What Are Bonuses and How Do They Work? (2022)

Think about the last time a checkout clerk offered you a bonus discount on an item or you came across a bonus feature in a movie. You probably felt pretty great, right?

People love the idea of bonuses because “extra” or “free” stuff is hard to pass up. It’s why we get excited as consumers, and also why they intrigue us when considering a job offer.

But bonuses come with a lot of caveats, too. Understanding how they work and why they’re provided in the workplace can help you choose between a job with poor compensation and one where you’re set financially. We’ll break ’em down so you come out feeling like a pro:

  1. What Is a Bonus?
  2. Why Do Companies Provide Bonuses?
  3. What Types of Bonuses Are There, and How Do They Work?
  4. Are Bonuses a Guaranteed Thing?
  5. Can Bonuses Be Negotiated?
  6. How Can I Ensure I’ll Receive a Fair Bonus?

1. What Is a Bonus?

A bonus is “a form of compensation that’s not guaranteed and that is usually paid after the completion of a certain event,” says Adi Dehejia, The Muse’s Chief Financial Officer.

Bonuses come in many shapes and sizes (all of which we’ll explain later), but generally speaking they’re performance-based, meaning a company distributes them based on how an employee or group of employees contributes to team or company goals—typically revenue-based ones.

That said, a lot of bonuses are discretionary, meaning rather than the bonus being tied to a specific quota, your level, or your performance, a manager simply gets to decide who is and isn’t worthy of one, as well as how much the bonus is.

As you can imagine, this makes bonuses a pretty complicated subject for companies and employees alike.

2. Why Do Companies Provide Bonuses?

Often bonuses are provided because that’s what the market tells companies to do. If other organizations of similar size, industry, or geography are offering their employees bonuses, a company may feel obligated to do the same to compete for good talent. This is why you’ll rarely find a sales role without a bonus structure.

They also want to hire people who they know are going to perform, and when there’s a reward for output you’ll attract a certain kind of person.

But the main reason employers are drawn to bonuses is because they encourage employees to work hard to help the company succeed. “They want to align incentives—like, ‘You do well if the company does well,’” says Dehejia. And it tends to pay off—people who know they can make more money by bringing in more revenue, whether directly (like sales) or indirectly (like marketing or executive leadership) are going to be highly motivated to do so.

(Video) Understanding signing bonuses

“They’re trying to share the risk between the company and the individual,” adds Dehejia. When a company does poorly because of poor performance, the employee pays the price with lower compensation—as opposed to someone with no bonus structure who gets paid the exact same way no matter how well the company does.

Some people may find this concept stressful. But the flip side—having a yearly salary without a bonus—means there will be times where you work extra hard and aren’t compensated for that work. It’s a trade-off, and one certain people are willing to make.

Dehejia notes that bonuses are never meant to be the sole driver of employee retention and motivation. Compensation is one means to drive performance, but “it doesn’t substitute for management, [and] it doesn’t substitute for praise, learning and development, training, [and] opportunities,” he says. That’s why companies should always be thinking about the value of their bonus plans and balancing them with other perks and benefits.

3. What Types of Bonuses Are There, and How Do They Work?

Some bonuses are distributed quarterly, others yearly. Some are a one-time thing, others are recurring. It all depends on what role you’re in, what level you’re at, what you contribute, what your leadership is like, and what kind of company you work for (among many other things).

Annual Bonus

An annual bonus is usually based on overall company performance. So you may get a large or small bonus (or no bonus at all) depending on how successful your organization or specific department was that year, as well as how big a part of that success you were. This can also be considered “profit sharing.”

The reason companies wait a full year before paying you is simply because it means you have to stick around longer—which is why very few people leave their jobs before collecting their yearly bonus. It’s also, again, tied to company goals, so they want to ensure they’re driving performance for all 12 months, not just a chunk of the year.

Spot Bonus

A spot bonus is for people who go above and beyond and is “usually tied to a task that was outside the scope of your role,” says Dehejia. If, for example, you helped out with a special project, worked extra hours, or played an integral part in the company’s success in an unexpected way, your manager can use their discretion to offer you some additional compensation. It’s normally a one-time thing, if not an occasional occurrence depending on budgeting, priorities, and your leadership.

Signing Bonus

A signing bonus is a one-time bonus provided when you sign on to a new role. Companies might offer it when an employee is walking away from something better, or if the employee is moving to a new city for the job and the company wants to cover some of the costs (this could also be in the form of a relocation bonus or package). It’s also a way for employers to make up for salary demands they can’t meet. Basically, it’s to incentivize candidates to accept the job.

