Although I don’t necessarily promote the use of rewards & incentives in the workplace, there are certainly times when base compensation just doesn’t cut it. Perhaps turnover has caused your team to pull more than their usual weight. Maybe you’re looking for a way to share some of the excess cash from a particularly high-margin project.

The Obvious (and Expensive) Solution

If your first thought is to put a little something extra in everyone’s next paycheck, be aware that after income taxes and payroll taxes, that cash bonus looks a little lean. And lest we forget, you as the employer must match the payroll taxes on this extra money. Ouch! A $1,000 cash bonus ends up costing you $1,100, but maybe only $700 goes to your employee (yes, I’m estimating and rounding).

Consider This Instead

Obviously you’d rather spend $1,000 while your employee gets a $1,000 value. In other words, you’d really like the bonus to take the shape of something that will generate a tax deduction for your business, while not resulting in taxable income to your people. There are many ways to achieve this desirable outcome. Consider these ideas as you begin formulating your tax-efficient bonus strategy:

  1. Provide additional paid time off for salaried personnel.This approach might be a real win, especially if the bonus is in order because folks have been overworked lately. Note: This works not by reducing taxable income to employees, but by giving them increased value for the taxable income they are already picking up.
  2. Invest in IT. Is half the office griping about software that’s unreliable and inefficient? Are laptops making loud, whining noises? Spend some money on tech and delight everyone with smoother, more efficient workdays.
  3. Pretty up the office.The restroom sink has had a slow leak for years. The coffee from a low-cost vendor is endured rather than enjoyed. Look around and ask staff for easy ways to improve the physical work environment. 
  4. Party up the office. Generally, the costs of a holiday get-together, summer outing or other event that mainly benefits rank & file folks will be 100% tax deductible, and aren’t considered compensation to employees. Go have some fun!
  5. Cover transportation costs. Subject to annual limitations, amounts you pay for employees to take mass transit, park at the office, etc. aren’t counted as income to employees.
  6. Make a retirement plan contribution. If you don’t already have a plan in place, consider starting one with some degree of employer contributions. If you do have one, work with your plan administrator to learn about available options for a one-off discretionary contribution.
  7. Pay for education. Most expenses you pay (or reimburse) to help employees perform their current duties are considered ‘working condition benefits’ that earn a tax deduction for the company without creating taxable income to employees. This includes education costs, so think about continuing professional education or college tuition for certain classes. You may also provide educational assistance that isn’t strictly relevant to the employee’s current job, but this should be done under a written educational assistance program and some of the educational payments could be taxable to the employee.

Don’t Let the Tail Wag the Dog: 

  • Be careful not to let a one-time non-cash bonus turn into a new employment benefit that staff expect on an on-going basis. For example, paying for employee parking is a great idea, but how will your team react if you discontinue it?
  • Keep in mind that some large purchases may be considered fixed assets which may or may not be 100% tax-deductible in the current year. Consult your tax advisor before committing.
  • Some of your folks are just going to want the cash, plain and simple. Depending on the size of your company, customizing each person’s bonus may be feasible. If you go this route, make sure you’re not short-changing (pun intended) anyone by providing cash to a few, but also providing non-cash bonuses that benefit everyone.
  • If an across-the-board non-cash bonus makes the most sense, you may need to put a little effort into communicating the idea so your employees recognize the value in what you are giving.

Bonuses are a great way to reward hard work and exceptional performance. With the right strategy, you can ensure your generosity delivers maximum value to the company as well as employees.