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How to Give Your Employees Bonuses as a Small Business Owner

As a small-business owner, you know employees are your greatest asset. Quality over quantity is the name of the game for small companies. Showing your appreciation helps keep your best and brightest on the payroll. Employee bonuses serve the dual purposes of motivating employees to do their best while rewarding them for their contributions.

Before you dole out holiday bonuses and gift cards, however, you’ll need to put a plan in place. Employee bonuses might seem like a fun perk to you, but to your employees, it could mean so much more.

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The U.S. Small Business Administration estimates that 35% of small-business owners offer some type of end-of-year bonus, but there is a wide spectrum of methods, amounts, and types of employee bonuses. Choosing the right strategy means getting an inside look at how, when, and why small businesses reward their employees.

The Small-Business Owner’s Guide to Types of Bonuses

I recently sat down with our accountant to go over my small business’ bonus structure. We employ a couple of different bonus strategies, and I wanted to make sure we were on par for the industry and that employees were satisfied with the way we offered and executed different types of bonuses.

My accountant and I settled on maintaining our bonus structure, which is a holiday bonus at the end of the year and “spot” bonuses on a monthly basis. It’s right for a small design firm like ours, but your small business might require a different approach. Get to know the types of bonuses before you decide what’s right for you and your employees.

Holiday Cash Bonuses

When you think of employee bonuses, you probably think of the holiday bonus. We’ve all seen the scene in “National Lampoon’s Christmas Vacation” where the Griswolds are astonished to realize their expected and long-awaited Christmas bonus is really just a jelly-of-the-month club membership. It’s hammed up for the movie, but it’s definitely a relatable theme. Employees often count on their holiday cash bonus so it’s important to set expectations and carry through or risk losing employee motivation through the rest of the year.

Holiday bonuses are typically related to gratitude rather than performance or profitability. I personally prefer the holiday cash bonus for a few different reasons. The majority of our employees have young families and the holiday bonus helps reduce some of the financial strain they feel during an expensive time of the year. It also helps keep morale high and sets the tone for the coming year. I usually combine the bonus with a little gift and a personal note to let each employee know how important they are to our success as a small company. It’s a gesture that has helped us maintain our small family business values, even as we’ve grown over the years.

Holiday Cash Bonus Best Practices

  • Don’t Tie Bonuses to a Specific Holiday. Holiday bonuses should not be religion-specific. Referring to the perk as a “Christmas bonus” could alienate employees who celebrate other holidays. Instead, refer to it as a “holiday bonus” and hand them out on a holiday season-neutral date. I like to make sure employees have their bonuses in the first two weeks of December so they can use them for whatever holiday they celebrate.
  • Choose Parameters. A holiday bonus shouldn’t be a dollar amount selected out of thin air. Choose the parameters for your holiday bonus, such as an amount for each year an employee has been with the company or a percentage of their salary. All employees should have the same parameters.
  • Set Expectations. Don’t leave your employees guessing about their holiday bonus. Although it’s true that it should feel like just a little extra cash, employees often count on those bonuses to make up shortfalls or cover the costs of holiday gifts and travel. Set the amount ahead of time and make your policy known to all employees. Although a holiday bonus is meant to be a fun perk and token of gratitude, it still helps if employees know what to expect and how to plan for their holiday season.

End-of-Year Employee Bonuses

Bonuses that are tied to the company’s annual profitability and performance as a whole are usually framed as end-of-year bonuses. This type of bonus gives you the chance to assess your small business’ year and reward employees for the part they played in your success. They are usually only given when a small business has been profitable, so the amounts often vary from year to year. During a lean year the bonus is smaller, and the amount increases in more successful years.

Either way, end-of-year bonuses build a level of ownership with employees as they take responsibility for the size or availability of a bonus.

