Many employers reward and recognize high performers with a bonus, especially toward the end of the year. If you award bonuses, here are some overtime and tax rules to consider.

Note: We recently held a webinar on processing bonuses in the RUN Powered by ADP® (RUN) platform, which covered:

• How to run a bonus with regular payroll.
• How to run an off-cycle bonus payroll.
• How to record a bonus as a manual check.
• When to run holiday bonuses.
• How to run bonus payrolls with direct deposit.

If you missed it, you can still watch it on-demand.

Bonuses and overtime pay:

Overtime calculations:

Under the federal Fair Labor Standards Act (FLSA), employers must pay non-exempt employees overtime at one and a half times their "regular rate of pay" for all hours worked over 40 in a workweek. Some states require overtime under additional circumstances. 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 bonuses;
• Bonuses for quality and accuracy of work;
• Bonuses announced to employees to induce them to work more efficiently;
• Attendance bonuses; and
• Safety bonuses (i.e., number of days without safety incidents).

These bonuses are nondiscretionary because the employee knows about and expects the bonus, and it's based on defined terms. The understanding of how an employee earns the bonus may lead them to expect to receive the bonus regularly. The fact that the employer has the option not to pay the bonus doesn't make the bonus discretionary.

How to calculate overtime with a nondiscretionary bonus:

If the nondiscretionary bonus is earned over a single workweek:

Add the bonus to the employee's regular earnings when determining the regular rate of pay for that week.

Example: A non-exempt employee is paid $15 per hour, works 50 hours, and receives a $100 nondiscretionary productivity bonus for that week. To calculate overtime:

Step 1: Calculate total straight-time. ($15 hourly rate x 50 hours worked) + $100 bonus = $850

Step 2: Calculate regular rate of pay. $850 straight-time pay divided by 50 hours worked = $17

Step 3: Calculate overtime premium pay. $17 regular rate of pay x .5 x 10 overtime hours = $85

Note: Since the straight-time earnings have already been calculated for all hours worked (see Step 1), the employee is entitled to an additional 10 hours of overtime pay, calculated at one-half the regular rate of pay.

Step 4: Calculate total compensation for week. $85 overtime pay + $850 straight-time pay = $935

If the bonus is earned over a series of workweeks:

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 pay due on the bonus.

Example: If an employee receives a $2,600 bonus for meeting certain annual goals, divide $2,600 by 52 weeks ($50/week). Add the $50 to the employee's regular earnings in each workweek the employee worked overtime to figure out the employee's regular rate of pay and overtime due for that week. For any workweek in which the employee worked overtime, you would then need to make catchup payments for the difference between what you paid the employee in overtime at the time and what the employee is entitled to now that the bonus is known.

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. These employees are known as "exempt" employees. To be considered "exempt," these employees must generally satisfy three tests:

1. Salary-level test. Employers must pay employees a salary of at least $684 per week to qualify for the executive, administrative, and professional employee exemptions.
2. Salary-basis test. With very limited exceptions, the employer must pay employees their full salary in any week they perform work, regardless of the quality or quantity of the work.
3. Duties test. The employee's primary duties must meet certain criteria.

Since 2020, employers have been permitted to use nondiscretionary bonuses, incentive payments, and commissions to satisfy up to 10 percent 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 2022 comes to a close, ensure you've satisfied this requirement, if applicable. 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 ended up being less than anticipated. For example, if an employer chooses this option, each pay period, the employer must pay their exempt executive, administrative, or professional employee at least 90 percent of the salary level ($615.60 per week). Then, 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.

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 2022 and those wages are identified separately from regular wages, the flat withholding rate is 22 percent. When an employee receives over $1 million in supplemental wages, the withholding on the supplemental bonus would be 37 percent.

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. If employers have questions, they should consult their tax advisor.

In RUN, what is the difference between bonus earnings and supplemental bonus earnings?

Regular bonus earnings are taxed using whatever tax rate the employee has chosen on their W-4 forms for their federal tax settings. Supplemental bonus earnings are taxed at a flat rate (see above).

In RUN, how can you calculate the net pay amount for a bonus?

The "Calculate checks" tool will help you calculate net pay (or gross pay) for a bonus payment. You can find it under the Payroll section in RUN. You can navigate there by clicking on Payroll on the left-menu of your RUN home page.

Conclusion:

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.