Bonuses are a form of variable pay that are used to inspire employee loyalty or reward performance, and it’s essential to know about the different kinds.
A bonus is discretionary if it’s given solely at the employer’s discretion and does not cause an expectation of payment from the employee. The bonus should not be contingent on the employee’s performance or tied to any agreement with the employee, nor should it be routine — thereby creating the expectation of regular payment.
For example, a Christmas bonus is discretionary if it meets both of these conditions:
- The employer has sole discretion over the fact that the payment will be made and over the amount of the payment.
- The employee does not have a contractual right to the bonus or was not promised the bonus.
A bonus is not discretionary if the employer retains the freedom to provide the bonus at its sole discretion but also announces to the employee that he or she will receive the bonus, consequently creating the expectation of payment. For instance, a bonus rewarding an employee for exceptional performance is discretionary, provided no advance notice of the payment is given to the employee.
A bonus is nondiscretionary if it causes an expectation of payment by the employee because the employer has promised to pay the bonus or because there’s an employer-employee agreement regarding payment of the bonus.
Nondiscretionary bonuses are usually offered for the purpose of improving performance and productivity, in which case the employer must set work goals and performance standards in advance of the payment. These bonuses are tied to the employees’ quality and quantity of work and are designed to motivate them to work more efficiently or to remain with the company.
Hiring bonuses, attendance bonuses and individual or group production bonuses are all examples of nondiscretionary bonuses.
Effect on overtime
If the bonus is discretionary, the amount should not be factored into overtime calculations. However, under the Fair Labor Standards Act, nondiscretionary bonuses must be included in nonexempt employees’ overtime pay calculations for the period of time that the bonus covers.
To calculate the overtime rate of pay for a nondiscretionary bonus earned over a single workweek:
- Add the bonus to the employee’s total wages for the workweek.
- Divide the total wages for the workweek by the total hours worked for the workweek to arrive at the regular rate of pay.
- Multiply the regular rate of pay by 1.5 to get the overtime rate of pay.
If the bonus is earned over multiple weeks, the bonus amount for each workweek will need to be figured and included in the regular rate of pay for all overtime weeks covered by the bonus.
Ultimately, accurate overtime calculation is dependent upon you knowing whether the bonus is discretionary or nondiscretionary.