Benefits and Compensation

Bonuses? Great, But Legal Pitfalls Abound

Bonuses are an integral part of many companies’ compensation packages because they:

  • Are an expression of goodwill from employer to employee.
  • Exemplify a personal touch and may evoke loyalty and dedication.
  • Allow organizations to manage pay for performance
  • Can be used as an incentive to retain top performers or to attract new employees
  • Allow the employer to reward financially without raising the base

However, bonuses may also cause legal problems if they are not handled right.

Promised Bonuses May Be Seen as Contracts

Employers have been held legally responsible for the payment of bonuses expressly promised to employees as incentives. Once the worker has satisfied whatever criteria the employer has established to qualify for the bonus, courts will typically order the employer to pay.

Bonuses that are completely discretionary are not usually viewed as implied contracts, but those offered to induce people to achieve some desired goal are likely to be held enforceable.

Employers have also been ordered to pay bonuses when they offer smaller salaries with large bonuses. In general, the larger the bonus is, the more likely it will be considered a part of the employee’s total compensation package.

One way to avoid liability is to declare publicly (and often) that bonuses are awarded entirely at the discretion of management, are not intended to be binding on the company, and may be withdrawn at any time.

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Bonuses Must be Included in Overtime

Under the federal Fair Labor Standards Act (FLSA), bonus payments are divided into discretionary and nondiscretionary types. Nondiscretionary bonuses must be included in an employee’s regular rate of pay for the purpose of determining overtime, while discretionary bonuses need not be.

Bonuses are discretionary if:

  • Both the fact that payment is to be made and the amount of the payment are determined at the sole discretion of the employer; and
  • The bonuses are not paid under any prior contract, agreement, or promise causing the employee to expect such payments regularly.

Bonuses are nondiscretionary if the employer promises, contracts, or agrees to pay a bonus to the employee. Nondiscretionary bonuses include:

  • Bonuses that are promised to employees upon hiring
  • Bonuses that are the result of collective bargaining
  • Bonuses that are announced to employees to induce them to work more steadily, more rapidly, or more efficiently
  • Attendance bonuses
  • Individual or group production bonuses
  • Bonuses for quality and accuracy of work
  • Bonuses that are announced to employees to induce them to remain with the firm
  • Bonuses contingent upon the employee’s continuing in employment until the time the payment is to be made

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The FLSA provides for several narrow exemptions from the requirement that bonuses be included in an employee’s regular rate of pay. The onus is on the employer to prove that a payment meets one of the exemption requirements. The exemptions include:

  • Gifts, or payments in the nature of gifts, made at Christmas time or on other special occasions, as a reward for service, the amounts of which are not measured by or dependent on hours worked, production, or efficiency
  • Vacation, holiday, or sick leave pay; payment for failure of the employer to provide sufficient work, or other similar cause; reasonable payments for traveling expenses, and other similar payments to an employee that are not made as compensation for his or her hours of employment
  • Premium pay for working holidays or weekends

In tomorrow’s Advisor, taxability of bonuses and de minimus bonuses, plus good news for employers of tech employees.

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