Bonus:
Definition, Comparison, Uses & Types

A bonus is a payment or extra amount of money given to an employee above and beyond their normal salary or wages. It represents financial compensation that exceeds the normal payment expectations of the employee and is typically not guaranteed. Bonuses are generally given as an incentive to encourage employees to perform well, to reward exceptional work, to recognize achievements, or to thank employees for their hard work and dedication.

Bonuses can be given as a one-time payment or as a percentage of the employee's salary on an annual basis. Under the Fair Labor Standards Act (FLSA), all compensation for hours worked, services rendered, or performance is included in the regular rate of pay, with certain statutory exclusions. Bonuses may be given to employees in any position within a company, though they are most commonly given to employees in management, executive, or sales roles.

Related terms: performance bonus, nondiscretionary bonus, discretionary bonus, commission, incentive pay

A performance bonus is a financial incentive paid to an employee in addition to their regular salary or wages. Performance bonuses are typically given to employees who exceed expectations or achieve specific goals. They can be given in the form of a lump sum payment or a percentage of the employee's regular salary.

Performance bonuses are a popular way to motivate employees and reward them for their hard work. These bonuses are nondiscretionary because employees know about and expect them based on predetermined criteria such as individual or group production, quality and accuracy of work, or meeting specific performance targets.

A nondiscretionary bonus is a bonus that fails to meet the statutory requirements of a discretionary bonus and must be included in the regular rate of pay for overtime calculation purposes. Nondiscretionary bonuses are those where employees know about and expect the bonus based on predetermined criteria.

Examples of nondiscretionary bonuses include bonuses 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. The fact that the employer has the option not to pay the promised bonus does not make the bonus discretionary.

A discretionary bonus is excludable from the regular rate of pay for overtime calculation purposes if it meets all statutory requirements. The employer must have sole discretion until at or near the end of the period to determine whether to pay the bonus and the amount, and the bonus payment cannot be made according to any prior contract, agreement, or promise causing an employee to expect such payments regularly.

Examples of discretionary bonuses include bonuses for overcoming a challenging or stressful situation, bonuses to employees who made unique or extraordinary efforts not awarded according to pre-established criteria, employee-of-the-month bonuses, severance bonuses, and certain referral bonuses. The label assigned to the bonus does not conclusively determine whether it is discretionary, the determination must be made on a case-by-case basis depending on specific circumstances.

A retention bonus is an incentive offered to an employee to stay with the company. It is usually a lump-sum payment and is often offered to key employees or employees who are in high demand. The purpose of a retention bonus is to keep the employee from leaving the company and taking their knowledge and skills with them.

Retention bonuses are typically provided during an acquisition, merger, or big company restructuring to convince someone to stick around for an extra period of time, especially if they were looking to leave or have a competing offer elsewhere. These bonuses are paid on the backend, meaning employees do not receive them until the specified time period is completed.

A signing bonus is a one-time bonus provided when an employee signs on to a new role. Companies might offer it when an employee is walking away from something better, if the employee is moving to a new city for the job and the company wants to cover some of the costs, or as a way to make up for salary demands they cannot meet.

Signing bonuses are used to incentivize candidates to accept the job offer. Generally, there is a clause in the employment contract stating that if the employee leaves before a certain amount of time, typically a year, they owe the money back to the company. Sign-on bonuses given to employees with or without clawback provisions may be excluded as gifts or as other payments not tied to quality or quantity of work performed.

A referral bonus is a payment given to employees for recommending a qualified applicant who is hired by the establishment. It is meant to encourage current employees to refer great candidates for jobs at their company.

The bonus is typically not given until the candidate is hired and has stayed on for several months. The amount must be interesting enough that employees actually refer someone, so it is usually a good amount of money depending on the job and level, anywhere from $1,000 to several thousand dollars. Some companies use a flat rate for every role, while others pay a higher amount for roles that are harder to fill. Referral bonuses may be discretionary if employee participation is strictly voluntary, the recruitment efforts do not involve significant time, and the activity is limited to after-hours solicitation among friends, relatives, neighbors, and acquaintances.

