What is Bonus? | HR Glossary

A bonus labeled ‘discretionary’ that is paid every year based on company performance is likely non-discretionary in practice.

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Bonus is a variable compensation payment made to an employee beyond their base salary or wages, typically tied to performance, company results, tenure, or a specific event such as hiring or retention. Bonuses can be discretionary (at employer’s election) or non-discretionary (contractually expected). Also called: incentive pay, variable pay, incentive bonus.

Types of bonuses

Type	Description	Typical amount	Key compliance note
Performance bonus	Tied to individual, team, or company performance metrics over a period	5-30%+ of base salary depending on level and industry	Non-discretionary if criteria are pre-set; must be included in FLSA regular rate
Signing bonus	One-time payment to attract a new hire, often with a clawback provision	1 month to 6 months salary for senior roles	Not included in FLSA regular rate; clawback provisions must be documented
Retention bonus	Payment to retain a key employee through a defined period or milestone	10-50% of base salary	Must vest on defined schedule; clawback if employee leaves before vesting
Annual / year-end bonus	Discretionary or formula-based payment at year-end	5-20% of base salary for most roles	Discretionary version excludable from FLSA regular rate; formula-based is non-discretionary
Profit-sharing bonus	Distribution of company profits to employees on a defined formula	Variable – tied to company profitability	Generally non-discretionary where formula exists; included in FLSA regular rate
Referral bonus	Payment for referring a candidate who is successfully hired and retained	$500-$5,000 typically	May be non-discretionary if qualifying criteria are pre-defined
Spot / recognition bonus	Immediate small bonus for outstanding performance or contribution	$100-$2,500 typically	Discretionary; generally excluded from FLSA regular rate
Holiday / festive bonus	Time-based payment not linked to performance	One week’s salary is common	Discretionary; excluded from FLSA regular rate if not tied to performance

Discretionary vs non-discretionary: the FLSA critical distinction

The Fair Labor Standards Act (FLSA) requires overtime to be calculated at 1.5x the “regular rate” – which is not the same as the base rate. The regular rate includes most additional compensation, including non-discretionary bonuses.

Non-discretionary bonuses (production bonuses, attendance bonuses, safety bonuses, quarterly performance bonuses with pre-set criteria) must be included in the regular rate and therefore increase the overtime obligation. The most common FLSA compliance error is paying overtime at 1.5x the base hourly rate when non-discretionary bonuses should have increased the regular rate.

Discretionary bonuses (year-end gifts, spot bonuses given at the employer’s sole discretion without any prior promise or established criteria) are generally excluded from the regular rate. To qualify as truly discretionary, the employer must retain complete discretion over whether to pay the bonus, its amount, and the criteria for receiving it – right up to the time of payment.

The test is not what the employer calls the bonus. A bonus labeled ‘discretionary’ that is paid every year based on company performance is likely non-discretionary in practice. Misclassification creates back-pay liability for overtime underpayment.

Worked example: non-discretionary bonus overtime correction

An employee earns $20/hour and works 50 hours in a workweek, plus receives a $200 weekly production bonus (non-discretionary, tied to output targets).

Without the bonus correction: overtime is 10 hours x $30 = $300. With the bonus included in regular rate: regular rate = ($20 x 50 + $200) / 50 = ($1,000 + $200) / 50 = $24/hour. Overtime = 10 x ($24 x 0.5) = $120 premium (base was already paid). Total additional liability = $120 – $100 already paid in overtime = $20 per week. Over two years (FLSA lookback), liability per employee = ~$2,080 before liquidated damages.

Performance bonus design

Effective performance bonuses are built around four elements:

1. Defined metrics. Measurable KPIs (revenue, margin, NPS, production volume, quality scores) linked to the bonus formula. Vague criteria (‘at management discretion’) reduce motivational value and create non-discretionary classification risk simultaneously.

Clear thresholds. Minimum performance level to earn any bonus (threshold), on-target bonus at expected performance (target), and uncapped or capped maximum (stretch). The payout curve matters – linear, accelerated above target, or gated.
Funding mechanism. Company financial performance gate (no individual bonus if company misses threshold), department gate, or individual-only. Company gates reduce total payout risk; individual-only designs lose team coordination incentives.
Communication and timing. Employees cannot be motivated by a bonus they don’t understand. Communicate the formula, the current tracking, and the payout timeline. Quarterly updates on progress toward bonus targets sustain engagement.

Signing bonus design and clawback

Signing bonuses are used to attract candidates, compensate for unvested equity forfeited at a prior employer, or offset relocation costs. Best practices:

Clawback provision. Require repayment if the employee leaves within a defined period (typically 12-24 months). Without a clawback, signing bonuses are a pure hiring cost with no retention function.
Pro-rata clawback vs full repayment. Pro-rata (25% clawback if leaving after 9 of 12 months) is more employee-friendly and may improve offer acceptance; full repayment is simpler to administer.
Tax gross-up consideration. Signing bonuses are taxed as supplemental income (22% federal flat withholding in the US for amounts under $1M, or applicable marginal rate). Some employers gross up the bonus to deliver a net target amount.
Document in writing. Clawback provisions must be in a signed agreement; oral promises are unenforceable in many states.

