Effective Management of Pay Raise or Bonus in Your Company Payroll

Last Updated:
September 14, 2023
Kay Nicole

Effective Management of Pay Raise or Bonus in Your Company Payroll

Paying employees is an important part of managing a business. Employees may feel that they deserve a higher pay raise than their employer can afford to give them. Raise and bonus options help to manage these situations. Bonuses are less costly to a business than pay raises because they are variable expenses that can be lowered or eliminated during tough economic times.

Calculate the Bonus

Bonuses are a great way to reward your team for meeting goals and hitting metrics that help the business succeed beyond an annual pay raise. They can also keep payroll costs down in lean times, as they're often based on variable amounts of money, such as sales or production volumes. However, just like regular wages, bonuses must be taxed as supplemental income. As a result, the IRS offers two ways to calculate how much withholding to apply to bonus payments. The first is to add the total bonus amount to an employee's previous pay period's regular compensation to determine how much should be withheld. The other option is to add the bonus payment to an employee's steady paycheck, which is easier for businesses to manage since it's a lump sum that follows the same deductions and taxes.

For example, Jill is a new hire in your accounting department who has helped reduce company expenses by 10% this year. To recognize her hard work, you want to give her a bonus of $5,000. You can pay the compensation directly in cash or use payroll to add it to her regular paycheck. The latter method is easier to manage and may feel more tangible for employees. However, this will be reflected in her salary differently, and the difference is how much withholding should be applied to her federal taxes.

Communicate with Employees

When an employee receives a pay raise or bonus, it's important to communicate the details to them. It's best to do this in person, but you should send them a letter if that's impossible. It can help to maintain the privacy of the situation, and it also allows you to explain the context of the increase. For example, if the reason for the salary increase is that they are doing better than others, you can include specific information about their performance and how they've been measured. It will give them a sense of how the company values their work and what it's like to be part of a successful team. If the reason for the salary increase is a general across-the-board cost-of-living or inflation increase, it's also important to provide that context. It can be frustrating for employees to feel their hard work is overlooked and will not be recognized. It's important to let them know why the company gave them a raise so that they don't get discouraged and lose their motivation.

It's also a good idea to talk to employees about their career goals and how the pay increase may help them achieve them. It will encourage them to stay at the company and inspire them to continue improving their performance.

Make the Decision

Pay raises, and bonuses can be a great way for business owners to show employees that they value their work. However, it's also important to remember that the company needs to be able to afford the increased costs that may come with them. Typically, raises are set at a certain percentage of an employee's base salary. The amount may increase based on performance or decrease if an employee doesn't perform well enough to merit higher compensation. Many companies have a structured annual performance review process based on specific, measurable goals for the individual.

However, other companies are less formal or need a performance review system. Some companies use different methods for determining when to give an employee a raise or bonus, such as a predetermined dollar amount based on the company's budget or a percentage of each employee's base salary. A percentage method can help to ensure that everyone receives a fair amount regardless of the size of their salary. Alternatively, some companies offer different types of incentives in addition to or instead of a pay increase, such as profit-sharing, stock options and equity, flexible working conditions, tuition reimbursement, travel allowances, gift certificates and entertainment tickets. While these options can help keep company costs down, they harm staff morale.

Make the Payment

When it comes to payroll, a pay raise or bonus is not only a form of employee retention but also a way for your business to incentivize employees and drive company performance. However, a permanent increase in compensation is a significant expense for many small businesses, and it is important to ensure that your company generates enough revenue and cash flow to meet these new payroll expenses. As a result, many companies are more willing to use bonuses rather than annual salary increases.

Rewards are easier to manage as a variable cost and can be lowered or eliminated when sales or production numbers decline. Unpredictable pay fluctuations disrupt staff and may encourage them to look for work elsewhere. Using payroll to distribute a bonus allows the company to incorporate it into the employee's regular paycheck, which means that it is treated as part of their normal earnings and subject to the same deductions and taxes. Bonuses can be paid in various ways, including cash and additional wages for overtime or shift work. A company may also give a reward through stock options or equity. Regardless of how the bonus is delivered, it is important to communicate the amount and the reason for the payment to employees so that they understand what their new compensation amounts are.

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