Some bonuses are easier to calculate than others. Performance-based bonuses depend on factors for which you may need to gather data, such as total sales revenue for the month or the number of new clients signed during the year. To pay nonperformance bonuses, you might need to set an arbitrary amount, like $1,000, or calculate payroll payouts based on individual salaries or work hours.
Gusto is a payroll software that, in addition to offering an unlimited number of pay runs, allows you to run a separate bonus payroll that withholds taxes per IRS guidelines or add it to the employees’ regular payroll at no additional cost. Sign up for a free trial today.
Calculating Performance-Based Bonuses
Performance-based bonuses can include individual sales incentives or sales commissions, department-wide incentives, and annual or quarterly performance compensation. They can usually be calculated with simple multiplication or division. Before you begin, you’ll need to determine the percentage you plan to use if basing employee bonuses on factors like sales or salaries.
To calculate a bonus for an employee who earns “X” dollars in sales, multiply the sales total by the bonus percentage you established.
For example, let’s assume Kara was responsible for $50,000 in client sales for the year. If you opt to pay each salesperson 10% of the sales they earn, Kara would have earned $5,000.
$50,000 x 0.10 = $5,000
If you want to pay bonuses based on goals reached by a particular department or team, be sure you know how many people are in each. To calculate, divide the total bonus you want to distribute by the number of employees who will be receiving it.
For example, assume the accounting department set a goal of lowering this year’s expenses by 2%, which it achieved by reducing expenses from $100,000 to $96,500. You decided that the department would earn $5,000 for the year if the goal is met. There are eight employees on the accounting team. How much would each employee receive?
The total bonus would be divided by the number of employees in the department to determine the bonus per employee:
$5,000 (total bonus) / 8 (total number of accounting employees)
= $625 bonus
Each employee in the accounting department should receive a $625 bonus for the current year.
Calculating Nonperformance-Based Bonuses
Nonperformance bonuses are an easy way to make sure all employees share in the incentives, and it simplifies bonus calculations for you. Some common bonuses not based on performance include percent of salary, holiday bonuses, retention or sign-on incentives, and referral bonuses.
Percent of Salaries
If you want to ensure all of your employees receive a bonus, consider basing it on their annual salary or wages. You could offer 3%, and everyone would receive a check. To calculate, you will need access to all employee salary or wage amounts. You may need to use prior-year figures to estimate annual wages for hourly employees (who don’t work consistent hours).
For example, to calculate the bonus for a graphic designer who earns $55,000 a year and a secretary who earns $30,000, you would multiply the bonus rate—let’s assume 3%—by their salary amounts.
$55,000 x 0.03 = $1,650 (bonus for graphic designer)
$30,000 x 0.03 =$900 (bonus for administrative assistant)
In this example, employees who are paid more in regular salary will receive a higher bonus. This could lead to some dismay since the bonus is determined by the type of position each employee holds, but it ensures every staff member receives a payout.
Sign-On & Retention Bonuses
Both sign-on and retention bonuses are usually paid as flat rates, which means there’s no calculation necessary if it’s all paid out at one time. For example, if your policy states to pay new employees who relocated for the job a $2,500 sign-on bonus, you will distribute that amount.
The terms of a bonus agreement or policy might indicate the bonus should be paid in increments, and if that’s the case, you will need to determine how much you should distribute and how often.
For example, let’s assume Sally accepted a nursing position that offered a $3,000 sign-on bonus to be paid out over the course of her first four months on the job. In this case, you would divide the total bonus by the number of months to find the monthly bonus distribution you will need to make.
$3,000 (bonus) / 4 (months bonus should be distributed)
= $750 per month
This means you will need to distribute $750 to Sally each month during her first four months.
Retention bonuses are calculated similarly but are usually paid out long after the employee is hired.
