Different Types of Bonuses for Employees: 2025 Ultimate Guide

A bonus is an extra lump-sum payment given to status and adjunct employees to recognize contribution and extraordinary effort. There are several types of bonuses. Some plans simply give employees a certain share of the company profits, or perhaps a bonus to the entire company. Other programs give financial incentives to individuals or teams to perform at or above certain thresholds. And a variety of cash and noncash awards are possible for certain types of achievements in some companies.

Whatever the structure, bonus pay helps motivate and reward employees. This article discusses different types of bonuses for employees, how to determine them effectively, and the tax implications organizations need to consider.

10 different types of bonuses 

Types of bonuses include profit sharing, gain sharing, spot awards, noncash, sign-on, mission, referral, retention, holiday, and sales commissions.

Calculating bonuses manually can be slow and error-prone. Salary.com’s Compensation Planning Software streamlines the process by managing all bonus plans in one place. It standardizes formulas, enforces eligibility rules, validates data, and reduces administrative work, improving accuracy and efficiency.

1. Profit sharing

   One very basic type of bonus program is current profit sharing. A company sets aside a predetermined amount; a typical bonus percentage would be 2.5 and 7.5 percent of payroll but sometimes as high as 15 percent, as a bonus on top of base salary. Such bonuses depend on company profits, either the entire company's profitability or from a given line of business. Sometimes these incentives are given across the board, while in other cases larger percentages of compensation are awarded to higher-earning employees.

   The purpose of profit sharing is to encourage employees to understand how their work affects the company's performance and to improve the company's profitability. When employees understand how the organization makes money and how their role impacts financial outcomes, employee engagement increases as they work toward business goals. Providing access to resources such as the annual report or performance statements also helps reinforce this connection, while signaling leadership’s commitment to transparency and shared success.

2. Gain sharing

   This type of bonus program is most common in manufacturing plants and is designed to reward productivity and improved product quality. Gain sharing works best when employees become responsible for production quantity and quality and are encouraged to improve the way the product is made. This program reflects a philosophy that employees know their job best.

   Gain sharing programs pay out bonuses for statistical improvements in production and quality on a quarterly or sometimes monthly basis, providing a sense of excitement for participants. These programs are often very successful, transforming the manufacturing plant into a center of employee commitment.

3. Spot bonus award

   Some companies reward employees on the spot for achievements that deserve special recognition. A spot bonus award is typically $50 and up and can be made by an immediate supervisor or any higher-level person in the company. Employees can receive these awards for actions such as being extra helpful or going beyond expectations.

   The math is in employees' favor: companies with spot bonus programs offer approximately 1 percent of payroll and expect to give out such bonuses to 25 percent of the employees eligible for them, allowing them to earn more than one instant bonus in a year.

4. Noncash bonus

   Although the wrong kind of "employee of the month" concept can be cheesy, it's all in the execution. A well designed noncash bonus program can instill pride and improve employee morale. Employees who have done a great job should have to come to the front of a crowded room at a special ceremony as if they are receiving an Academy Award. The certificate or trophy should be thoughtfully and cleverly designed, and appropriate to the occasion. These awards are sometimes coupled with a token tangible award, such as a gift certificate, a bonus day off, or a great parking space.

5. Sign-on bonus

   No longer just for star athletes, signing bonuses have become commonplace. Their usage now extends to nearly all level of employees, especially when unemployment is low and top talent is hard to find.

   Given to new employees who have just joined the company, this award serves two purposes:

   • Establish goodwill

   • Buy out any compensation "left on the table" from a previous employer.

   The second purpose is important to remember. Candidates often participate in multiple compensation programs with their former organization. If they are expecting a bonus in a few months, the new employer can use a sign-on bonus to buy them out of it. If they have any stock options, particularly options that are in the money, the employer can match this value through cash or new stock options.

   Employers should also remember to account for profit-sharing or defined contributions (for example, a 401(k) match or an Employee Stock Options Program (ESOP)) made to a retirement account. The objective of a sign-on bonus is to keep the employee whole as they move from one set of compensation programs to another.

