Make the Most of End of Year Bonuses for Your Employees

Year-end planning is focused on reducing taxable profit. One popular way to reward employees and mitigate taxes is by issuing year-end bonuses.

Business owners often create a pool of money for bonuses based on employee compensation. This can be a percentage of their salary, or a portion based on their individual achievements. The goal is to put the business in a better tax position and determine the most comfortable percentage of income to pay. 

bonuses as profit-sharing vs Salary

When paying bonuses as salary, businesses must also pay FICA tax, which includes Social Security and Medicare tax. This adds an extra 7.65% cost.

An alternative route is to use a profit-sharing plan, which involves a one-time employer contribution to a 401(k) plan. This contribution is tax-deductible and does not require paying Social Security and Medicare tax. Employees can save anywhere from 12% to 37% on taxes, depending on their income level. 

Profit-sharing contributions can also include a vesting schedule, which requires employees to work for a set period before they can fully access the contributed funds. This serves as a retention tool and encourages employees to save for retirement. It is important for business owners to regularly review their financial portfolio and retirement plans with a financial advisor. 

Minimize tax Burden of Bonuses

When giving bonuses, it is crucial to consider how they will be taxed. If treated as regular income, the bonus may be taxed at a higher rate, assuming the employee earns that amount every pay period. However, it is possible to elect to have the bonus taxed separately at a lower rate. This can help lessen the tax burden for employees. 

Overall, the best option to keep more money in employees' pockets is through profit-sharing contributions. These contributions can be made until September of the following year and still be deducted for the prior year. This provides flexibility for businesses with cash flow fluctuations. 

make bonuses a win-win

Year-end bonuses can be a great way to reward employees and reduce taxable profit. By planning and considering different tax strategies, businesses can make the most of their bonuses and create a better financial position for themselves and their employees. 

Do you want help figuring out the best way to provide bonuses or prepare for the end of the year? Kaizen CPAs + Advisors can help set you up for success. Use the “Let’s Chat” button and find out if we are the right fit for you.