End-of-Year Employee Bonus Best Practices

  • Tie Bonuses to Companywide Performance. End-of-year bonuses help employees see themselves as part of a team. In a small-business setting, employees should understand how they personally contribute to its success. Set companywide performance goals and offer the bonus only if those goals are met.
  • Pay Before the End of the Calendar Year. According to the Internal Revenue Service, you can count employee bonuses as expenses you can deduct on your small-business taxes as long as they’re paid out before or on December 31 of the previous year. The end-of-year bonuses for 2020, for example, can be deducted on your 2020 tax return if they’re paid out by December 31, 2020. If bonuses are given out after that date, they’ll be counted as a 2021 expense and you’ll need to wait until 2022 to file and receive the deduction.
  • Style Bonuses as Profit Sharing. Because end-of-year bonuses are tied to your company’s annual profitability, styling them as “profit sharing” gives employees even more ownership of their own bonus. Choose a percentage of the profit — one that your business has the cash flow to afford, naturally — that each employee will get at the end of the calendar year. If you made more profit than usual, the bonus will be bigger than usual. Profit sharing helps motivate employees to contribute to your company’s success as much as possible. It also helps drive employee retention because employees have a reason to stick around until (at least) the end of the year.

Performance Bonuses

There are two types of employee bonuses: those that thank and those that motivate. Performance bonuses are meant to increase employee motivation. Tied to individual results, a performance bonus is only given when a specific team member reaches their goals. It’s one of the most common types of bonuses. According to a survey by HR consultancy Korn Ferry, 49% of employees say their annual bonus is tied to their individual performance.

Performance bonuses are more flexible than other annual bonus structures because they can be paid whenever it’s best for your small business. They can also be used to help push through a hard year of COVID-19 fatigue and an ever-changing workplace landscape, as small business employees often carry a heavier load and play more roles than a big corporate employee. Performance-based bonuses close the gap between employees’ changing responsibilities and their current salary.

Performance Bonus Best Practices

  • Make It Fair. Every employee should have the same opportunity to receive bonuses based on their performance. Create a clear bonus structure and be as transparent as possible to avoid being accused of playing favorites or only rewarding certain employees.
  • Choose Measurable Goals. >Performance-based bonuses must be tied to specific, measurable goals. You could choose a specific sales amount per quarter, a number of new accounts, a certain percentage of customer satisfaction, or a project completion rate. Whatever you decide, ensure that employees have clarity and know exactly what they need to accomplish to earn a performance bonus.
  • Separate Personal and Team Bonuses. Some small businesses offer team bonuses for performance, but doing so could make things feel like a school project: one person doing all the work while everyone reaps the benefits. One way to separate team and personal goals is to offer different rewards for each. After meeting a goal, a team could earn a lunch for the whole department, for example, while individuals are rewarded monetarily for reaching their benchmarks. This increases employee engagement levels for those who thrive on personal stakes while still offering incentives to be a team player.

Spot Bonuses

Spot bonuses are defined as any employee benefits or bonuses that are paid out “on the spot” to reward a job well done. A survey by PayScale found that 31% of small businesses in the United States used spot bonuses, making it one of the most common types of nonsalary employee compensation.

Spot bonuses shouldn’t be as structured like other types of bonuses, but are awarded irregularly to improve morale and show your employees that you’re noticing their hard work. They’re the most flexible type of bonuses, because they’re tied to in-the-moment behavior rather than annual performance or calendar dates. However, they could land you in hot water if employees feel like spot bonuses are a signal of favoritism, so tread carefully.

One way I like to use spot bonuses is by empowering managers to reward their own team members. Even in a small-business setting, it’s impossible to see all the moving parts and the way your employees contribute. By allowing managers to award spot bonuses, employees feel seen and are rewarded for the smaller day-to-day behaviors like teamwork, a good attitude, meeting a short deadline, or helping train another employee. I also like that spot bonuses work equally as well for full-time employees and part-time employees, since they focus on behavior rather than hours worked or long-term goals.

Spot Bonus Best Practices

  • Set a Budget. If you or your managers are constantly awarding spot bonuses, they can add up and put you over budget quickly. Make sure you keep rewards in check by giving managers a set budget for spot bonuses throughout the year, then let them decide how to allot their budget.
  • Create Bonus Tiers. The spot bonus for a good attitude shouldn’t be the same as a spot bonus for taking on a big project or staying late to meet a particularly important deadline. Try creating three tiers for your spot bonus program and award bonus amounts, gift cards, or other perks to correlate with the positive behavior.
  • Use Them as a Spotlight. Profit-sharing, yearly, and holiday bonuses don’t need to be publicized because the amounts and circumstances vary from employee to employee. Spot bonuses are typically smaller in dollar amount and, because they deal with daily behavior and habits, can be used to shine a spotlight on your best employees. It’s OK to call out an employee exemplifying good habits and your company values to encourage other team members to model that behavior.

