Performance Bonus: Definition, Types, Tax Treatment

What Are Performance Bonuses?

A performance bonus is a form of additional compensation paid to an employee or department as a reward for achieving specific goals or hitting predetermined targets. A performance bonus is compensation beyond normal wages and is typically awarded after a performance appraisal and analysis of projects completed by the employee over a specific period of time.

Who Gets Performance Bonuses

Not all companies offer bonus plans and those that do often define the maximum amount that an employee can receive for exemplary performance. Companies that use an appraisal or employee review process may set a score threshold that an employee will have to meet or exceed to be considered. Because this bonus is given for performance above expectations, employees are not automatically entitled to it.

Performance bonuses may be given to an entire team or department if, for example, specific sales figures were met, or if the actions of that group were deemed to have been exceptional.

How Performance Bonuses Are Offered

Employees might or might not have performances included in the language of their hiring contracts. The inclusion of performance bonuses may be used as a way to make the position more attractive to potential hires. Even if an employee is not guaranteed under contract to receive a performance bonus, they may be instituted at the direction of the employer. Performance bonuses may be instituted regularly, such as annually, biannually, or monthly. They might also be made available only for specific periods, perhaps to drive extra effort for a particular project or a critical sales quarter.

Performance bonuses are often counted as income for tax purposes, which means the take-home pay from such compensation will typically be lower than the gross amount of the bonus. Thus, an employer might refer only to the gross amount of the potential bonuses to heighten employee interest in earning such rewards.

The effectiveness of using performance bonuses may come into question if they are not administered consistently by managers who are responsible for overseeing them. For instance, employees might issue complaints to their managers if they believe they have earned such a bonus, but the specific criteria were not met to disburse those funds. This may leave managers weighing further disruption among the staff when the performance bonuses were meant to encourage greater output by employees. This can result in employees receiving such funds regardless of their activity as a type of entitlement that obviates the purpose of the bonus.

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