How to Calculate & Pay Taxes on Bonuses
Once you determine the type of bonus you want to pay, you need to decide how you will handle payroll taxes. Bonuses are taxable as supplemental wages, and the IRS gives you a couple of options on taxing the amount. You can opt to pay the employee’s regular tax rate by adding the bonus to their regular paycheck or paying it in a separate check and withholding 22%. Be sure you understand all the different ways you can do payroll when bonuses are involved.
Pay Bonus With Regular Check Without Specifying Amount
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, 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).
As the employer, you’ll also have to pay your portion of FICA and unemployment taxes.
Pay Bonus With Separate Bonus Check
The IRS also gives you the option to pay employee bonuses using a completely separate paycheck. If you decide to use this option, you have two choices on how to tax the bonus.
Option 1 for Calculating Taxes on Employee Bonuses
The first option is to withhold a flat 22% (no other percentage allowed) for taxes. Some of the best payroll software, like Gusto, gives you the option to run off-cycle bonus payments for free and will automatically withhold the 22% to help you maintain compliance.
Option 2 for Calculating Taxes on Employee Bonuses
The second option is to hypothetically add the bonus amount to the employee’s regular wages for the prior pay period to help you calculate how much in taxes to withhold. Once you add them together, you’ll need to determine the taxes that would’ve been withheld had the bonus actually been paid out. Then, subtract actual taxes paid for the prior period from that amount. The difference is what you should withhold from the bonus check.
For example, let’s say you pay Sally a semimonthly salary. Her Feb. 1 paycheck is $2,000. Using her W-4 form and the IRS’ 2021 wage bracket tables to determine applicable tax rates, you withhold $237 for taxes. On Feb. 15, she is due to receive a bonus of $2,000. Let’s assume that you’ve chosen to pay her bonus separately from her regular wages using the prior period’s pay information.
Here’s how to calculate how much you should withhold for taxes:
- Add the bonus amount to the amount of wages from the most recent base salary pay date, Feb. 1: ($2,000 in regular pay + $2,000 bonus = $4,000 total)
- Calculate the withholding on the combined $4,000 to be $723 using the IRS tables.
- Subtract the amount withheld from wages on the most recent base salary pay date (Feb. 1) from the combined withholding amount ($723 – $237 = $486).
- Withhold $486 from the bonus payment, meaning that the bonus payment made to the employee would be for $1,514 ($2,000 bonus – $486 taxes).
Gross-Up Bonus Checks
If you want your employees to receive a specific bonus amount after taxes (the net payment), you can use the tax gross-up method to determine how much of a bonus you need to give. You will have to increase the bonus amount for this to work.
Here are the steps you need to follow to gross-up employee bonuses:
- Sum all tax rates, including federal, state, and local, if applicable.
- Subtract the total tax rates from 1 (equivalent to 100%): 1 – tax rate = net percent employee will be paid.
- Divide the net payment by the net percent to get the gross bonus payment.
- Verify your answer by multiplying the gross payment by the tax rate and then subtracting that number from the gross payment. You should be left with the net bonus payment you were seeking for your employee.
For example, let’s assume that you are a Florida employer who’s paying a $500 bonus to an employee. Let’s follow the steps we discussed above.
- FICA taxes are 7.65%, the Federal supplemental wage rate is 22%, and there are no state or local income taxes to withhold. Total taxes are 29.65% (7.65% + 22%).
- 1 – 0.2965 = 0.7035 (net percent to pay employee)
- $500 (bonus) / 0.7035 = $710.73 (gross bonus payment)
- Verify the calculation:
$710.73 (gross payment) X 0.2965 (total tax rate)
= $210.73 (taxes to be withheld)
$710.73 (gross payment) – $210.73 (taxes)
= $500 (net pay for employee)
Paying employee bonuses can be as simple as deciding on a flat rate to distribute to each employee or as complex as tracking metrics, calculating bonuses due, dividing the bonus among employees in a systematic way, and grossing up to cover taxes.
However you choose to structure your bonus plan, Gusto can help make it an easy process. The software allows you to run a separate bonus payroll or add it into regular wages in your next payroll cycle. It only takes four to five steps to complete. Sign up for a 30-day free trial.