How to calculate different types of bonus pay

Bonuses are excellent morale boosters and give employees another reason to love working for you. But employee bonus calculation is a science, and knowing how and when to give a bonus is an art. So take a beat before rewarding your employee in this way—savvy People Ops teams research the best practices for establishing an equitable compensation plan that motivates employees.

Learn how to calculate bonus pay and what types of incentives you can offer so you can show your employees how much you appreciate their hard work.

What is an employee bonus?

A bonus is supplemental pay an employee receives on top of their regular compensation. 

Often, these incentives are predictable. For example, an employee might know they'll receive extra compensation for achieving a particular milestone, which motivates them to reach that goal. Or an employer may consistently offer a holiday bonus to reward employees for their hard work during the year.

But bonuses can also be surprise perks, such as when a supervisor rewards someone for a job well done on a particularly tricky project.

Types of employee bonuses

Incentive-based compensation takes many forms. Here are some of the most common ones:

• Performance bonuses are for exceptional individual or team performance. When an employee or group hits a certain milestone or key performance indicator (KPI), they earn additional compensation. For individuals, this can be a percentage of their standard pay, a variable amount, or a lump sum. Teams may share the bonus equally or give higher amounts to those who played a more critical role in the work.
• Holiday or year-end bonuses are additional payments employees receive in December (or January/February, reflective of the prior year). An annual bonus can be a fixed figure or salary percentage, and while some companies give one to everybody, that’s not always the case. For example, an employee may have to reach a goal or sales quota to receive a year-end bonus. Company bonuses can also depend on the business’s performance—an operation might only have funds for bonuses if it hits its financial goals for the year.
• Sign-on bonuses are a financial incentive that sweetens a job offer. These can be one-time or multiple payments and even include stock options. Companies may offer this type of bonus to attract top talent or balance out a salary and benefits package that isn’t sufficiently compelling.
• Milestone or project bonuses are offered to an individual or team upon completing a project or essential milestone. These bonuses motivate teams to complete work effectively and efficiently.
• Sales commissions are an additional compensation a sales professional receives. Commissions are often percentages directly related to sales numbers, so a high-performing salesperson earns more in commissions than a colleague who doesn’t sell as much. 
• Profit-sharing is when employees earn a percentage of the company's profits, and the share can be higher for more senior roles. Profit-sharing helps workers feel closer to the business's mission and success, as getting a bonus depends on the organization's performance. 
• Referral bonuses are available to employees who refer talent to the company. When the referred candidate signs their contract, the person who made the referral earns a one-time fixed sum.
• Retention bonuses encourage employees to remain at a company. These incentives are generally lump-sum, one-time payments businesses give when they want a worker to stay for a specific period of time or event like a merger.
• Spot or discretionary bonuses are surprise bonuses supervisors give to employees doing top-notch work. Team members never know when to expect this perk, so leaders can leverage these bonuses to keep employees on their toes.

How much are bonuses? Calculating various types

While many company bonuses average between 1% and 15% of the employee’s salary, when defining bonus numbers, you get to set the terms based on your operation’s budget and working methods. The following steps walk you through the basics of calculating an employee bonus.

1. Determine the type of bonus

Decide what types of bonus payments your company will offer. Perhaps attracting top talent is essential right now, so sign-on bonuses are smart. Or maybe you manage a team of hardworking salespeople who deserve a commission. 

As you puzzle out what to offer, consider the cadence: Will you give one-time or periodic bonuses? Will these incentives be percentages or flat rates? Are the rates higher for senior team members, or does everyone earn an equal amount?

2. Define the criteria and eligibility

Determine who can receive the bonus and for what reasons. Settle on measurable milestones and metrics to have a clear system for recognizing when someone earns a perk. It's unfair to offer bonuses to some and not others based on arbitrary criteria (or lack thereof).

3. Choose a calculation method 

There are two primary ways to calculate a bonus: percentage-based (based on a percent of the employee’s salary) and flat-rate (a fixed figure). Calculating a percentage-based bonus may seem more complicated, but only takes a little bit of math. Here's an example of a yearly bonus calculation formula to guide you.

• Identify the employee’s yearly salary (i.e., $120,000). 
• Identify the bonus percentage (i.e., 5% or 10%).
• Multiply the yearly salary by the bonus percentage. Be sure to put the decimal before the percentage number if it’s over 10%, and add a zero between the decimal and the percentage number if it’s under 10% ($120,000 x 0.10 for a 10% bonus or $120,000 x 0.05 for a 5% bonus). 
• You’ve now calculated the bonus amount ($12,000 for a 10% bonus and $6,000 for a 5% bonus).

Flat-rate bonuses (often given for making referrals or signing on as a new employee) require research rather than calculation. Your People Ops team should do their homework on how much similar employees in the industry generally earn.

4. Account for bonus tax 

There are two ways of calculating taxes on bonuses: the percentage method and the aggregate method.

In the first method, the employer withholds the required percentage of federal bonus tax (which, in the United States, is 22% for any bonus under one million dollars). On a $6,000 bonus payment, the company would retain $1,320 and the employee would net $4,680. 

In the aggregate method, the employer adds the bonus amount to the employee’s normal paycheck and withholds taxes on the sum. If a person earning $120,000 per year gets a bonus of $6,000, they’d have a total of $126,000 for the year. The IRS would tax the percentage of this total that corresponds to the person’s tax bracket.

5. Adjust for any applicable state tax requirements

In the United States, some states have bonus tax, so research local regulations on supplemental income for employees. For example, Ohio and New York apply regular payroll taxes to bonuses, while Texas and Florida don’t. An employee living in Ohio would lose a bit of their bonus due to the state’s tax rate that someone in Florida, who is only subject to federal tax, wouldn’t.

6. Process the bonus and document it 

After your People Ops team decides how much to award and whether to process a bonus as part of a regular paycheck (aggregate) or separately (percentage), calculate the applicable taxes before processing payment. Afterward, keep a payslip in your records that states the date, the amount, and why the employee received the bonus.

How employers benefit from giving bonuses

Employees aren’t the only ones to benefit from bonuses. By providing this morale-boosting perk, companies can enjoy the following rewards:

• Improved retention: Employers offering attractive bonuses have a leg up—employees will likely want to stay with a company offering bonuses than jump to another that doesn’t.
• Better recruitment outcomes: Companies can reel in talent with sign-on bonuses and upfront information about what employees earn when they perform well. 
• Increased alignment with company goals: When bonuses depend on the company’s success, employees are motivated to contribute. They’re more likely to take an active role in trying to reach the company’s goals, so everyone wins.

Easily include bonuses in your global payroll with Oyster

Worried about getting bonus calculations right? Let Oyster help with the math—and more. 

Oyster’s comprehensive global payroll solution helps employers deposit bonuses accurately and compliantly for geographically distributed teams. Calculate, process, and send bonus funds quickly and safely, adhering to the applicable tax laws wherever you make payments.

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About Oyster

Oyster is a global employment platform designed to enable visionary HR leaders to find, engage, pay, manage, develop, and take care of a thriving distributed workforce. Oyster lets growing companies give valued international team members the experience they deserve, without the usual headaches and expense.

Oyster enables hiring anywhere in the world—with reliable, compliant payroll, and great local benefits and perks.