How to Calculate Year-End Bonuses

As a small business owner, you may wish to reward your employees for a job well done during the year. A year-end bonus is a great way to do so. Employees appreciate the extra cash around the holiday season, and rewards can potentially improve employee retention. 

Bonuses can also remind employees how much their contributions are intertwined with overall business performance. There are two basic types of year-end bonuses. The first is a performance-based bonus, and the other is non-performance-based. 

Typically, sales personnel and executives will be rewarded on the basis of performance, while general and administrative staff bonuses are based on their original contract or the earnings of the company as a whole. 

However, no two companies’ bonus structures are the same. Each business owner has the right to decide how to structure their plan or if they will have one at all. Let’s consider how to calculate the main types of year-end bonuses:

How to Calculate Bonus Based on Sales Earned During the Year

If you reward your employees based on their total sales during the year, you should simply apply the agreed-upon bonus percentage to the sales that they earned for the company during the year, as figured in the year-end payroll. 

For example, suppose Sam earned $300,000 in sales for the company. His employment contract guarantees him a bonus of 4% on all sales that he makes. Thus, his bonus would be calculated as indicated below:

$300,000 sales x 4% bonus rate = $12,000 total bonus

You would follow the same procedure for all employees who are given a bonus based on their yearly sales.

How to Calculate Bonus Based on Departmental Goals

Some companies set strategic goals at the beginning of each year to encourage employees to meet them. For example, you may encourage your Finance team to reduce expenses by 4% from the prior year. If the Finance team meets the goal, you will distribute a bonus of $10,000 amongst the team of four people.

To calculate the bonus due, compare last year’s expenses of $5,000,000 to this year’s expenses of $4,750,000. The total expenses for the year must be less than $4,800,000 to earn the bonus:

$5,000,000 prior year expenses x (100% - 4%) = $4,800,000 expenses to earn bonus

The total expenses for the year are $4,750,000, which indicates that the Finance team has exceeded their department goal of reducing expenses by 4% and are entitled to their bonus. Thus, the $10,000 would be divided equally amongst all four team members in the year-end payroll:

$10,000 department bonus / 4 team members = $2,500 bonus each

If your company’s bonus structure is based on department goals, you would compare the goals amongst each department’s performance to determine bonus entitlement.

How to Calculate Non-Performance-Based Bonuses 

A non-performance-based bonus is generally given as a percentage of an employee’s salary. For example, a business owner may decide to give all employees a bonus equal to 3% of their annual salary. Such a bonus could be calculated by multiplying their year-end payroll earned by the percentage to find their bonus payment due:

$80,000 salary x 3% bonus percentage = $2,400 bonus

While this type of bonus ensures that employees receive an extra gift at the end of the year, it doesn’t particularly encourage employees to maximize the company’s potential. However, it is still a good way to encourage employee retention and goodwill.

Calculating Taxes on a Year-End Bonus

Companies can follow one of two methods when calculating the tax due on a year-end bonus. The first method is the percentage method and is based on the current bonus tax rate defined by the IRS. The second method is the aggregate method and is calculated based on the individual’s tax bracket.

The Percentage Method

The percentage method is the easiest way for small business owners to calculate taxes on year-end bonuses. The rate defined by the IRS for the year (22% in 2021) is applied to the total value of the bonus. 

The bonus is also subject to Social Security and Medicare taxes, as well as potential state and local taxes, depending upon where the employee is based. 

$10,000 bonus x (100% - 22% bonus withholding rate) = $7,800 after-tax bonus

Social Security and Medicare taxes are not included in the calculation for the above example because all wages earned by the employee during the year must be considered to arrive at the appropriate withholding amount.

Aggregate Method

The aggregate method is much more difficult for payroll managers to calculate and is not recommended as frequently they will withhold more than is necessary. 

It is based on the tax bracket of earnings for the period, which could inadvertently lead to moving the employee to a higher tax bracket. It is typically not separated from regular wages earned during the period.

Allow Symply to Assist in Your Payroll Needs

If your business could use some assistance with payroll, consider reaching out to Symply. Our payroll platform is created just for small businesses and has all of the features that you need to ensure your bonus payments are calculated correctly, with the proper taxes withheld. 

Download our 2021 Year-End Checklist to get your business squared away for the end of the year today!