What Is a Discretionary Bonus?
A discretionary bonus is a one-time payment an employer gives to an employee as a reward, without prior agreement or expectation. These bonuses are not promised in advance, not written into employment contracts, and are not tied to specific performance targets or quotas. Instead, they are awarded at the employer’s sole discretion.
What Qualifies as a Discretionary Bonus?
For a bonus to be legally considered discretionary, it must meet certain criteria:
- It is given at the employer’s sole judgment.
- There are no set conditions or performance goals attached.
- It is not included in any written or verbal agreements.
- Employees do not anticipate it as a regular occurrence.
- It is excluded from regular compensation calculations and does not factor into overtime pay under the Fair Labor Standards Act (FLSA).
Though these bonuses are not guaranteed, many employers choose to allocate budget space for them throughout the year as a way to reward and motivate their teams unexpectedly.
Examples of Discretionary Bonuses
Discretionary bonuses can take several forms. Common examples include:
- Retention Bonuses: Given to encourage employees to remain with the company after events like mergers or major transitions.
- Holiday or Year-End Bonuses: Provided without prior notice or contractual obligation, often as a token of appreciation.
- Spontaneous Rewards: Such as gift cards, surprise paid time off, or other small perks offered unexpectedly.
- Spot Bonuses: Granted on the spot to recognize exceptional work on a specific task or project.
- Challenge Bonuses: Given in response to a difficult workday or an employee’s handling of an unexpected challenge.
Why Do Employers Use Discretionary Bonuses?
Many businesses turn to discretionary bonuses as a flexible tool for boosting morale and strengthening workplace culture. Some of the key reasons include:
- Boosting employee morale through surprise recognition.
- Retaining valuable employees by acknowledging loyalty and dedication.
- Encouraging continued high performance, reinforcing positive behavior.
- Creating a culture of appreciation, where employees feel seen and valued.
Because discretionary bonuses are not bound by schedule or policy, employers can deploy them as needed, during critical business moments or in recognition of standout effort.
Tax Implications of Discretionary Bonuses
Even though these bonuses are considered unplanned, they are still taxable. The IRS classifies them as supplemental income, which can be taxed using one of two methods:
- Aggregate Method: The bonus is combined with regular wages in a single paycheck and taxed based on the total.
- Percentage Method: Bonuses up to $1 million are taxed at a flat 22%. Any amount above that is taxed at 37%.
To simplify bonus processing and tax compliance, many employers partner with payroll providers like Beyond, which helps ensure bonuses are properly calculated, taxed, and reported.
In summary, discretionary bonuses are a powerful tool that allows employers to reward and retain talent without long-term commitments. When used wisely, they help reinforce a positive, performance-driven culture and show employees their contributions matter.