Rewarding your employees for their hard work is crucial for keeping morale — and productivity — high. These days, many employers are forgoing the traditional model of raises in base compensation in favor of bestowing merit or holiday bonuses.
To help you determine if giving your employees bonuses is the best route for your business, here’s a review of the biggest benefits and drawbacks of this method:
Pro: Less long-term obligation than a raise
If you give an employee a raise following their review period, that’s an increase in salary you’re obligated to continue paying year after year — whether or not the employee continues to deserve that higher salary and whether or not you can afford to pay it.
Alternatively, bestowing a one-time bonus to recognize hard work gives you the flexibility to choose whether to give that bonus again next year or make this an isolated event.
“It’s easier to give bonuses in one year and not the next, rather than to give pay raises that are built into the employee's base compensation,” explains Jean Murray in an article for The Balance Small Business.
Con: It could set unrealistic expectations
Unfortunately, you can’t guarantee your employees won’t expect a bonus the following year. Any sort of payment — or lack of one — sends some sort of message.
As Gregory Hamel of the Houston Chronicle’s small business section points out, “Employees who receive bonuses one year and nothing the next year may feel disappointed, which can hurt morale.” As an example, Hamel describes a scenario in which a small business gives generous bonuses one year but can’t afford to do so the next year, and “employees might expect bonuses again even if the company doesn't have the money to pay bonuses.”
If you don’t address these potential signals and mitigate them right away, you could discourage morale instead of boost it.
It’s always wise to be clear up front about why you’re giving a bonus and if it’s a limited occurrence. And if you only give some employees bonuses, always have a well-defined, fair rationale for doing so.
Pro: You can receive a business tax deduction
If you’ve had a surplus of profits this year, it’s a wise financial move to hand out bonuses to your employees. Why? You can write off these additional compensations as deductions on your business taxes.
Murray explains, “Bonuses are a deductible business expense, in the category of ‘payments to employees.’” The IRS has strict guidelines for a bonus to qualify as a tax deduction, so consult the official regulations before acting.
Con: Bonuses are taxed at a higher rate
Unfortunately, the recipients of these bonuses may not feel their full impact. As Hamel points out, bonuses are subject to special tax withholding requirements that severely reduce how much money will initially wind up in the associate’s wallet. Typically, these involve a 25-35 percent tax rate in addition to the usual Social Security, Medicare, and state taxes.
Although some of that withheld money may come back after income tax returns are filed, your employee might not perceive the bonus as very generous at first.
If you decide granting bonuses is right for your business, consider which kind of bonus supports your goals best: incentive, profit-sharing, referral, productivity, or achievement. Then, establish clear expectations with your team. Otherwise, you may send the wrong message or reinforce the wrong behavior.