Considering Paying a Tax Reform Bonus? 7 Questions You Need to Consider
Since the tax reform legislation passed in late 2017, there's been a lot of news about companies paying bonuses — and for good reasons.
A bonus makes employees happy. It also makes companies happy because it’s a good financial move. That's because the IRS allows companies — assuming they’re not on the cash basis of accounting – to deduct the cost of bonuses in the year before as long as they’re paid out before March 15th. Many high-profile companies are doing just that: taking the deduction in 2017 (when rates are higher) by announcing and paying them now. So, besides being a good people strategy, it's also a good tax strategy.
This is a one-time thing. The same strategy won't be relative come March 15, 2019. However, this doesn't mean that you should give bonuses just once. In fact, your company should be giving out bonuses as often as possible. But before you do, you — like many of my clients — probably have questions. Here are some of the most common ones I get and the answers I give:
1. Should you always pay bonuses out after year-end?
Yes. Remember, you can declare a discretionary bonus after the end of the year and still take a deduction in the prior year as long as you're not a cash-basis taxpayer and you pay by March 15th. Of course, check with your accountant in case there are other circumstances that apply to your company. I prefer this approach so that you can calculate the best total bonus to pay out once you've got an idea what your financials look like for the year. Think of paying out bonuses during the year end like you're paying them in the dark — without full-year financial information. For an expense this large, you want to have all the facts at hand before releasing the cash.
2. Speaking of cash, is that the best kind of bonus?
No. I think the best kind of bonus is a contribution to your employees' 401(k) accounts. You can give out a little cash (who doesn't like cash?), but if you really want to show your appreciation, contribute to their retirement plan — that way they’ll be thanking you from that future sunny condo in Miami! Not only can contributions to a retirement plan usually be made pre-tax, but – assuming you pass discrimination tests — the more you contribute to your employees, the more you can put away for your own retirement. Retirement plans are portable and can be cashed out early, albeit with penalties.
3. Should I contribute to a charity in lieu of a bonus?
Yes. Making a contribution to a charity to be chosen by the employee is a great way to demonstrate your social consciousness — and you may be able to take a tax deduction too! Of course, charity starts at home and most employees will desire that at least some of their bonus winds up in their bank account. But, data has shown that today's millennial generation — the 18-34 year olds who now make up the largest generational employee group working in the U.S. small business sector — prefer to work for companies that are socially responsible, and this is a great way to demonstrate your (and their) commitment.
4. Does a bonus have to be cash?
No way. In fact, many companies get creative with their bonuses. Some of my clients offer a portion of a bonus by giving added time off because workers today — more so than others in the past — rightfully place a high value on balance, vacation, flexibility, and time with their families, and that’s a great thing. Don’t want to give a vacation bonus? Others I know have given gift certificates, TV sets, furniture, bus fare, college loan repayments, priority parking spots, and even changes in titles as bonuses. Please keep in mind — there's really not a specific tax benefit for these kinds of alternatives because compensation is compensation, and your employees will be taxed on these things just as if it was cash. But, if you think these types of bonuses would resonate more with your people than just cash, by all means go for it.
5. Should I give a bonus every year?
Hopefully. Here's the thing: when employees get a benefit, they may expect to get that benefit every year. From an HR perspective, it's very tough to take something away once you’ve given it to an employee. However, you should make it clear that your bonus is discretionary and not part of a formal plan. This way, both the amount and the occurrence can be under your control. Your employees won't be happy if, after a number of years, you skip one. But if times are tough and you need to conserve cash to survive, they'll likely be happier that they still have jobs. It's tough to explain that to some people, so your best bet is to keep things as flexible as possible and be sure to comply with applicable wage and hour laws when providing non-discretionary bonuses.
6. Should my bonus be based on my company's profits?
Maybe. How's that for a clear answer? Studies have shown that it's more effective to pay people based on their performance rather than on the performance of the company. So, consider making your bonuses incentive-based and tied to meeting agreed upon performance objectives — a non-discretionary bonus — remember to comply with applicable wage and hours law. Discretionary bonuses, on the other hand, are not tied to an agreed upon performance standard, but perhaps the company has a great year profit-wise and you want to reward your employees with some extra cash in their pockets. In a case like the latter, if you don't have the profits you shouldn't pay the discretionary bonuses. Your employees may not know the minutiae about the company's profitability, but it's your job as the organization's leader to be fiscally responsible. Bottom line: make the bonus all about your employees, but only pay them out if you can truly afford to.
7. Do you follow your own advice?
Of course not. I pay out bonuses to my people every year, but I don't do it as well as I should. It's generally equivalent to their last paycheck and I've been doing the same for so many years that people expect it. Why? Because (typically) I’m lazy — and that’s a problem. I should be doing what I advise to my clients that I mention above: tying my bonuses more to their individual performance, making it clear that it's discretionary, and considering payments other than cash.
Following the enactment of the tax reform bill, you may be wondering whether you should pay bonuses to your employees. As you can see, there’s a lot to consider. That’s why it’s a good idea to work with your HR consultant, financial advisor, or accountant to determine what will work best for your business.