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The process of calculating and paying bonuses is a complicated one that must be made in accordance with company policy, legal requirements, and state laws. Because the calculations are often complex for employees who don’t have accounting knowledge or experience, firms should make sure they’re adequately prepared to manage their business processes before implementing any pay structure.
The bonus calculation formula is a mathematical equation that calculates bonuses for employees. The equation can be used to calculate the bonus amount and present it in a table format.
Some bonuses are more straightforward to figure out than others. Performance-based incentives are based on elements for which you may need to collect data, such as total monthly sales income or the number of new customers recruited over the course of the year. You may need to select an arbitrary sum, such as $1,000, or compute payroll payments based on individual salaries or work hours to pay nonperformance incentives.
Calculating Bonuses Based on Performance
Individual sales incentives or commissions, department-wide incentives, and yearly or quarterly performance remuneration are all examples of performance-based bonuses. The majority of the time, they can be computed using basic multiplication or division. If you’re going to base employee incentives on criteria like sales or salary, you’ll need to figure out what proportion you’ll use first.
Commission on sales
Multiply the total sales by the incentive % you selected to compute a bonus for an employee who makes “X” dollars in sales.
Let’s say Kara was in charge of $50,000 in customer sales for the whole year. Kara would have made $5,000 if you choose to pay each salesperson 10% of the sales they make.
$50,000 multiplied by 0.10 is $5,000.
Departmental Objectives
If you want to offer incentives based on a department’s or team’s achievement of certain objectives, be sure you know how many employees are in each. Divide the amount bonus you wish to give by the number of workers who will receive it to arrive at a calculation.
Assume the accounting department established a target of cutting expenditures by 2% this year, which it accomplished by cutting expenses from $100,000 to $96,500. If the target is accomplished, you determine that the department will earn $5,000 for the year. The accounting department employs eight people. What would be the pay scale for each employee?
To calculate the bonus per employee, divide the total bonus by the number of workers in the department:
Total bonus: $5,000 / 8 (number of accounting personnel) = $625 bonus
For the current year, each accounting department employee should earn a $625 incentive.
Calculating Bonuses That Aren’t Performance-Based
Non-performance bonuses are a simple approach to ensure that all workers benefit from the incentives while also making bonus computations easier for you. Percentage of pay, holiday bonuses, retention or sign-on incentives, and referral bonuses are all examples of non-performance bonuses.
Salary Percentage
Consider basing your bonus on your workers’ yearly pay or earnings if you want to make sure they all get one. You could provide a 3% discount and everyone would get a check. You’ll need access to all employee pay or wage numbers in order to compute. For hourly workers (who don’t work constant hours), you may need to estimate yearly salaries using prior-year numbers.
To compute the bonus for a graphic designer earning $55,000 per year and a secretary earning $30,000, multiply the bonus rate—say let’s 3%—by their respective income amounts.
$55,000 divided by 0.03 is $1,650 (bonus for graphic designer) $30,000 divided by 0.03 is $900. (bonus for administrative assistant)
Employees who earn a higher regular wage will get a greater bonus in this case. This may cause some dissatisfaction since the bonus is decided by the sort of role each person has, but it assures that everyone on staff gets compensated.
Sign-On & Retention Bonuses
Both sign-on and retention incentives are often provided at flat rates, which eliminates the need for calculations if the bonus is paid all at once. For example, if your policy requires you to offer a $2,500 sign-on bonus to new workers who migrated for the position, you will disburse that amount.
If the provisions of a bonus agreement or policy state that the bonus should be paid in installments, you’ll need to figure out how much to distribute and how often.
Let’s say Sally took a nursing post with a $3,000 sign-on incentive that would be paid out during the first four months of her employment. In this situation, you’ll need to divide the total bonus by the number of months to get the monthly bonus distribution.
$3,000 (bonus) / 4 (bonus distribution months) = $750 each month
This implies you’ll have to give Sally $750 per month for the first four months.
Retention bonuses are computed in the same way as hiring incentives, however, they are normally handed out after the person has been employed.
