Compliance/Best Practices Employment Law

It’s Bonus Time! Here’s What Employers Need to Know

employee bonusThe end of the year equals bonus time for some employees. When it comes to bonuses, employers have a lot of discretion and few legal requirements, but there are some things to consider.

What is a cash bonus? A cash bonus is an amount of compensation that’s earned at the end of a bonus period and is based on performance during that period. There’s no requirement that employers give bonuses, but if they do, their bonus plans are binding contracts. Neisendorf v Levi Strauss & Co. (2006) 143 CA4th 509.

Why give a bonus? The primary goal of a cash bonus is to provide an incentive for short-term performance. Bonuses are also used for employee retention by requiring the employee to stay on the payroll through the end of the performance period to receive the bonus. Some employers try to get even more retention value out of the bonus by deferring the payment of the bonus and requiring the employee to remain employed for some period beyond the performance period. But any deferral of a bonus must comply with IRC §409A (regulating the timing of deferred compensation) and wage and hour laws. Note that under the California Supreme Court’s recent decision in Dart v Alvarado Container Corp. (2018) 4 C5th 542, payment of a bonus can affect the calculation of overtime owed to nonexempt employees.

How are bonuses paid? Employers have tremendous flexibility in structuring cash bonuses. They can pay them out in various ways:

  • On a completely ad hoc basis;
  • Under an incentive bonus plan adopted by the employer that applies to a specific number of employees, including executives; or
  • Based on a separately negotiated formula for each executive.

The employer retains the greatest discretion if bonuses are paid according to a separate formula negotiated for each executive. Despite the advantages of paying bonuses in an ad hoc manner, establishing targets in advance and providing regular updates on progress toward those targets likely provides the greatest incentive for performance.

The most common approach for a cash bonus policy is to develop an incentive bonus plan that sets targets related to net income, operating income, sales, or revenues, with a scale for the level of bonus and potential earnings under the plan, for a specified performance period.

What should bonus plans include? Although employers have wide latitude in designing and implementing bonus plans, they must take care in describing the following elements:

  • The employees who will be eligible to receive bonuses;
  • The amount or formula for computing bonuses to be paid;
  • The criteria that must be satisfied to qualify for a bonus; and
  • The period over which the performance criteria will be measured.

For more on employment contracts and executive compensation, turn to CEB’s Advising California Employers and Employees, chap 2 and Drafting Employment Documents for California Employers, chap 8. Both of these titles include sample language for a cash bonus plan.

Other CEBblog™ posts you may find useful:

© The Regents of the University of California, 2018. Unauthorized use and/or duplication of this material without express and written permission from this blog’s author and/or owner is strictly prohibited.

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