“And then generally speaking there’s a clause in your employment contract...which says that if you leave before a certain amount of time, typically a year, you owe the money back to the company,” says Dehejia. Unfortunately, it’s hard for companies to enforce this. The risk that companies take is hoping that the bonus actually gets you over the first-year hump and encourages you to stay on longer.

Retention Bonus

A retention bonus, similar to a signing bonus, is about retaining valuable talent. It’s typically provided during an acquisition, merger, or big company restructuring to convince someone to stick around for an extra period of time, if they were looking to leave or have a competing offer elsewhere.

(Video) 6 Types of Bonuses I Give To My Employees

“Retention bonuses are really paid on the backend,” explains Dehejia, meaning you don’t get it until the time period is up.

Referral Bonus

A referral bonus is meant to encourage current employees to refer great candidates for jobs at their company. It’s typically not given until the candidate is hired and has stayed on for several months.

The bonus itself, Dehejia says, has to “be interesting enough that you actually refer someone,” so it’s usually a good amount of money depending on the job and level—anywhere from $1,000 to several thousand. “Sometimes they just do [a] flat [rate] for every role, some companies do a higher amount for roles that are harder to fill,” he adds.

Holiday Bonus

Also known as a “13-month salary” or “Christmas bonus,” a holiday bonus is another way to recognize employees for a hard year’s work, and to give them an extra boost during an especially expensive time of year. It’s a lot more common for companies based outside the U.S. It’s often—but not always—a set percentage of your annual salary, say anywhere from 5% to 10%.

Commission

Like bonuses, a commission is considered “non-guaranteed compensation,” but legally they’re often defined separately, and they work slightly differently.

Commission is about individual performance. Tons of jobs work under a commission structure (like sales, account management, real estate, finance, and recruiting, to name a few) and payment can be distributed monthly, quarterly, or yearly, depending on the plan and when commission is considered “earned.” (For example, “earned” may be defined as when a client signs a contract, meaning that the employee who sold the deal won’t get their commission until a signature is collected and the deal is verified.)

Commission can be a set percentage—say, a recruiter gets an amount equal to 15-20% of their hire’s first-year salary—or can be defined by a formula, the idea being that everyone at the exact same level has the same formula. This makes it easy for companies both to measure success and hand out compensation and avoid being accused of favoritism.

Your commission is generally tied to a quota or goal, which can be a dollar amount, an amount of items sold, or an amount of closed deals or booked meetings. The idea is that if you get to 100% of your quota, you’ll earn 100% of your commission.

4. So Are Bonuses a Guaranteed Thing?

The short answer is no. Most bonuses are discretionary and an addition to someone’s salary, making it practically impossible to force companies to provide them. And there’s no real federal law that states you have a right to a bonus.

If employment is at-will this means a company can fire you without cause or compensation. “So unless you have a written contract, there’s no guarantee that you’re going to get anything. As long as [the bonus is] discretionary, they can do whatever they want,” says employment attorney Brian Heller, a partner at Schwartz Perry & Heller, LLP.

(Video) How employers competing for workers turn to $100K signing bonuses

Commission does sometimes fall under the category of mandatory compensation. New York State Labor Law, for example, states that any “earned” commission is “legally considered wages and must be paid to the salesperson,” even if that person is fired, laid off, or leaves a job.

But allowing companies to define what “earned” means gives them a lot of leeway. “There [are] a lot of bonuses that say you have to be working for the company when the bonus is issued in order to get it,” says Heller. So if you’re terminated (or leave) before your bonus or commission is paid out, you may not technically be entitled to it, even though you feel you’ve rightfully earned it.

And there’s nothing stopping companies who do provide bonuses from divvying them up unequally amongst employees. “Favoritism is not against the law, unless it’s based on some type of discrimination,” Heller adds.

5. Can Bonuses Be Negotiated?

If you truly believe you deserve more, it’s worth negotiating in some way. This is the case for salary as well as bonuses.

Chelsea Williams, a Muse career coach and Founder and CEO of College Code, advises that bonuses be negotiated “before a formal contract is shared”—a.k.a., before you’ve agreed to or signed anything—and that you should “go into the conversation with a clear target—of course this target should be higher than what you truly are hoping to receive.”

Theresa Merrill, a salary strategist and interview coach on The Muse, worked with a client who would have ended up with a gap between jobs based on their offered start date. “[We] asked for a signing bonus to cover that period of time. First, we asked for an increase in the salary and commission. I always advise clients to negotiate that first. But if you can’t move them on that, then go for the signing bonus. Companies would rather pay that than increase the salary,” she says.