Tax treatment

United States

Bonuses are supplemental wages subject to income tax withholding. Two methods:

Aggregate method. Bonus is combined with regular pay; withholding applies to the combined amount using normal withholding tables.
Flat rate method. 22% federal flat withholding on supplemental wages under $1M; 37% on amounts over $1M.

Signing bonuses are fully taxable in the year received. Clawback repayments can create a tax deduction in the year repaid (or a claim for refund if the repayment exceeds $3,000 under the “claim of right” doctrine).

India

In India, bonuses are governed by the Payment of Bonus Act 1965 (for establishments with 20+ employees), which mandates a minimum annual bonus of 8.33% of annual wages (subject to a wage ceiling) and allows a maximum of 20%. Performance and ex-gratia bonuses outside the Act are taxed as salary income under Section 17 of the Income Tax Act and subject to TDS.

Bonus vs incentive vs commission

Term	Definition	When earned	Primary purpose
Bonus	Variable payment beyond base, tied to performance, tenure, or events	After performance period; retrospective	Retention, performance recognition, sharing company results
Incentive	Variable payment structured to drive specific future behavior	On achievement of pre-set target; prospective	Behavior change, goal alignment
Commission	Variable payment calculated as a percentage of revenue or sales	On transaction completion	Direct revenue linkage

The terms are often used interchangeably, particularly ‘bonus’ and ‘incentive.’ The legal distinction that matters most is discretionary vs non-discretionary, not the label used.

Pair bonus program design with validated skills assessments that measure the capability drivers of the performance outcomes the bonus rewards. See also base pay for the total compensation framework, base rate for the FLSA regular rate calculation, and back pay for wage-and-hour compliance.

Frequently asked questions

A bonus is a variable compensation payment made to an employee beyond their regular base salary or wages, typically tied to performance, company results, tenure, or a specific event such as a new hire or retention milestone. The most important legal distinction is between discretionary bonuses (at the employer’s sole election) and non-discretionary bonuses (contractually expected or tied to predetermined criteria), which have different FLSA and tax treatment.

A discretionary bonus is one where the employer retains complete discretion over whether to pay it, how much to pay, and the criteria for receiving it – right up to the time of payment. A non-discretionary bonus is contractually expected or tied to pre-set criteria (production targets, attendance, quarterly performance). Non-discretionary bonuses must be included in the FLSA regular rate for overtime calculation; discretionary bonuses generally can be excluded.

Yes, if the bonus is non-discretionary. The FLSA requires overtime to be calculated at 1.5x the “regular rate,” which includes most non-discretionary bonuses. If a production bonus, attendance bonus, or performance bonus with pre-set criteria is paid, it must be included in the regular rate before calculating the overtime premium. Failure to include non-discretionary bonuses in the regular rate is one of the most common FLSA wage-and-hour violations.

A signing bonus is a one-time payment made to attract a new hire, often used to compensate for unvested equity forfeited at a prior employer or offset relocation costs. Signing bonuses typically include a clawback provision requiring repayment (full or pro-rata) if the employee leaves within a defined period (usually 12-24 months). Signing bonuses are not included in the FLSA regular rate for overtime purposes.

A clawback provision requires an employee to repay a signing bonus, retention bonus, or other payment if they leave the organization within a defined period or if certain conditions are not met (compliance violations, financial restatements for executive clawbacks under Dodd-Frank). Clawback provisions must be documented in a signed agreement; oral promises are unenforceable in most states. Pro-rata clawbacks (proportional repayment based on time served) are more employee-friendly than full repayment provisions.

Yes. In the US, bonuses are supplemental wages subject to federal and state income tax withholding. Employers may withhold at a 22% flat federal rate on supplemental wages under $1 million (37% above $1 million) or use the aggregate method combining the bonus with regular pay. In India, bonuses under the Payment of Bonus Act 1965 and performance bonuses are taxed as salary income under Section 17 of the Income Tax Act and subject to TDS.

The Payment of Bonus Act 1965 applies to establishments in India with 20 or more employees. It mandates an annual bonus of a minimum of 8.33% of annual wages (calculated on wages up to a ceiling of Rs 7,000 per month or the minimum wage, whichever is higher) and a maximum of 20%, based on allocable surplus derived from the statutory formula. Employers with a positive allocable surplus must pay at least 8.33%; if allocable surplus is insufficient, the employer pays the minimum bonus regardless.

A retention bonus is a payment made to keep a key employee through a defined period or milestone – a critical project completion, an acquisition integration, or a succession transition. Retention bonuses typically vest on a schedule or at a specific date, with clawback if the employee leaves before vesting. They are used when the employer has identified that the specific employee’s departure would cause material disruption and the employee is at risk of leaving due to competing offers or organizational uncertainty.