6. Mission bonus (also known as a task or milestone bonus)

   These are given to a team of employees for achieving a milestone or for completing an important project. Usually, these are offered sparingly, but they have been used more frequently in software and hardware development to encourage meeting tight deadlines. Sometimes these employee bonus programs incorporate a quality measure to guard against too much focus on speed.

   These incentives can be significant (one month's salary is not uncommon, and certainly no less than one week). For employers, this award recognizes the type of achievement that demonstrates measurable impact and reinforces organizational success.

7. Referral bonus

   In hot job markets, it can be difficult for employers to find qualified personnel. When talent is scarce, many employers retain recruiters to find candidates, typically paying the recruiter 20 to 30% of the new hire's first-year pay. Many employers prefer to avoid this fee, and instead, offer referral bonuses to employees for recommending friends and acquaintances. Employers are comfortable in hiring friends of employees because employees are unlikely to recommend people who will make them look bad.

   They are typically hundreds to thousands of dollars and depend on the level of the new hire. Some firms pay as much as $10,000 to $20,000 for the successful referral of a senior leader.

8. Retention bonus

   Companies often offer retention bonuses to employees in unusual circumstances, such as a merger or acquisition, or when an important project needs to be completed. These are designed to provide continuity when there is potential uncertainty about an employee's continued employment at the company. The bonus encourages employees to stay until a specified date so that critical activities can continue without disruption. Employee retention bonuses are usually about 10 to 15% of salary.

9. Holiday bonus

   Holiday bonuses, also known as annual bonuses, range from small gifts; from cash to the ubiquitous holiday turkey to one month's salary. The amount is usually dictated by the company's practices. If an organization provides one month's salary, it is often viewed as part of regular financial compensation when employees compare offers elsewhere. This practice is usually referred to as a "13-month salary," and it is not considered a true holiday bonus since no performance is required to receive it.

10. Sales commission

    Sales commissions are awarded to salespeople for selling. Usually, these awards are paid out as a percentage of sales volume. In some cases, commission percentages can increase with higher sales volume. In fewer cases, the percentage can decrease. It all depends on the scheme. Sales commissions are a significant source of income for sales employees, comprising at least 50% of total cash compensation.

    Speaking of commissions, Compensation Planning Software makes commission planning effortless. It allows organizations to calculate monthly and quarterly commissions, generate clear statements, and streamline incentive communications, all in one place.

Discretionary vs nondiscretionary bonuses

The difference between discretionary and nondiscretionary bonuses is that discretionary are given at the employer’s choice and are not expected by employees, while nondiscretionary are promised, expected, or tied to performance and must be counted in the regular rate of pay for non-exempt employees under the Fair Labor Standards Act (FLSA).

The U.S. Department of Labor states that a bonus is discretionary only if:

• The employer decides at the end of the period whether to pay it;

• The employer decides at the end of the period how much to pay; and

• The bonus is not based on any prior contract or promise that creates employee expectation.

Examples of discretionary bonuses include:

• Bonuses for overcoming a challenging or stressful situation;

• Recognition for unique or extraordinary efforts not tied to pre-established criteria;

• Employee-of-the-month awards;

• Severance bonuses;

• Referral bonuses to employees not primarily engaged in recruiting activities (subject to additional criteria).

The label or reason for a bonus does not decide if it is discretionary. If the requirements for discretion are not fully met, the bonus is treated as nondiscretionary. In addition, discretionary bonuses cannot be credited toward overtime pay for non-exempt employees under the FLSA.

In contrast, nondiscretionary must be included in the regular rate of pay since they come from established policies, agreements, or programs that create an expectation of payment for employees.

Examples include:

• Production bonuses based on a formula;

• Bonuses for quality or accuracy of work;

• Incentives announced to encourage higher efficiency;

• Attendance bonuses; and

• Safety bonuses (e.g., days without incidents).

These are considered nondiscretionary because employees know the conditions in advance and expect payment once those conditions are met. An employer’s later decision not to pay does not make the bonus discretionary.