And she argues, don’t just settle for the first offer you get if it doesn’t seem like enough. “If they offer 8K, ask for 10K. Most job seekers get so excited when a signing bonus is extended, they forget to do that.”

She outlines several times when you have the upper hand and thus it’s worth negotiating for a signing bonus:

  • When you have multiple companies interested in you—whether you have official offers or have moved on to the second or third round of interviews. “I had a client who was trying to negotiate an offer and the recruiter asked, ‘Do you have other interested parties? That’s something I can go back to the company and present as a reason to up your salary,’” she explains.
  • When the recruiter or hiring manager is the one who pursued you first
  • When you’re leaving an established company to join a startup
  • When you’re moving to another city
  • When you’re accepting a salary that’s less than what you were making previously

Doing your research and having proof is key. “In all cases, strong performance both on behalf of the company and individual are necessary for effective negotiation,” says Williams. You can ask for a certain number, but if you’re not a high achiever with tangible evidence of your accomplishments or they’re clearly not bringing in a lot of money as a company, you’re not going to make them budge. And you should also understand market trends and what others are making in your position to fully back up your claims (these salary calculators can help with gathering the facts).

But the best way to be successful is to simply be confident in your approach. Merrill suggests using phrases such as “I will sign the offer letter today if you can add a $X signing bonus” or “I’m looking at a comparable role where the salary is X% greater. How can you close that gap?” Again, there’s no guarantee it’ll work, but if you walk in as someone who’s well-informed and self-assured, you’re more likely to get what you want.

(Video) Are Bonuses Taxed Differently Than Regular Salary? (HOW ARE BONUSES TAXED)

6. How Can I Ensure I’ll Receive a Fair Bonus?

Any time you consider accepting a job it’s important to read the fine print and ask thoughtful questions. This especially applies to roles where there’s a bonus structure. As we’ve explained, nothing is a guarantee, so when a bonus makes up the bulk of your income you should know your stuff going in.

Understand how you’re going to be paid. If you’re in an interview, you can ask questions like, “What is the bonus structure for this role?” or “How do bonuses work here?” They may not provide you with an exact number (often because it’s dependent on so many factors), but even a range of pay or idea of how they think about bonuses can be helpful in understanding how they value their employees.

One thing to note is that you should never be having the conversation around money until you’re in the final round of interviews. And don’t just take the interviewer’s word for it—lean on your network to get a sense of what people in similar roles are being paid and whether or not this offer holds up.

Another thing to remember is that if it sounds too good to be true, it probably is. If, for example, a company is touting an unusually large bonus, there could be a ton of hidden factors: Your quota to reach it could be unattainable, the bonus could be highly dependent on the company’s performance, or the bonus could be a cover-up for the company paying you much less in base salary.

Also, weigh the pros and cons of the bonus itself and if there are better opportunities available to you. A signing bonus may seem like a lot of money up front, but consider if you were to negotiate a higher salary (or pursue another role with no signing bonus), you might make more in the long run.

Speaking of the long term, understand what accepting a bonus means for your salary trajectory. If your base salary is fairly low (with a bonus making up the bulk of your income), that could affect how you negotiate your compensation down the road, whether you pursue another opportunity in your field or change careers. So always consider first whether you can increase your base rather than your bonus to set yourself up for a better financial situation moving forward.

If a bonus seems reasonable, get it in writing—either through a formal contract or an informal email—and make sure you read all the details and fully comprehend what achieving that bonus means.

“You can’t take any promises at face value about what you’re going to get. Unless they’re in writing, they’re generally not enforceable,” says Heller.

Always assume the worst and factor in what would happen if you didn’t receive that bonus for whatever reason. Would you still be able to pay rent? Afford groceries? Do you still have a decent base salary to work with?

This means thinking about taxes, too. Bonuses are usually considered “supplemental wages” by the IRS, which means that they’re often taxed at a higher rate than your regular paycheck (read this article for more information on how bonuses are taxed).

(Video) How do bonuses work?

Finally, be willing to put in the work of being in a role where your pay heavily depends on your performance. It’s not for everyone, but plenty of people thrive off this kind of motivation—so know yourself and know exactly what responsibilities you’d be taking on before deciding.

It’s human nature to care about money. And if there’s one thing you take away from this article, it should be that understanding how your salary works—including how bonuses are involved—is so, so important.

But so many other factors—company culture, management, team goals—matter just as much in finding a job you’re willing to work hard in and an organization you’re excited to grow at. So make sure you’re looking at the whole picture when deciding your career path. You may find that the extra compensation matters a lot less than the opportunities presented to you.

