Year-end bonuses are one of the best ways to thank your team for their hard work, but they can also trigger payroll and tax issues if you don’t plan ahead. Before you hand out those checks, be sure to check these items off your list.
When to Pay: Before or After December 31?
Choosing when to issue bonuses (before or after December 31 check date) can shape how cleanly your year closes out. A bit of early planning makes it much easier.
If you want year-end bonuses to appear on this year’s W-2s, payments must be made on a check date of December 31 or before. Bonuses paid with a check date in January will count towards the following year’s wages.
Because each payroll provider has their own processing deadlines, it’s smart to consult with your payroll team early. A quick check-in helps ensure withholdings are handled properly and avoids last-minute corrections when everyone else is closing the books for the year.
Understand How Bonuses Are Taxed
Bonuses may feel like gifts, but the IRS sees them as supplemental wages and they’re taxed accordingly.
You can handle the tax withholding one of two ways:
- Aggregate method: Combine the bonus with the employee’s regular paycheck and tax it as usual.
- Flat rate method: Apply the IRS flat supplemental rate (currently 22%) separately to the bonus amount. For bonus amounts over $1 million, the supplemental rate is 37%.
Your payroll provider can help you choose the right approach for your situation. The IRS offers additional information about tax withholding if you want to explore the topic further.
Plan for 401(k) and Retirement Contributions
Bonuses can impact retirement plans in surprising ways. Does your company’s 401(k) plan count bonuses as “eligible compensation”? Some plans include them automatically, while others require employees to elect to contribute.
If you’re not sure, ask your 401(k) recordkeeper or plan administrator before processing bonus payments. If you work with an external payroll processor, they rely on the plan details that you provide, and it’s your responsibility to share any updates. It’s much easier to confirm eligibility now than to correct missed contributions later.
Gross vs. Net Bonuses: Set Clear Expectations with Employees
You’ve probably heard this scenario before. An employee hears they’re getting a $1,000 bonus, but once taxes and deductions apply, the paycheck tells a different story and they’re left confused, thinking, “I thought I was getting more.”
That misunderstanding comes down to whether you’re paying a gross or net bonus:
- A gross bonus means the total amount before taxes and deductions.
- A net bonus means the employee receives a specific take-home amount after taxes.
If your goal is for employees to take home an even amount (say, $1,000), your payroll processor will need to gross-up the payment. A quick conversation upfront avoids confusion later and ensures your “thank you” feels as generous as you intended.
How Bonuses Affect Overtime and Classification
A year-end bonus can lift spirits but also complicate payroll if you’re not careful.
Under the Fair Labor Standards Act (FLSA), some bonuses affect how you calculate overtime or maintain exempt classifications.
- Non-exempt employees: If a bonus is promised or tied to performance, it’s considered nondiscretionary and must be included in the employees’ regular rate of pay for overtime.
- Exempt employees: Occasional discretionary bonuses (like a holiday bonus) are fine. But if the bonus becomes guaranteed or formula-based, it could raise questions about the employee’s exempt status.
The U.S. Department of Labor’s Fact Sheet #56A offers a helpful breakdown of how bonuses affect overtime under the FLSA.
When in doubt, confirm your calculations with your payroll partner, especially if bonuses are tied to measurable goals.
Don’t Overlook State-Specific Bonus Rules
Not all bonus rules are created equally. Some states define and regulate bonuses differently, especially when it comes to what counts as “earned wages.”
For instance, Massachusetts and California both have laws requiring certain earned bonuses to be paid as wages. If your business operates in multiple states, take a quick look at each state’s official sources, such as Mass.gov or CA.gov to confirm state-specific obligations.
It’s a small step that can prevent regulatory problems, particularly when you have employees based in various states.
Communicate Early and Often
When you explain the “why” behind bonus amounts, it strengthens confidence in the process. Let employees know when to expect their bonus, how taxes will affect the amount, and whether it’s based on company performance or individual achievement.
When everyone understands what to expect, your bonus announcement stays positive and free of surprises.
Commonwealth Payroll & HR: Your Partner for Bonus Season and Beyond
Year-end bonuses are more than a payout—they’re a powerful way to recognize and motivate your team. But without careful planning, what should feel rewarding can quickly turn into compliance headaches and costly corrections.
At CommPayHR, we work alongside you to ensure every detail is handled properly. Our team has the expertise to identify potential compliance risks and can provide clear guidance, so payouts are accurate, timely, and stress-free.
Let’s get the ball rolling. Talk to us now, share where you need support, and we’ll build a plan that keeps your business confident and compliant well into the new year. Reach out today and start 2026 on the right track.
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