The critical difference between discretionary and non-discretionary bonuses is the degree of certainty and control that employers have over their pay.
Discretionary Bonuses
A discretionary bonus is an extra payment given by an employer to an employee that is not guaranteed. The amount and timing of the bonus are determined at the employer’s sole discretion. In other words, the employer has complete discretion over whether to give the bonus and how much it will be. Discretionary bonuses are not tied to specific criteria or performance standards. They are not considered part of an employee’s regular wages.
Non-Discretionary Bonuses
On the other hand, a non-discretionary bonus is a payment that an employer promises to an employee in advance and is usually tied to specific criteria or performance standards, such as meeting sales targets or achieving particular job objectives. The employer is obligated to pay the non-discretionary bonus once the requirements or standards have been met, and the amount of the bonus is usually predetermined or based on a formula.
The Difference
The critical difference between the two types of bonuses is that a discretionary bonus is entirely at the employer’s discretion. There is no legal obligation to pay it. In contrast, a non-discretionary bonus is an earned payment that an employer must legally pay once the predetermined criteria or standards have been met.
It’s worth noting that the tax treatment of discretionary and non-discretionary bonuses may also differ. Discretionary bonuses are typically subject to federal income tax withholding, Social Security tax, and Medicare tax. In contrast, non-discretionary bonuses are treated as regular wages. They are subject to the same tax treatment as an employee’s regular pay.
Because a non-discretionary bonus is treated as regular wages, it must also be considered when performing an overtime calculation. Under the Fair Labor Standards Act (FLSA), the regular rate of pay used to calculate overtime includes all compensation considered part of an employee’s “remuneration for employment,” except for certain types of payments that are specifically excluded by law. Non-discretionary bonuses are not specifically excluded from the regular rate of pay, so they are generally included in the calculation of overtime pay.
For Instance
Suppose an employer pays a non-discretionary bonus, such as a bonus based on the employee’s production, sales, or other objective criteria. In that case, the bonus amount is typically added to the employee’s total compensation for the workweek. The regular rate of pay is then calculated by dividing the total compensation for the workweek by the total number of hours worked. The overtime rate of pay is then calculated at 1.5 times the regular rate of pay for all hours worked over 40 in the workweek, including any hours for which the employee received the non-discretionary bonus.
It’s important to note that there are some exceptions and nuances to these rules, and the specific rules may vary depending on the state and industry. Employers should consult with legal counsel or an experienced payroll professional to ensure they are calculating overtime pay correctly and complying with applicable laws and regulations.
Written by,
Jeremiah Bogdon, CPA, CPSP
Need help processing bonuses for your employees? We do that! Check out our Payroll Service here!
Want to learn more about our services? Click the link here, and one of our Pros will contact you!