FAQs

What Are Bonuses and How Do They Work? ›

Bonuses are a type of compensation paid to an eligible employee in addition to a previously set hourly wage, contract amount or annual salary. While many companies provide bonuses in the form of cash, a bonus can really take any form as long as it provides value to employees as well as the organization.

How do the bonuses work? ›

A bonus is a financial compensation that is above and beyond the normal payment expectations of its recipient. Bonuses may be awarded by a company as an incentive or to reward good performance. Typical incentive bonuses a company can give employees include signing, referral, and retention bonuses.

What is the difference between a salary and a bonus? ›

In broad terms, 'salary' refers to the weekly or monthly compensation that the employee or office holder receives for doing their job; and 'bonus' refers to a one-off amount paid in recognition of the individual having hit a target, or the company having performed well.

How much do you get for a bonus? ›

Executives tend to receive higher bonuses that can multiply based on performance, while most employees earn bonuses equal to 1% to 5% of their overall salary.

Why do companies give bonus instead of salary? ›

Raises and bonuses boost morale, incentivize employees, and ensure that staff feel rewarded and appreciated. Raises are a permanent increase in payroll expenses; bonuses are a variable cost and therefore give business owners greater financial flexibility when business is down.

Do bonuses get taxed? ›

In California, bonuses are taxed at a rate of 10.23%. For example, if you earned a bonus in the amount of $5,000, you would owe $511.50 in taxes on that bonus to the state of California. In some cases, bonus income is subject to additional taxes, including social security and Medicare taxes.

Which is better salary or bonus? ›

The unanimous opinion seems to be that higher base pay is always preferable in the long run to a one-time signing bonus. A signing bonus is a one-time lump sum of money offered to a prospective candidate at the time of the contract signing.

What is a typical bonus structure? ›

A company sets aside a predetermined amount; a typical bonus percentage would be 2.5 and 7.5 percent of payroll but sometimes as high as 15 percent, as a bonus on top of base salary. Such bonuses depend on company profits, either the entire company's profitability or from a given line of business.

Do employers pay less taxes on bonuses? ›

When it comes to actually paying taxes on your bonus, your employer has two options: the percentage method or the aggregate method. The percentage method is simplest—your employer issues your bonus and withholds taxes at the 22% flat rate—or the higher rate if your bonus is over $1 million.

What is a negative of getting a bonus? ›

THE CONS. You could see a bigger tax bite on that money. Depending on how your company chooses to pay out your bonus, either as a separate check or as part of your regular paycheck, you could be subject to a bigger tax withholding because your bonuses are categorized as supplemental income.

What are the disadvantages of bonus system? ›

Another potential disadvantage of employee bonuses is that they can foster competition between employees rather than collaboration. For instance, if a small business offers bonuses based on hours worked during the year, employees may be less willing to share work with one another.

Does a bonus increase your salary? ›

1. Bonuses Are Usually Calculated as a Percentage of Your Base Salary. This means that having a higher base salary will also improve your bonuses in most companies. This doesn't work in reverse, though; negotiating for a higher bonus does nothing for your base salary now or in the future.

What is an average bonus 2022? ›

As of Aug 31, 2022, the average annual pay for a Bonus On in the United States is $55,350 a year.

Is bonus a part of salary? ›

Calculation of bonus: Salary/wages and dearness allowance (DA) are included while calculating bonus. However, other allowances such as over-time, house rent, incentive or commission are not included.

What does it mean when your boss gives you a bonus? ›

A bonus payment is additional pay on top of an employee's regular earnings. A bonus payment can be discretionary or nondiscretionary, depending on whether it meets certain criteria. Bosses hand out bonus payments for a variety of reasons, including as a reward for meeting individual or company goals.

Why is my bonus taxed at 40 %? ›

Bonuses are taxed heavily because of what's called "supplemental income." Although all of your earned dollars are equal at tax time, when bonuses are issued, they're considered supplemental income by the IRS and held to a higher withholding rate. It's probably that withholding you're noticing on a shrunken bonus check.

How can I pay my bonus without paying taxes? ›

Bonus Tax Strategies
  1. Make a Retirement Contribution. ...
  2. Contribute to a Health Savings Account (HSA) ...
  3. Defer Compensation. ...
  4. Donate to Charity. ...
  5. Pay Medical Expenses. ...
  6. Request a Non-Financial Bonus. ...
  7. Supplemental Pay vs.
Apr 1, 2022

Are Christmas bonuses taxable? ›

Key takeaway: Holiday bonuses are subject to federal and state income tax, as well as FICA tax, and withholding may be higher when you include bonuses in employees' paychecks than when you give separate checks.