An annual bonus is usually based on overall company performance. Employees may receive a large or small bonus, or no bonus at all, depending on how successful the organization or specific department was that year, as well as how significant a part of that success they were.

This can also be considered profit sharing. Companies wait a full year before paying the bonus to encourage employee retention, as very few people leave their jobs before collecting their yearly bonus. The timing of an annual bonus is generally based on the company's fiscal year, with payments typically made in the months following the end of the fiscal year.

An end-of-year bonus is a payment to employees near the end of the year as a sign of appreciation for working hard throughout the year. This type of bonus recognizes employees for their contributions during the entire year and provides an extra financial boost during an expensive time.

End-of-year bonuses are common across various industries and establishment sizes. In March 2020, 11 percent of private industry workers had access to end-of-year bonuses. Access rates vary by industry, with information industry workers having 26 percent access and construction workers having 18 percent access.

A holiday bonus is a payment made on a holiday as a sign of appreciation. The payment is usually a token gesture, with all employees receiving the same amount. This type of bonus is also known as a Christmas bonus in some regions.

Holiday bonuses are more common for companies based outside the United States and often represent a set percentage of annual salary, typically ranging from 5 percent to 10 percent. In March 2020, 6 percent of private industry workers had access to holiday bonuses, with higher rates in smaller establishments.

A recognition bonus is a type of bonus typically given to employees who have achieved a certain level of success or performed exceptionally well in their role. It is a way to show appreciation for the employee's hard work and dedication.

Recognition bonuses can take many different forms, such as a cash bonus, gift card, or extra vacation days. They are usually given in addition to the employee's regular salary or wages. Employee recognition bonuses are payments that reward performance or significant accomplishments and are typically considered nondiscretionary if announced to employees to induce them to work more efficiently.

A spot bonus is for people who go above and beyond and is usually tied to a task that was outside the scope of their role. If an employee helped out with a special project, worked extra hours, or played an integral part in the company's success in an unexpected way, their manager can use their discretion to offer some additional compensation.

Spot bonuses are normally a one-time occurrence, if not an occasional event depending on budgeting, priorities, and leadership decisions. They are typically considered discretionary bonuses because they are not preannounced and the employer has sole discretion in determining whether to pay them and the amount.

Cash profit sharing is a payment to employees in recognition of their contribution to company profitability. This type of bonus aligns employee incentives with company performance, encouraging workers to contribute to overall organizational success.

In March 2020, 7 percent of all private industry workers had access to cash profit sharing. Access rates are relatively high in manufacturing (13 percent), trade, transportation, and utilities (12 percent), and financial activities (11 percent). Cash profit sharing is most common at establishments with 100 or more workers, with an 11 percent access rate.

A longevity bonus is a bonus or lump-sum payment paid to employees on the basis of their length of service. This type of bonus rewards employee loyalty and tenure with the organization.

Certain longevity bonuses are excludable from the regular rate of pay as gifts when given as a reward for service or tenure, provided the bonus payments are not made pursuant to a collective bargaining agreement, city ordinance, or policy. In March 2020, 1 percent of private industry workers had access to longevity bonuses.

Bonuses are generally given to employees as an incentive to improve performance or reward exceptional work. They can be given as a one-time payment or as a part of an employee's regular salary. The timing of a bonus is generally based on the company's fiscal year, with payments typically made in the months following the end of the fiscal year.

However, there may be circumstances in which a bonus is given outside of the normal payment cycle, such as to reward employees for meeting a specific goal, overcoming a challenging situation, or achieving unique accomplishments. Companies provide bonuses to compete for talent, align incentives between employee and company success, and share risk between the organization and individual.

