What's the Difference Between Discretionary and Non-Discretionary Bonuses?

This article is for informational purposes and is not meant to provide legal, regulatory, accounting, or tax advice.  In our last article about bonuses, we discussed what kind of bonuses are typically given out around the holidays. Bonuses are a great way to bring cheer to your teams and share in your company’s success. However, before you start making promises to your staff, you’ll need to understand the bonus-specific differentiators that could affect your payroll. One very important differentiator when it comes to the bonus is the difference between discretionary bonuses and non-discretionary bonuses. 

Discretionary bonus

A discretionary bonus is a bonus given to an employee at the discretion of the employer. There are no expectations of receiving this bonus, or guidelines/outlines of how to become eligible to receive one. The amounts, criteria, and timing are not made known in advance, and they are given out after the fact. For example, an employer might reach their company’s financial goal, and decide that because they have some additional cash, they will give some people a surprise bonus. These bonuses are not included in any contract nor are they required to be given. There are no criteria spoken about in advance that would make someone eligible to receive this kind of bonus.

Non-Discretionary bonus

A non-discretionary bonus is a bonus that must be paid out if certain criteria are met. It’s a bonus that is announced and established ahead of time. For example, employees might be told that if they have 100% attendance over a certain period of time, they will receive an attendance bonus. It is paid when certain criteria are met, and the employee will expect payment if they fulfill said requirements. 

Why it's important to differentiate the two bonuses

Understanding their unique use case and application is extremely important and can impact the way you’re remaining compliant with local payroll laws. When giving out non-discretionary bonuses with hourly workers, the implications become important when calculating their overtime. The Fair Labor Standards Act requires that when you pay out non-discretionary bonuses, this bonus amount be added to their overall compensation.  As a result, their overall hourly wage is increased with the addition of this bonus.  On regular days worked, there is no difference or action needed. However, an increased hourly rate due to non-discretionary bonuses means that the overtime pay must be recalculated with a higher rate to include the period that the bonus was paid out. Thus, more money would be owed to the worker as their new premium hourly wage would increase their overtime pay. This is primarily a situation that affects hourly workers. To see a demonstration of how this calculation works, check out this YouTube demonstration. The miscalculations of overtime when an employee is paid a non-discretionary bonus is not something to be ignored. In some legal cases, federal laws for calculating overtime hours will differ from state laws, like in California. In cases like this where the employee’s overtime was miscalculated due to payout of a non-discretionary bonus, the employee can take legal action against the employer.  When thinking about your bonuses this season, be clear about what kind of bonus you are giving (discretionary versus non-discretionary). If you realize that you have in fact promised some kind of non-discretionary bonus ahead of time to your employees, be sure to check in with your local payroll association or legal counsel to ensure you’re covering your bases with overtime calculations.