Employers are generous but sometimes uninformed in December, handing out holiday gifts and bonuses without realizing the legal consequences. As an employer, you have to consider the tax and compensation consequences of your gifts. Bah Humbug!
The Fair Labor Standards Act divides bonuses into two categories: discretionary and non-discretionary. Discretionary bonuses must be decided in the employer’s sole discretion. They cannot be earned by any formula or used as a motivator or incentive. If they are truly discretionary (which is up to the employer to prove), cash bonuses do not have to be rolled into an hourly employee’s regular rate of pay on which overtime is calculated.
Holiday bonuses may be discretionary if they just fall like manna from heaven onto the employee without the employee knowingly working towards the bonus. Generally, the amounts, timing and basis for the discretionary bonus should not be announced in advance to avoid the appearance of being an incentive.
If the holiday bonus is earned by the employee by meeting certain announced criteria, then the bonus is non-discretionary and must be used to calculate overtime for hourly employees. Any kind of incentive compensation, production bonus, attendance bonus, performance bonus, safety bonus, longevity award or other motivating bonus must be considered non-discretionary.
The Department of Labor is always going to assume that a bonus is non-discretionary. If it is determined that a bonus is non-discretionary, the employer must include that bonus amount in the employee’s regular rate of pay to calculate a new and higher overtime rate for the period the bonus covers.
So if you have a quarterly incentive period, the bonus earned at the end of that quarter must be added to the pay earned during that quarter and all overtime pay earned during that quarter would have to be supplemented in the next paycheck. Example of making those calculations have been provided by the Department of Labor on this webpage.
If the DOL hasn’t dampened your holiday mood, the IRS also has something to say about your holiday gifts and bonuses. Non-monetary gifts of minimal value (no more than $75), such as the proverbial holiday turkey, can be given to employees without any tax consequences to the employee or the employer.
Monetary gifts of any amount, including gift cards, must be taxed, so that the employee and the employer are paying FICA and unemployment taxes on those amounts and the employee must also pay income tax (which the employer must withhold). So much for handing out gift cards to all of your employees this year.
Remember that your employees are highly motivated by cash bonuses and gifts. Don’t let the IRS and DOL spoil your fun during the Christmas season. Just be prepared to award only discretionary bonuses at Christmas and to deduct the required taxes from those monetary gifts.