Non-discretionary vs discretionary bonuses: Do you know the difference?

Bonuses are a great way to show your hourly employees that you value them and their contributions to your business. But bonuses can also be complicated. Depending on how and why you reward your employees, it can affect your taxes, your employee’s overtime pay, and more. Before you shower your employees with gifts, it’s important to understand non-discretionary vs discretionary bonuses, how to calculate employee bonuses, and the best way to treat your team without affecting your bottom line.

What is a non-discretionary bonus?

A non-discretionary bonus is a form of additional compensation that’s tied to a metric or expectation. An employee needs to meet that metric or expectation in order to earn the bonus. If it’s a non-discretionary bonus, there’s no guesswork. Employees know exactly what’s required to earn their bonus and both employees and employers are clear on the parameters. Non-discretionary bonuses are often used to incentivize employees.

Let’s say you have a retail store and you offer a bonus to any employee that exceeds their monthly sales targets. If one of your employees has an incredible month and you reward them with extra pay, that’s a non-discretionary bonus.

Non-discretionary bonuses can include:

• Performance-based bonuses: These bonuses are given to employees based on performance against specific, pre-established goals or metrics. For example, a team of baristas might be promised a bonus if they exceed a customer satisfaction benchmark.

• Attendance bonuses: Some companies offer bonuses to employees who consistently maintain good attendance records or meet specific attendance criteria. These bonuses might be given to encourage punctuality and reduce absenteeism.

• Safety bonuses: If your business has a focus on workplace safety, you might offer non-discretionary bonuses to employees who adhere to safety protocols and contribute to a safe working environment. Safety bonuses can be a good way to reduce workplace accidents.

• Referral bonuses: Referrals are a great way to find top talent, so many companies offer bonuses to employees who refer qualified candidates. These bonuses are typically paid when the referred candidate is hired and successfully completes their probationary period.

• Compliance or certification bonuses: In certain industries, employees may need to maintain certifications, licenses, or compliance standards. Companies may offer non-discretionary bonuses as incentives for employees to get their credentials and ensure they stay current.

What is a discretionary bonus?

A discretionary bonus is the opposite of a non-discretionary bonus. These bonuses are based entirely on the discretion of the employer and have no pre-arranged parameters. Discretionary bonuses aren’t part of any employment contract or verbal agreement and there’s no expectation of pay. Employers tend to pay discretionary bonuses as rewards when employees go above and beyond their regular duties.

For example, if you own a restaurant and you surprise one of your servers with a $200 bonus for taking extra care with customers, that’s a discretionary bonus. There was no predetermined criteria for the bonus or expectation of pay from your employee.

Discretionary bonuses can include:

• Performance-based discretionary bonuses: Employers may choose to give discretionary bonuses based on exceptional individual or team performance. These bonuses aren’t contractually obligated or expected; they’re typically given as a reward for outstanding performance.
• Spot bonuses: Spot bonuses are spontaneous, unexpected bonuses given to employees for exceptional efforts. They’re often awarded as recognition for achievements like great customer service, ideas that help improve the business, or being an outstanding team member.
• Holiday bonuses: Some companies give discretionary bonuses during holiday seasons, like Christmas or New Year’s, as a gesture of appreciation and goodwill. These bonuses aren’t linked to performance, they’re just a nice way to recognize employees and boost morale.  
• Special achievement bonuses: Employees who have achieved significant milestones like 10 years with the company, or done something exceptional, like built a community partnership, might be awarded a special achievement bonus. These bonuses serve as an incentive to keep up the good work and recognize a high level of performance.

Why would you pay bonuses to hourly employees?

There are many reasons you’d pay bonuses to hourly employees, from incentivizing certain behaviors, to recognizing a job well done. Here are a few of the benefits of rewarding your hourly employees with bonuses.

Improved motivation and performance

By linking bonuses to performance, you can encourage hourly employees to improve their productivity and efficiency. When employees know that their efforts have a direct impact on their bonus earnings, they may be motivated to go the extra mile. Showing appreciation for hard work also boosts morale and contributes to employee happiness—and we all know that happy employees are productive employees.