How are bonuses taxed?

Bonuses are taxable and subject to federal, state, and local taxes. Employers must withhold the correct taxes, record the payments in payroll, and report them on employees’ W-2 forms. Federal withholding on bonus pay can be calculated using two methods: the percentage method or the aggregate method.

1. Percentage method: Employers treat the bonus payment separately and withhold 22% for federal taxes. For cash bonuses over $1 million, the first $1 million is withheld at 22%, and the rest at 37%.

   Example using the percentage method: If an employee receives a $10,000 incentive bonus and the flat 22% withholding rate is applied, the federal tax withheld would be: $10,000 x 0.22 = $2,200.

   For very large cash rewards over $1 million, the withholding rate changes: 22% on the first $1 million and 37% on the amount above $1 million.

   Another example: If an employee receives a $2.5 million bonus, federal withholding would be calculated as follows:

   • $1,000,000 x 0.22 = $220,000 (first million)

   • $1,500,000 x 0.37 = $555,000 (remaining 1.5 million)

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   Real-time monitoring of bonus and raise allocations.

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   Total withholding = $220,000 + $555,000 = $775,000

2. Aggregate method: Employers include the bonus with regular wages in one paycheck and withhold taxes as if it were a single payroll period. This method is often used for commissions or recurring supplemental pay.

   Example using the aggregate method:

   If an employee receives a $3,000 bonus or financial reward included in a $4,000 regular paycheck, the total $10,000 is taxed as one paycheck. Assuming a 22% effective federal withholding rate for this payroll period, the federal tax withheld would be: $7,000 x 0.22 = $1,540.

How to determine bonuses for employees

Here is a guide to planning and implementing employee bonuses:

1. Understand your bonus objectives: Explain the purpose. Decide if they reward performance, team success, company profits, or help retain employees. Clear goals guide all other decisions.

2. Choose the bonus type to offer: Select the bonus type that fits your goals. Options include discretionary (paid at the employer’s choice), nondiscretionary (based on set targets or agreements), performance bonuses, or profit-sharing.

3. Set eligibility criteria: Identify who is eligible for the bonus. Consider role, tenure, performance, or goal achievement. Clear criteria promote fairness and transparency.

4. Determine metrics and payouts: Decide how these incentives will be calculated. Base them on measurable performance, sales targets, project results, or company profits. Decide on a fixed amount, a percentage of salary, or a performance-based formula.

5. Communicate the program: Communicate the bonus plan clearly. Explain the type, who is eligible, how it is measured, and when it will be paid. Written details help set expectations, build trust, and follow employment laws.

While planning bonuses can be complex, Salary.com's Compensation Planning Software makes it easy. It automates multi-factor bonus calculations for any industry or company size and securely manages all bonus data for accurate, transparent, and efficient payouts.

FAQs

Here are some common questions related to the types of bonuses:

Is a bonus a gift?

No, a bonus is not a gift. A gift is given voluntarily, like a TV, jewelry, or an Amazon voucher, without expecting performance. A bonus is usually a cash reward tied to employee performance, added on top of regular pay.

Are bonuses paid in cash?

Yes, bonuses are typically paid in cash. However, they can also come as stock options, gift cards, extra time off, or other non-cash rewards, depending on company policy.

Are all bonuses taxable?

Yes, most bonus payments are taxable. They are treated like regular income and subject to federal, state, and local taxes. Certain non-cash perks or de minimis gifts may be exempt, according to the Internal Revenue Service.

Why are bonuses taxed so high?

Bonuses can appear heavily taxed because they are treated as supplemental income. Employers are required to withhold a flat federal rate (22%) plus state, Social Security, and Medicare taxes.

Are referral bonuses taxable?

Yes, referral bonuses are taxable. How they are taxed depends on your role in the company and the bonus amount.

How does a company decide on a bonus structure?

Companies decide on a bonus structure by reviewing goals, budget, roles, and performance, linking rewards to outcomes like productivity, retention, or sales.