Performance Bonus

A performance bonus is a cash payment made in addition to salary because something was achieved: a company result, a team result, an individual scorecard, or some combination. It is usually annual, usually expressed as a percentage of base salary at target, and usually paid a month or two after the period it covers, once results are known and approved.

It is worth separating from its neighbors at the outset, because four different payments share the word bonus. A signing bonus pays for joining rather than for performing. A retention bonus pays for staying to a date. A commission is a percentage of sales the employee personally generated. A performance bonus is paid for a result over a period, and the amount is normally not fixed in advance.

Target is not a promise, and the difference is where most disappointment comes from. A "15% bonus" normally means 15% of base salary if the plan pays exactly at target. What actually arrives is target multiplied by a payout percentage produced by the plan's scorecard, which can be well below or somewhat above 100%. Whether the components multiply or add, whether a company gate has to be cleared before the individual portion pays at all, and whether there is a cap are all plan design questions, and the plan document answers them. Anyone comparing job offers on target bonus alone is comparing two numbers neither employer has promised.

Proration is normal and rarely explained. Someone who joins partway through the period, changes roles, or moves to part-time hours will generally receive a pro-rated award, and the fraction is usually months of service over months in the period. Time on some kinds of protected leave may or may not count, which is a plan and state-law question rather than a matter of custom.

The "employed on the payment date" clause is often the most consequential line in a bonus plan. It conditions payment not on doing the work but on still being there when the check is written, which for a calendar-year plan paid in the following March means a resignation in February can forfeit a full year of qualifying performance. Whether that condition is enforceable against an employee who has already earned the award is a question of state wage law and the plan's own wording, and the answer differs from state to state. What is universal is that the clause is worth reading before resigning, not after.

The legal line is discretionary against promised, and the label on the plan does not decide it. Under the Fair Labor Standards Act a bonus is excluded from an employee's "regular rate" only where, in the statute's own words, "both the fact that payment is to be made and the amount of the payment are determined at the sole discretion of the employer at or near the end of the period and not pursuant to any prior contract, agreement, or promise causing the employee to expect such payments regularly". The Department of Labor's regulation is blunt about what defeats it: "If the employer promises in advance to pay a bonus, he has abandoned his discretion with regard to it." And it lists what falls the other way, saying that bonuses "announced to employees to induce them to work more steadily or more rapidly or more efficiently or to remain with the firm are regarded as part of the regular rate of pay", naming among them "bonuses contingent upon the employee's continuing in employment until the time the payment is to be made".

Two consequences follow, and the second one is a small irony worth noticing. First, a plan document circulated in January describing targets and a payout formula is a promise, and 29 CFR 778.211(d) states plainly that "labels are not determinative", so calling it a discretionary bonus does not make it one. Second, the very clause employers add to keep the money from leavers, requiring employment on the payment date, is itself named in the regulation as a characteristic of a bonus that belongs in the regular rate. The clause that protects the employer on departures moves the bonus into the category that costs it more in overtime.

What that means in practice depends entirely on whether the employee is exempt. For an exempt salaried employee, none of this changes anything: there is no overtime to recompute. For a non-exempt employee who worked overtime during the period the bonus covers, a nondiscretionary bonus has to be spread back over those weeks and additional overtime pay owed for each of them. That arithmetic, and worked examples of it, belong to the overtime entry, which covers them in full. The point here is only that the classification of the bonus decides whether the arithmetic happens at all.

The tax treatment is separate from all of this. A bonus is supplemental wages, so employers commonly withhold federal income tax on it at a flat rate rather than at the employee's own rate, which is a withholding rule and not a higher rate of tax. The mechanics belong to the bonus withholding entry.

1. The plan sets a target. Usually a percentage of base salary, sometimes a flat dollar amount, stated for a full period at full-time hours.

2. The period is measured. Company results, team results and individual performance are scored against whatever the plan specifies.

3. A payout percentage is approved. Target is multiplied by that percentage, and the result is prorated for anyone who was not there for the whole period.

4. The forfeiture condition is applied. If the plan requires employment on the payment date and the employee has gone, nothing is paid.

5. The payment is made as supplemental wages, with tax withheld, and for a non-exempt employee an additional overtime recalculation may be owed for the weeks the bonus covers.

A hypothetical example of the two things that move the number. Rafi has a base salary of $95,000 and a target bonus of 15%, so his target award is 0.15 × $95,000 = $14,250.

His plan weights the award 60% to a company measure and 40% to his own scorecard. The company portion pays at 80% of target and his individual portion at 120%. The company piece is 0.60 × $14,250 = $8,550, paid at 80%, which is $6,840. His individual piece is 0.40 × $14,250 = $5,700, paid at 120%, which is also $6,840. The award is $6,840 + $6,840 = $13,680, or 96% of target, despite one component beating target by as much as the other missed it.

Now proration. Rafi joined on April 1, so he was employed for 9 of the 12 months. His prorated award is 9/12 × $13,680 = $10,260.

And then the clause. The plan pays in March of the following year and requires employment on the payment date. If Rafi resigns in February, the entire $10,260 is forfeited, for work that was finished, scored and approved. All figures are illustrative.

Pros

• It raises total pay above base salary without permanently raising the employer's fixed cost, which is part of why it is offered at all.
• Because it is recalculated each period, it can reward a strong year in a way a salary increase applied months later cannot.
• A plan with a written formula gives the employee something specific to understand and, at review time, something specific to point at.
• For a non-exempt worker, a promised bonus also increases the overtime already earned during the period it covers.

Cons

• Target is a planning figure, not an entitlement, so a household that budgets around it is budgeting around an estimate.
• The employment-on-payment-date condition can forfeit a full period of earned performance over a few weeks of timing.
• Discretionary plans give the employee no contractual claim at all, and the employer decides both whether and how much.
• Company-level components can wipe out an excellent individual year for reasons entirely outside the employee's work.
• Flat supplemental withholding often takes more or less than the eventual tax, so the amount landing in the account is a poor guide to what was actually earned.