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Rewarding Employees with a Bonus

promote loyalty among the employees and act as motivation for continued good performance throughout the year. A new small business that has never given a bonus before may have several questions on how to perform such an act, so it is important to learn about the tax rules by which a small business must abide when deciding to give bonuses. Here are some key points to keep in mind when distributing bonuses at the end of the year.

As the economy shows signs of improvement, so does the number of small businesses that offers bonuses to their employees. Roughly one-third of small businesses plan to bonus their staffs by the end of this year, and this ratio is growing increasingly larger by the year. The decision of how to bonus an employee varies from offering performance-based bonuses or simply company-wide bonuses.

It is important to keep in mind that these bonuses are also subject to payroll taxes, meaning that federal and state income taxes need to be withheld. Tax withholding varies by the state but is usually a flat rate of 25 percent. Special withholding rates for supplemental pay, including in bonuses, may also apply in some states.

The tax method chosen for bonuses determines whether or not the business is reliable for the deduction that year. If a bonus is issued on a cash basis before the end of the year, that bonus is deductible for the same year. If done on an accrual basis, bonuses that are authorized this year but paid next year can get the tax deduction for them this year as long as the checks are paid out to the employees by mid-March of the next year.

Deferred compensation is another form of bonus that can transform employees’ bonuses into compensation usually with lower tax rates such as a retirement plan, pension or even an employee stock option.

At Padgett Payroll Services®, we know that tax season is just around the corner. As the year comes to a close, many businesses are deciding on whether or not to offer bonuses. This can lead to a lot of financial and tax questions that many small business owners are not prepared for. If you are in need of a tax management or payroll services, contact us today to find out how we can work for you.