How to Calculate & Pay Taxes on Bonuses
After you’ve decided on the sort of bonus you’ll provide, you’ll need to figure out how you’ll manage payroll taxes. Bonuses are taxed as additional compensation, and the IRS provides you with a few alternatives for taxing them. You have the option of paying the employee’s standard tax rate by including the bonus in their regular paycheck or paying it separately with a 22 percent withholding. When bonuses are involved, make sure you understand all of the numerous methods you might approach payroll.
Without specifying an amount, pay the bonus with a regular check.
The bonus tax rate will be the same as regular tax rates (7.65% FICA rates designated by law and income tax rates determined by the employee’s W-4 form) if you pay a bonus with an employee’s regular paycheck by simply adding it to the gross wages earned without differentiating the amount from regular wages.
You’ll also have to pay your share of FICA and unemployment taxes as the employer.
Bonuses should be paid using a separate bonus check.
Employee bonuses may also be paid via a separate paycheck, according to the IRS. If you choose this option, you have two options for taxing the bonus.
Option 1: Calculating Employee Bonuses Taxes
The first option is to withhold a fixed rate of 22 percent for taxes (no other percentages are permitted). Some of the better payroll software, like Gusto, allows you to execute off-cycle incentive payouts for free and will automatically deduct the 22% to keep you in compliance.
Option 2: Determining Employee Bonus Taxes
The second option is to compute how much in taxes to withhold by adding the bonus amount to the employee’s normal compensation for the previous pay period. Once you’ve added them up, you’ll need to figure out how much tax would have been withheld if the bonus had been paid out. Subtract the actual taxes paid in the previous period from the total. The difference is how much of the bonus check you should keep.
Let’s imagine you pay Sally a semimonthly wage, for example. Her first paycheck is for $2,000 on February 1st. You withhold $237 for taxes using her W-4 form and the IRS’ 2021 wage bracket tables to estimate appropriate tax rates. She is expected to get a $2,000 bonus on February 15th. Assume you’ve decided to pay her bonus separately from her normal income, based on her pay information from the previous quarter.
Here’s how to figure out how much tax you should withhold:
- Add the bonus to the earnings earned since the most recent base salary pay date, Feb. 1: ($2,000 normal salary + $2,000 bonus for a total of $4,000)
- Using the IRS tables, calculate the withholding on the total $4,000 to be $723.
- Subtract the amount withheld from wages on the most recent base salary pay date (February 1) from the total amount withheld ($723 – $237 = $486).
- Withhold $486 from the bonus payment, resulting in a $1,514 bonus payment to the employee ($2,000 bonus minus $486 taxes).
Bonus Checks for Gross-Up
You may use the tax gross-up approach to estimate how much of a bonus you need to provide if you want your workers to get a specified bonus amount after taxes (the net payment). To make this work, you’ll need to boost the bonus amount.
The steps to grossing up employee incentives are as follows:
- If appropriate, add all tax rates, including federal, state, and municipal.
- Subtract the overall tax rates from 1 (which equals 100%): 1 – tax rate equals the net amount paid to the employee.
- To calculate the gross bonus payment, multiply the net payment by the net percent.
- Multiply the gross payment by the tax rate, then deduct that figure from the gross payment to verify your answer. You should get the net bonus payment you requested for your employee.
Assume you’re a Florida business that gives a $500 incentive to an employee. Let’s go through the steps we spoke about before.
- There are no state or local income taxes to withhold since FICA taxes are 7.65 percent, the Federal supplementary wage rate is 22 percent, and there are no state or local income taxes to withhold. The total tax rate is 29.65% (7.65 percent + 22 percent).
- 0.7035 = 1 – 0.2965 (net percent to pay employee)
- $710.73 = $500 (bonus) / 0.7035 (gross bonus payment)
- Double-check the math:
$210.73 = $710.73 (gross payment) X 0.2965 (total tax rate) (taxes to be withheld)
$210.73 (taxes) – $710.73 (gross payment) = $500 (net pay for employee)
Conclusion
Employee incentives may be as easy as agreeing on a set amount to send to each employee or as complicated as collecting metrics, computing bonuses due, evenly splitting the bonus among workers, and grossing up to meet taxes.
Frequently Asked Questions
How much should employee bonuses be?
A: Employees should be paid bonuses based on their level of performance during their work. Bonuses should vary from 1-10% for low performers and 20-30% for high performers.