More retention, less turnover

Bonuses can also help you retain your hourly employees by fostering loyalty. When employees receive bonuses, they feel valued and acknowledged, which can strengthen their commitment to your company. This can help reduce turnover and the costs that come with hiring and training new employees.

You can attract top talent

Offering bonuses can help you earn a reputation as an employer that rewards their employees’ efforts. It may even help you stand out in a competitive labor market. Potential hires might be enticed by the opportunity to earn additional income. Plus, everyone appreciates a company that recognizes and respects the people who work for them. Getting perks outside of base pay is a growing expectation of job seekers, and will likely stick around for the indefinite future.

Create a positive work environment

Bonuses can also foster a sense of fairness and equity. When employees feel their contributions are recognized and appropriately rewarded, it creates a more positive work environment. It can also foster teamwork and collaboration, and increase overall job satisfaction. Employees who look forward to coming to work are more likely to show up on time, respect break times, and follow internal policies. A positive work environment benefits everyone.

Discretionary vs non-discretionary bonuses: How they affect hourly employees overtime

Under the FLSA, all compensation for hours worked, services rendered, or performance is included in the regular rate of pay. According to their criteria, non-discretionary bonuses are included in an employee’s regular rate of pay. This is important because if non-discretionary bonuses can alter an employee’s regular rate of pay, they can also have an effect on the employee’s overtime rate.

You need to be careful about the amount of the bonus you’re offering to ensure it doesn’t lead to additional overtime pay. Otherwise you’re paying more than the bonus itself.

Discretionary bonuses don’t alter an employee’s rate of pay, so they can’t affect overtime. However, you need to be aware of a few exceptions. The following types of discretionary bonuses must be included in an employee’s regular rate of pay:

• Bonuses for quality and accuracy of work that employees are aware of ahead of time
• Any bonuses announced to employees to incentivize them to work in a certain way
• Attendance bonuses
• Safety bonuses for going a certain number of days without safety

Money that’s paid as a gift doesn’t affect an employee’s regular rate of pay. To be considered a gift, the payment can’t be tied to hours worked, production, or efficiency. Sign-on bonuses and holiday bonuses are most often considered gifts.

The best kind of bonus program for hourly employees

There are a few ways to offer your hourly employees bonuses without affecting your bottom line.

• Wait until the end of the tax year

When you know exactly how many hours your employee’s have worked, you can calculate their bonuses so they don’t result in overtime pay. This is especially helpful if you want to offer a non-discretionary bonus to reward or incentivize specific behavior.

• Make it a surprise

Treat your employees around the holidays, or at random intervals throughout the year when they’ve done a good job. As long as a bonus isn’t tied to specific metrics and it isn’t expected ahead of time, it doesn’t affect an employee’s regular rate of pay.

• Consider something other than cash

Cash might be king, but a gift is always appreciated. At the end of the day, a bonus is a meaningful way to acknowledge your employees and show them that you value their work. Just make sure the gift is of relatively low cash value to avoid tax implications for your employee and so it’s fully deductible for you.

How to calculate employee bonuses

Employee bonuses are typically calculated in three different ways: as a sales commission, as a percentage of salary, or as a flat rate. The best calculation depends on your industry, your specific business, and what kind of bonus you want to offer. Let’s look at the calculation for each so you can find the right fit.

Calculating by sales commission

Calculating by sales commission is best for companies with retail employees or any business where employees have the opportunity to earn commission. Many companies who want to incentivize sales performance offer sales commission. This type of bonus is performance based, so it’s a non-discretionary bonus. The following steps will help you calculate sales commission:

1. Determine the total sales your employee made
2. Determine the bonus percentage you want to offer
3. Multiply the employee’s total sales by total bonus percentage

For example, your employee made $7,500 in sales this year, and you want to offer 5% commision. The calculation you would use is: $7,500 x .05 = $375.

