount and add the “bonus” to your employee’s December paycheck. To illustrate, if you give $1,000 cash, then the gross taxable bonus could be $1,300 when you consider tax deductions (Social Security/Medicare, federal and state withholdings). In other words, the $1,000 cash bonus paid to employees is net of that 22% flat withholding rate. The actual amount withheld will depend on the payroll software used. For example, Gusto has a convenient option to enter the net check of $1,000 and the software will take care of the behind-the-scenes calculations to figure out the correct gross amount paid to employees. If you have any questions about how to handle year end cash payments, let us know.


 

Whether it be monetary compensation, the gift of time, or another token of appreciation, when your employees feel appreciated and important they will help to build your business up. We know that entrepreneurship can often be a lonely road but when we learn to take care of those that build us up, that road seems a lot less lonely and our businesses flourish as a result.


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