Hiring Bonuses

If your small business is part of a particularly competitive industry, you know that good people are hard to find. Offering a hiring bonus as part of a prospective employee’s salary package could help sway their decision to work for your company. PayScale found that only 14% of small businesses use hiring bonuses, and when compared to the 56% of large businesses offering them, it’s clear that bigger companies can have a distinct advantage in the hiring process.

Although you shouldn’t go over budget trying to woo a would-be employee, it might pay to save some money for a hiring bonus if you really want to encourage a candidate to come work for you. Some businesses calculate a signing bonus as a percentage of the offered salary and others simply offer a flat amount.

Hiring Bonus Best Practices

  • Use Hiring Bonuses as a Bargaining Chip. You don’t always have to offer a hiring or signing bonus. Instead, factor it into your hiring budget but wait until a prospective employee requests it or they indicate that another company has given a better offer. You can then use the hiring bonus as a perk to negotiate.
  • Go Half and Half. Sometimes called a “retention bonus,” you can hold back a percentage of the hiring bonus to ensure that your new employee stays with your company for a prescribed amount of time. Offer half of the bonus on their start date and the other six or even 12 months later to encourage better retention.
  • Keep It Private. A hiring bonus should not be discussed with anyone other than the person to whom it is offered. Signing bonuses aren’t always regulated like other bonus structures and the amount you offer to snag a desirable employee will likely fluctuate depending on competition, experience, and education. Keep the final negotiated amount private to avoid affecting morale among existing employees.

Cash and Noncash Bonuses

Cash is the most common type of bonus. Besides always being well-received, it’s the easiest way to keep your books organized when budgeting, balancing, and reporting for taxes. Bonus pay is recorded as supplemental wages on employees’ W-2s, and you can either apply employees’ usual withholdings or assess a flat 25% flat withholding. If the bonus is over $200, you’ll also need to withhold 0.9% for Medicare.

When I offer a cash bonus, I like to add enough to cover withholdings so that taxes don’t cut into their bonus amount. If the intended bonus to the employee is $500, for example, the additional bonus amount on their paycheck is $625 to account for the 25% flat withholding for taxes. If you aren’t sure what’s right for you, talk to your accountant about your options.

Cash isn’t the only way to pay out bonuses and reward stellar employees. If your small business budget already feels tight, a big lump sum can be hard to swallow. Still, rewards really make a difference in motivating and engaging employees, so think of other ways to offer bonuses, such as:

  • Stock options
  • Gift cards (restaurants, Amazon, and retail are my employees’ favorites)
  • A personalized gift basket
  • Increased paid vacation days
  • Extra sick leave
  • The gift of time to work from home
  • Employee incentive outings or trips
  • Lunches or get-togethers

Your accountant can help you better understand how to award and then report bonuses as annual expenses. Assess your budget and decide what you can afford. In most cases, your investment is rewarded with motivated employees who feel appreciated and seen.


Final Word

Small businesses often fight an uphill battle when it comes to attracting and keeping employees. The promise of a bonus helps beef up your benefits package and keep workers satisfied. Still, bonuses are more than just a bargaining chip; they create a foundation for a positive culture and employees who feel valued by their employer.

Where they lack in size, small and new businesses have the big advantage of a tight-knit workplace where every employee is equally responsible for the company’s success. Leverage that advantage by creating an affordable bonus structure to reward loyalty, engagement, and a job well done.

Jacqueline Curtis
Jacqueline Curtis writes about edtech, finance, marketing, and small business strategy. With over 14 years of copywriting experience, she's created content and scripting for organizations such as GE, Walgreens, Overstock, and MasterCard. She lives in Utah with her husband, three kids, and an overzealous springer spaniel named Penelope.

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