Your employee would earn a $375 commission bonus.

Calculating by percent of salary

Basing bonuses on your employees’ annual salaries or wages is a great way to ensure everyone gets a year-end bonus. Even though this type of bonus isn’t performance based, it’s still considered a non-discretionary bonus. To calculate this bonus, you’ll need all employee salaries or wage amounts, or an estimate from the prior year for hourly employees who may not work consistent hours. Follow these steps to calculate:

1. Determine the employee’s total salary
2. Determine the bonus percentage you want to offer  
3. Multiply employee’s salary by the bonus percentage

If an employee makes $35,000 per year, and you’re offering a 3% bonus, here’s the calculation: $35,000 x .03 = $1,050. Another employee who makes $47,000 per year would get $1,410.

Calculating flat-rate bonuses

Flat-rate bonuses are simple because there’s no calculation involved. These bonuses may be given when a new employee signs on, as a retention bonus for staying with your business for a certain period of time, or for a great referral. They can also be given as discretionary rewards like a holiday bonus or for outstanding performance. Flat-rate bonuses can be non-discretionary or discretionary depending on how they’re structured, and if the employee is expecting them.

Here are some examples of a flat rate bonus:

• You offer an employee a $100 bonus if they make it to the end of their probationary period.
• You give every employee a $50 gift certificate at the holiday party.
• Your employee recommended a friend and you hired them. You give them $50 as a reward for the referral.

You should remember that bonuses are taxable as supplemental wages, so you’ll have to factor that into your payroll. Make sure you understand how to stay compliant when you’re paying your hourly employees a bonus.

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Non-discretionary vs discretionary bonuses FAQs

What is the difference between discretionary and non-discretionary bonuses?

The difference between discretionary and non-discretionary bonuses is simple. In order to be considered non-discretionary, a bonus must have the following criteria:

• It’s tied to a clear metric or expectation.
• An employee needs to meet that metric or expectation in order to earn the bonus.
• Employees know exactly what’s required to earn their bonus
• An employee expects to be paid the bonus if they meet the predetermined metric

A discretionary bonus is the opposite of a non-discretionary bonus. Discretionary bonuses have the following criteria:

• They’re based entirely on the discretion of the employer
• They have no pre-arranged parameters
• They aren’t part of any employment contract or verbal agreement
• There’s no expectation of pay

Another important distinguishing factor is that non-discretionary bonuses can impact an  employee’s regular rate of pay, so they can contribute to their overtime hours. Discretionary bonuses don’t count towards an employee’s regular rate of pay. Both non-discretionary and discretionary bonuses are taxable.

What do you need to know to determine employee bonuses?

There are a few ways to calculate employee bonuses, so you’ll need to choose which one is right for your business. You can calculate your bonuses as a sales commission, as a percentage of pay, or as a flat rate.

If you go with a sales commission, you’ll need your employee’s total earnings and the percentage of commission you’re offering. If you’re giving bonuses as a percentage of pay, you’ll need your employees’ total salary or wages and the bonus percentage you want to give. And when you go with a flat rate, you just need to determine the size of the bonus; it doesn’t have to be a percentage of sales or salary.

You should also decide if you want to offer a non-discretionary or discretionary bonus. A non-discretionary bonus is tied to a metric or part of an employment contract. A discretionary bonus is offered as an unexpected reward for performance or a treat at the end of the year, it’s a discretionary bonus.

How do you know if your business would benefit from offering hourly employees a bonus program?

Any business could benefit from offering hourly employees a bonus program. Bonuses are a great way to incentivize everything from performance to teamwork, compliance, and retention. Benefits can include improved motivation and performance, less turnover and higher retention, and a more positive work environment.

Plus, if you develop a reputation as an employer who recognizes their employee’s efforts, you may be able to attract top talent. Acknowledge your employees’ work and reward them fairly so your employees are happier. Happier employees are more productive employees. Offering your hourly employees a bonus program benefits everyone.