Under the Payment of Bonus Act, only the basic salary and dearness allowance (DA) components are applicable for bonus payment. With a minimum rate of 8.33 percent and maximum rate of 20 percent, when wages or salary exceeds ?7,000 or the minimum wages fixed by the government, bonus will be payable on ?7,000 or the minimum wages as fixed by government, whichever is higher.

Employees drawing ?21,000 per month or less (basic plus DA, excluding other allowances) and who have completed 30 working days in that financial year are eligible for bonus payment. The bonus needs to be paid within 8 months from the close of the accounting year.

When a nondiscretionary bonus is included in compensation, overtime pay must be calculated based on the regular rate of pay, which includes the bonus. The calculation involves three steps: first, add total compensation for the week including the bonus and divide by total hours worked to get the regular rate per hour; second, multiply the regular rate by 0.5 to get the half-time premium for each overtime hour; third, multiply the half-time premium pay rate by overtime hours to determine overtime compensation due.

For example, if a non-exempt employee is paid $10.00 per hour and works 43 hours in a week while receiving a $50.00 nondiscretionary bonus, the calculation would be: $10.00 x 43 hours = $430.00; $430.00 + $50.00 = $480.00 total compensation; $480.00 ÷ 43 hours = $11.16 regular rate; $11.16 x 0.5 = $5.58 half-time premium; $5.58 x 3 overtime hours = $16.74 overtime pay due; total due = $496.74.

Employees drawing ?21,000 per month or less (basic plus DA, excluding other allowances) and who have completed 30 working days in that financial year are eligible for bonus payment. The Payment of Bonus Act applies to every factory and establishment which employs not less than 20 persons on any day during the accounting year.

Employers can hold bonus payable to an employee if the employee is disqualified and dismissed on the basis of fraud, misconduct, or absenteeism. If an employee exits the organization before the completion of the financial year, bonus needs to be paid as part of the settlement on a pro rata basis.

Nonproduction bonus offerings vary considerably by industry. Industry groups with relatively low rates of access include leisure and hospitality (22 percent), administrative and waste services (26 percent), and other services (26 percent). High rates of access are evident in financial activities (65 percent) and information (69 percent).

Offerings also differ by establishment size. Thirty-seven percent of workers at establishments with fewer than 100 workers had access to nonproduction bonuses, compared with 44 percent of workers at establishments with 100 or more workers. Among smaller establishments, end-of-year bonus and holiday bonus were the two most common types.

In March 2020, the average cost per hour of nonproduction bonuses for all private industry workers was $0.80 and made up 2.3 percent of the total cost of compensation. For establishments with 100 workers or more, the average cost per hour for nonproduction bonuses was $1.16, or 2.7 percent of total compensation.

Among establishments in private industry, those in financial activities and information had the highest cost per hour ($2.67 and $2.33, respectively) and relatively large shares of total compensation (5.4 percent and 4.1 percent, respectively). Management, professional, and related occupations had the highest average hourly cost of nonproduction bonuses ($1.90) and largest share of total compensation (3.1 percent).

A bonus is often compared to 2 related compensation concepts:

Bonus vs. Commission

Both terms refer to payments that employers make to employees on top of basic wages and salaries. However, commissions are usually based on the employee's performance, while bonuses may be based on either the business's performance or the employee's performance. Commission is considered non-guaranteed compensation and is about individual performance, often tied to a quota or goal such as a dollar amount, number of items sold, or number of closed deals. The term bonus may mean commission, but commission never means bonus when it refers to company performance. Commission can be a set percentage or defined by a formula, and payment is distributed monthly, quarterly, or yearly depending on when commission is considered earned.

Bonus vs. Incentive Pay

Incentive pay is a broader compensation category that encompasses bonuses, commissions, and other forms of performance-based compensation designed to motivate employees and reward achievements. While a bonus is a specific type of payment made in addition to regular earnings, incentive pay represents the overall strategy of using financial rewards to drive employee performance. Bonuses are one tool within the incentive pay framework, alongside commissions, profit sharing, and other variable compensation methods that align employee rewards with organizational goals.