How much of a bonus is taxed? ›

A bonus is always a welcome bump in pay, but it's taxed differently from regular income. Instead of adding it to your ordinary income and taxing it at your top marginal tax rate, the IRS considers bonuses to be “supplemental wages” and levies a flat 22 percent federal withholding rate.

How much is a typical Christmas bonus? ›

Known sometimes as a “13-month-salary,” the Christmas bonus is one given to employees at the end of the year. This practice will depend on the company's size, resources and financial performance, but the average holiday bonus is reportedly around $1,800, though the range could be anywhere from $100 to $5,000.

When should an employee get a bonus? ›

Many employers provide cash gifts for employees. Holiday bonuses are typically given at the end of the year, near Christmas or New Year's. Even though employees might think year-end bonuses are guaranteed, they are often at your discretion. You choose to give the bonus and how much to give.

Do bonuses show up on w2? ›

When your employer provides you with a bonus, they will report it on your W-2 in box 1—but it's combined with your normal wages or salary. In the eyes of the Internal Revenue Service, your bonus is no different than the salary you receive.

Are bonuses taxed twice? ›

The short answer: you aren't taxed any differently on your bonus income. The IRS just uses a different methodology to withhold taxes from paychecks where you only receive bonus income. If your bonus was lumped into a regular paycheck, the calculations will likely result in more federal income tax withheld, too.

Can you give an employee a bonus without taxes? ›

Are employee bonuses taxable? Yes, employee bonuses are considered taxable income. In the eyes of federal and state tax authorities, employee bonuses are another form of employee income, so as with the standard wages you pay your employees, any bonuses you give your employees are taxed.

What does a 20% bonus mean? ›

20. Assume, for example, your base salary is $3,000 per month. Determine the amount of your bonus by multiplying $3,000 times . 20 to get $600.

Is a 7% bonus good? ›

What is a Good Bonus Percentage? A good bonus percentage for an office position is 10-20% of the base salary. Some Manager and Executive positions may offer a higher cash bonus, however this is less common.

What does 200% bonus payout mean? ›

200% Source: Salary.com. Suppose that your target bonus is 20 percent of a base salary of $100,000 and you performed at the maximum performance level. That means you would earn 200 percent of that 20 percent bonus, or 40 percent.

What is a typical bonus structure? ›

A company sets aside a predetermined amount; a typical bonus percentage would be 2.5 and 7.5 percent of payroll but sometimes as high as 15 percent, as a bonus on top of base salary. Such bonuses depend on company profits, either the entire company's profitability or from a given line of business.

Is it better to have a higher base salary or bonus? ›

In any salary negotiation, go for a base salary increase first. This is because the base salary will remain unchanged long-term, while bonuses can fluctuate depending on the company's performance over a specified period.

How much of a bonus is taxed? ›

A bonus is always a welcome bump in pay, but it's taxed differently from regular income. Instead of adding it to your ordinary income and taxing it at your top marginal tax rate, the IRS considers bonuses to be “supplemental wages” and levies a flat 22 percent federal withholding rate.

Is bonus a part of salary? ›

Are bonuses part of the salary? Bonuses are usually calculated as a percentage of your Base Salary. This means that having a higher base salary will also improve your bonuses in most companies.

Do employers pay less taxes on bonuses? ›

If your employer delivers the bonus to you as part of your regular paycheck, it will be taxed like regular income. If it's delivered with a separate check, it's taxed as supplemental income. The difference is that supplemental income is taxed at a flat 22% while regular income is taxed at your regular rate.

What are the different types of bonus? ›

3. What Types of Bonuses Are There, and How Do They Work?
  • Annual Bonus. An annual bonus is usually based on overall company performance. ...
  • Spot Bonus. ...
  • Signing Bonus. ...
  • Retention Bonus. ...
  • Referral Bonus. ...
  • Holiday Bonus. ...
  • Commission.
Jun 19, 2020

How much is a typical Christmas bonus? ›

Known sometimes as a “13-month-salary,” the Christmas bonus is one given to employees at the end of the year. This practice will depend on the company's size, resources and financial performance, but the average holiday bonus is reportedly around $1,800, though the range could be anywhere from $100 to $5,000.

Do new employees get bonuses? ›

A sign-on bonus is given after the candidate accepts the job offer. Some companies pay the sign-on bonus in one lump sum after the new employee signs the paperwork for a new job. Others pay out the bonus in increments over the first year of the job.

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