Bonuses are an important part of employee compensation. If you are currently offering bonuses, or are thinking about offering them, this article is for you!
Bonuses offer additional compensation, above and beyond an employee’s regular salary or wages. They are typically given to recognize and incentivize employee performance, contribution, or commitment to the company. Some questions that you might consider are:
- What types of bonuses are there?
- Do all bonuses need to be reported on the employee’s W-2?
- Can I purchase gift cards for my employees as performance or spot bonuses without having to report it on their W-2 as income?
- Can the cost of the bonus be passed directly on to the government contract the employee works on?
- Can I include bonuses in my government rates?
It is important to know that your bonus policy should be explained in detail with the expected pay out of the bonus included in your employment contracts, employee handbooks, and other policy and procedures manuals. (SPOILER ALERT! BOOST, LLC can help you with guidance and drafting of these documents.)
WHAT TYPES OF BONUSES ARE THERE?
- Performance Bonus: Performance bonuses are given to employees based on their individual or team performance. Often, they are tied to specific goals, targets, or key performance indicators (KPIs) that employees need to achieve.
- Year-End or Holiday Bonus: These bonuses are offered during the holiday season or at the end of the fiscal year as a token of appreciation for an employee’s hard work throughout the year. Typically, these are fixed amounts or based on a percentage of the employee’s annual salary.
- Profit-Sharing Bonus: Profit-sharing bonuses are just what they sound like. Based on the financial performance of the company, the employee receives a portion of the profits as a bonus. Generally, the distribution is based on predetermined criteria, such as the employee’s salary and/or time with the company.
- Retention Bonus: A retention bonus is offered to employees to encourage them to stay with the company for a specific period of time. It is often used during mergers, acquisitions, or other situations where retaining key employees is essential.
- Signing Bonus: Employers may offer signing bonuses to new hires as an incentive to join the company. Typically, these bonuses are paid out when the employee accepts the job offer or within the first pay period with the company. These vary in amount depending on the position, industry, and needs of the company.
- Spot Bonus: Spot bonuses are similar to performance bonuses in that they are given to employees to recognize exceptional performance. However, these bonuses are usually spontaneous and given for efforts or contributions that go above and beyond their regular duties. They are often NOT tied to specific goals, rather they are intended to show appreciation.
- Discretionary Bonus: Discretionary bonuses are given at the employer’s discretion to reward employees for exceptional efforts or to acknowledge their loyalty and dedication. They may or may not be tied to specific criteria or targets.
DO ALL BONUSES NEED TO BE REPORTED ON THE EMPLOYEE’S W-2?
The short answer to this is ALWAYS refer to your HR, Payroll, or Tax Professional to determine reporting. The shorter answer to this question is Yes. Here is the long answer:
Depending on what you consider a bonus, some items may be exempt from W-2 reporting. It is important to note the IRS has stated any “cash or cash equivalent items provided by an employer are never excludable from income.” Some small, non-cash gifts with a nominal value may not need to be reported on the W-2. The catch is, what qualifies as a “nominal value”? The IRS spells out what “nominal value” is under Internal Revenue Code section 132(a)(4).
The hard and fast rule for nominal value is any item that exceeds $100 in value, even under unusual circumstances. Frequency has a role to play in the nominal value guidelines as well. The small, non-cash gift should be occasional or unusual in frequency. It should NOT be disguised as compensation. Achievement awards would be exempt from employee wages as long as it is “awarded as a meaningful presentation AND is NOT cash, cash equivalent, vacation, meals, lodging, theater or sports tickets, or securities.” You can find more about this topic here.
CAN I PURCHASE GIFT CARDS FOR MY EMPLOYEES AS PERFORMANCE OR SPOT BONUSES WITHOUT HAVING TO REPORT IT ON THEIR W-2 AS INCOME?
Any cash or cash equivalents cannot be excluded from taxable income. If you were hoping to avoid your employee having to pay taxes on a bonus, gift cards are not the answer. However, if a client gives employees bonuses that include their taxable portion, essentially the employer pays the taxes for the employees, making the employee net the total of the intended bonus (i.e., a $500 bonus would be given as $600 so the net after taxes would be the intended $500). This can be a tricky calculation so enlist the help of your payroll provider to navigate this endeavor. Again, the short answer remains: ALWAYS refer to your HR, Payroll, or Tax Professional!
CAN THE COST OF THE BONUS BE PASSED DIRECTLY ON TO THE GOVERNMENT CONTRACT THE EMPLOYEE WORKS ON?
Billing the government contract for employee bonuses depends on several factors and should be handled with extreme care as violating government contract regulations can have serious legal and financial repercussions. First and foremost, ALWAYS refer to your Contracts Team, HR, and Government Accounting professionals to help determine the ability to do so. Some factors to consider are specific terms of the contract, government regulations, and the purpose of the bonuses. Here are some key considerations:
- Contract Terms/Modifications: Review the terms and conditions of your government contract carefully. The contract will specify what costs are allowable and will reference the federal regulations that dictate which costs can be charged to the government. If you included bonus payments in your bid and proposal, this will likely be addressed in your contract award document. If not, you may be able to request a modification to do so. Work with your Contracting Officer Representative (COR) and/or your Contracts Team to negotiate this. If you need Contracts assistance, please let us know as that is a service we gladly offer.
- Allowable Costs: Employee bonuses may be considered allowable costs if they are reasonable, allocable, and directly related to the performance of the contract. The type of contract (i.e., Time & Materials, Firm Fixed Price, etc.) may determine the allowability of the bonus cost. Again, refer to the specific provisions in the contract, your Contracts Team, and your Government Accounting professionals.
- Allocability: To charge employee bonuses to a government contract, you must prove the bonuses are allocable to the contract. This means showing a direct relationship between the bonus and the work performed under the contract.
- Reasonableness: Costs charged to the government contract must be reasonable and necessary for the performance of the contract. If the bonuses are excessive or unrelated to the contract work, they may not be considered reasonable.
- Documentation: Proper documentation is essential! Ensure you maintain records that clearly demonstrate the purpose of the bonuses, how they relate to the contract, and why they are allowable under the contract terms and applicable regulations.
- Consistency: Your bonus policies and practices must be consistent and compliant with both the terms of the government contract and relevant federal regulations. Inconsistencies could raise compliance issues during audits or reviews.
- Government Audits & Reviews: Speaking of audits or reviews…be prepared for them. You may avoid them for a time, but they will catch up with you! Your contract costs and billing practices will be under scrutiny during an audit or review. The government agency is making sure you are in compliance with the contract terms and regulations. (Side note: please be kind to your accounting professionals when they hound you for receipts and documentation. We are simply trying to make your inevitable audit a complete success for you!)
CAN I INCLUDE BONUSES IN MY GOVERNMENT RATES?
Bonuses are typically included in calculating your government rates. If they are allowable, allocable, reasonable, and approved as a direct cost, they will be included in the direct costs portion of the rate calculation. If not, they will be included in your Fringe rate calculations.
Rate calculation can be daunting and confusing, especially if you are just getting started. Guess who has professionals who can help you with determining your government rates? I think you guessed it!
For any further questions, feel free to contact BOOST, LLC to assist you in navigating the government contract world, especially as it relates to employee bonuses.
About the Author, Anastasia Narlock
Anastasia Narlock, a BOOST Senior Accountant Consultant, is an accounting professional with over 20 years of experience in commercial and government accounting in industries including insurance, non-profit, small business, and government. She is experienced in GAAP compliance, FAR, GOVCON, and DCAA compliance.