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Bonus – What is a bonus?

A bonus is any compensation given to an employee on top of their standard pay.

If you're an employer, it is important to track how much your spend on your staff. Find out more about managing payroll as a small business owner.

A bonus can be both financial (i.e. cash) and non-financial (i.e. goods). Gifts an employer gives to their employees, such as Christmas presents, are usually considered bonuses.

Some contracts outline when an employee might be entitled to bonuses, while some contracts specifically restrict or cap the amount that can be earned on top of employees' base pay.

Types of bonuses

An employer might give out bonuses for a number of different reasons, such as incentivising employees, boosting morale, rewarding good performance, and increasing productivity. Bonuses might be given to current employees, prospective employees, or shareholders.

Incentive bonuses

Some types of bonuses are intended to encourage specific activities or behaviours, for example:

  • Sign-on bonus: employers sometimes offer financial rewards when someone signs with the company. Sign-on bonuses might be a specific amount of money, but it is also common to offer help with relocation, season tickets for travel, or other types of compensation that make the job offer seem more appealing.
  • Retention bonus: if a company is going through a particularly stressful period or a significant organisational change, they may reward employees who stay with the company. Retention bonuses are particularly common for companies involved with a merger or acquisition.
  • Referral bonus: some companies have referral programmes that reward current employees who refer candidates for job openings. Under these schemes, the current employee receives a bonus if the person they referred ends up being hired.

Performance bonuses

Unlike incentive bonuses, which are linked to particular activities or behaviours, performance bonuses are more general incentives that encourage employees to work harder throughout the financial year. However, performance bonuses are usually related to specific performance indicators. The value of the bonus is often calculated based on how much an employee, team, or department exceeds particular goals or targets.

Performance might be assessed monthly, quarterly, or annually, but performance bonuses are most commonly given at the end of the calendar or financial year.

Shareholder bonuses

Incentive bonuses and performance bonuses are usually paid to employees; however, companies may also give bonuses to their shareholders as a way of increasing the shareholders’ ROI.

Dividends and bonus shares are the most common types of shareholder bonuses. The value of bonus (the number of bonus shares or the amount paid in dividends) usually reflects the number of shares each shareholder already has.

Reporting and taxing bonuses

If you give bonuses to your employees, you will usually be required to report how much you have given. This is to make sure that bonuses can be taxed correctly.

Taxing cash bonuses

Bonuses paid in cash - or in vouchers that can be exchanged for cash – are considered as earnings or income. You therefore need to treat the bonus as any other type of earnings (e.g. salaries, wages, commission, tips, or benefits); this means recording how much is paid and applying tax through PAYE.

Taxes for non-cash bonuses

The rules for non-cash bonuses are more complicated. If the goods are worth £50 or less, are not mentioned in the employee’s contract, and are not a reward for job performance, the bonus is considered a ‘trivial benefit’. Trivial benefits are not taxed and do not need to be reported to HMRC.

However, if the goods do not count as trivial benefits, you will need to report their value and pay Class 1 National Insurance. If the goods have no resale value, their value is the amount they cost you. If the goods do have resale value, their value is either the amount they could be sold on for or the amount you paid for them - whichever value is higher.

In addition, if you give bonuses in the form of goods that can be easily turned into cash, you might need to use PAYE to report and pay tax on these bonuses.