Performance bonus

Common structures

Three patterns SMBs use:

• Company-performance bonus: the bonus is paid (or paid at a higher rate) when the company hits annual revenue, profit or other agreed targets. It suits roles where an individual quota would be artificial.
• Individual-performance bonus: a target amount, often a percentage of base salary, paid according to how far the employee met their targets. Targets can be measurable, such as a delivered project, or qualitative; qualitative ones need the assessment criteria written down in advance.
• Hybrid: one portion tied to company results, one to individual performance.

For commission-based sales roles, OTE is the more useful measure.

Setting up a performance bonus scheme

Decide whether it is contractual or discretionary (Great Britain). According to Acas, an employer must pay a contractual bonus when the agreed criteria are met, and the entitlement and criteria belong in the written statement of employment particulars. A discretionary bonus gives the employer flexibility, but the decision must still be made fairly; an unfair one can lead to a breach-of-contract claim. If you mean a bonus to be discretionary, say clearly that it is not a contractual right: unclear wording can be read as contractual, and bonuses paid regularly without a written agreement can become an entitlement through custom and practice. Part-time staff are usually entitled to the same bonus pro rata.

Run it through UK payroll. A cash bonus counts as earnings. You add it to the employee’s other earnings and deduct PAYE tax and Class 1 National Insurance through payroll (GOV.UK). Non-cash bonuses follow the rules for the specific item, and some, such as items easily converted to cash, also go through PAYE.

Withhold federal tax as supplemental wages (US). IRS Publication 15 treats bonuses as supplemental wages. If you pay the bonus separately and withheld income tax from the employee’s regular wages in the current or previous calendar year, you can withhold a flat 22% or use the aggregate method. Supplemental wages above $1 million paid to one employee in a calendar year are withheld at 37% on the excess. These are federal rules; state withholding is separate.

Include it in overtime pay where required (US). Under the Fair Labor Standards Act, nondiscretionary bonuses, such as those promised for meeting production, quality, attendance or safety targets, must be included in a non-exempt employee’s regular rate when calculating overtime. A bonus is discretionary only if the employer keeps discretion over both whether to pay it and how much until near the end of the period, and does not pay it under a prior contract or promise (DOL Fact Sheet #56C). A bonus promised in advance for hitting set targets does not meet that test.

What goes wrong

• Moving goalposts: targets are revised mid-cycle without that being part of the agreement. Trust suffers, and under a discretionary scheme the change may not meet the fairness standard Acas describes.
• A pool that doesn’t fund: the company misses its threshold, the pool is empty, and people who hit their own targets get nothing. If that is the design, say so in writing before the period starts.
• Ratings without spread: when nearly everyone gets the same rating, nearly everyone lands on target and the bonus stops rewarding performance differences.

What works

• Written criteria agreed in advance, so the employee knows what meeting and exceeding target look like.
• The same criteria for comparable roles: one-off arrangements for individuals are hard to justify and make pay harder to compare.
• A stated payment date in the contract or scheme rules, so nobody has to ask when the money arrives.