March 20, 2015

woman with a generous bonus system

Most businesses fail to implement a policy governing their bonus systems, and this is getting smaller employers into trouble when it comes to calculating employee paychecks in compliance with wage and hour laws.

We find that employers often don’t realize that bonus systems/programs are subject to wage and hour rules. In fact, most employers aren’t aware that bonuses affect overtime, often do not qualify for the infamous “discretionary” clause (more about this in a minute), and if offered, need to be governed by a comprehensive and separate bonus policy.

When done properly, this approach allows you to amend and adapt your bonus system when you need to, including discontinuing one that is not working.

Bonus Systems: Good or Bad?

Bonuses or “pay for performance” solutions are a hot topic across the small business world, as employers seek ways to engage and reward employees who perform well. More and more, bonuses are also being used to encourage employees to embrace and try new things. On the downside, they are often used as “cure-alls” for whatever ails a business. While this post does not address different types of bonus programs or their merits, employers need to know that enforcement responses to wage and hour law violations prompted by employee complaints about bonuses are now routine.

It’s all in the details

When it comes to bonus systems, do you know the answers below?

What if an employee quits in the middle of the week or month in which a bonus is due?

What if they get fired?

What if they are great at the conduct that earns them the bonus, but really bad at showing up on time?

What is the bonus for? Is it a reward for doing a great job or is it for anyone that does an OK job?

Is it contingent on anything else? Can it be?

Can you, at your discretion, just not pay out a bonus that has been earned by stating it in a policy?

Is there an eligibility requirement? Should there be one?

Why not just lump all this stuff into one program?

Can I get the best of both worlds by keeping my discretionary bonus and offering something to reward individuals?

For answers to these questions, you need to understand the difference between discretionary and incentive-based bonuses. At the bottom of this article we provide sample bonus policies for each type.

Discretionary and Incentive Bonuses: What’s the Difference?

There are many different kinds of bonus and incentive programs. For simplicity, they are broken down into two categories: discretionary-based and incentive-based bonuses. Discretionary-based policies are more subjective and general. Incentive-based policies are based on a formula, or tied to specific goals, either individually or for the whole team. More specifically:

  • Discretionary bonuses are those that are not based on an outcome, such as Christmas bonuses, because they are based on no particular criteria and of an undetermined amount. Simply put, they are at the discretion of the business owner.
  • Outcome-based bonuses are those that are based on sets of goals or outcomes, such as an increase in profit, number of new patients, sales, and internal referrals. These types of bonuses are actually considered wages and are factored into wages paid. (The same is true for commissions, by the way. They’re wages based on outcomes, by agreement, and therefore they are promises of additional wages.)

The additional amount for either an outcome-based bonus or a commission affects overtime calculations.

Cautionary Note about Incentive-Based Bonuses: Bonuses tied to individual job performance or to organizational performance tend to be considered an element of regular compensation, especially if given on a regular and consistent basis. This means an employer can get into a lot of trouble for not paying a promised bonus at the time of termination. Employers have been held legally responsible for bonuses expressly promised to employees as incentives. Once the worker has satisfied whatever criteria the employer has established to qualify him or her for the bonus, courts typically order the employer to pay. This is especially true where the salary or wage is small, and the bonus proportionately larger.

Bonus Policy Checklist

  • Consider the amount of the bonus you plan to offer. It should be more than a mere gesture, but not so much that it will be devastating if withdrawn or restricted.
  • Leaves of absence. Employees who have taken any leave of absence should not be disqualified from a bonus given to all other employees, as this may imply some type of discriminatory motive. For example, most leaves of absence at small practices generally involve medical leave for pregnancy. Therefore, excluding employees on that basis has a disparate impact on pregnant women. However, a bonus may be prorated based on the actual days/hours worked during the bonus period.
  • Most states require that all forms of remuneration, including bonuses, be treated as wages when figuring the amount of gross payroll for unemployment compensation tax purposes.
  • Subjective portions of any bonus/incentive should be determined by a team or committee (e.g., manager, supervisor, or office manager), not just one person.
  • If you are giving discretionary bonuses and want a specific way to incentivize your employees, consider giving an “award” distinct from a bonus. For example, give recognition for perfect attendance by offering an extra privilege or a paid day off.
  • If you want to discontinue or amend a bonus system, it is often best to pay the bonus based on your employees’ current understanding of it, then address changes in writing with an “effective as of” date.
  • Establishing a separate bonus policy allows you to modify and use a variety of bonus systems without having to alter and update your employee handbook.

Below, you will find two sample bonus policies similar to what most practices need to have in place:

Example of Discretionary Bonus Policy
Example of Incentive Bonus Policy

Questions about this trainer? Call CEDR anytime at 866-414-6056 or email us at We’ll be happy to look over your bonus policy for you and/or help you put one in place.


Friendly Disclaimer: This information is general in nature and is not intended to provide legal advice or replace individual guidance about a specific issue with an attorney or HR expert. The information on this page is general human resources guidance that is believed to be current as of the date of publication. Note that CEDR is not a law firm, and as the law is always changing, you should consult with a qualified attorney or HR expert who is familiar with all of the facts of your situation before making a decision about any human resources or employment law matter.