Bonuses: Discretionary vs. Non-Discretionary
Understand the differences between discretionary and non-discretionary bonuses for payroll calculations.
Discretionary and non-discretionary bonuses: Payroll considerations
Goals and takeaways
- Understand the difference between discretionary and non-discretionary bonuses
- Learn how each bonus type impacts regular rate of pay and overtime calculations
- See how to calculate total gross wages when bonuses are included
What are supplemental wages?
The IRS defines supplemental wages as “wage payments to an employee that aren’t regular wages.” These can include:
- Commissions
- Severance pay
- Awards and prizes
- Back pay and retroactive increases
- Bonuses (discretionary or non-discretionary)
This article focuses on how to distinguish between bonus types and how each one should be handled in payroll systems.
Discretionary bonuses
A discretionary bonus is variable pay that is awarded at the employer’s sole discretion, without advance notice or obligation. Discretionary bonuses are excluded from the regular rate of pay and do not impact overtime calculations.
Indicators of a discretionary bonus
- The employee does not expect the bonus in advance
- The employer has sole discretion over amount and timing
- There is no prior contract or stated goal attached to the bonus
To qualify as discretionary, all of the following must be true:
- The employer decides whether to pay the bonus at or near the end of the relevant period
- The employer determines the amount at or near the end of the period
- There is no prior agreement or promise that would lead the employee to expect the bonus
Common examples
- Spot bonuses for handling a tough customer issue
- A “thank you” bonus for working during a holiday rush
- Employee-of-the-month awards
- Referral bonuses not tied to specific recruiting KPIs
Non-discretionary bonuses
A non-discretionary bonus is tied to performance, output, or an agreement between the employer and employee. These bonuses must be included in the regular rate of pay and impact overtime calculations.
Indicators of a non-discretionary bonus
- The employee is told in advance how to qualify
- There is a written or verbal agreement about how bonuses are earned
- The bonus is used to incentivize productivity, accuracy, or behavior
Common examples
- Production-based bonuses
- Attendance or safety bonuses
- Bonuses announced to encourage specific outcomes
- Sign-on or retention bonuses tied to time worked
Impact on overtime and regular rate of pay
To calculate overtime, you must first determine the regular rate of pay, which may be affected by bonus type.
Bonus Type | Include in Regular Rate of Pay? |
Discretionary Bonus | No |
Non-Discretionary Bonus | Yes |
Example 1: Discretionary bonus (excluded from regular rate)
- Employee works 50 hours at $10.00/hour
- Receives $500 discretionary bonus
Calculation:
- Regular wages = $10 × 50 = $500
- Overtime wages = $10 × 0.5 × 10 = $50
- Bonus = $500 (discretionary)
- Total gross wages = $500 + $50 + $500 = $1,050
Example 2: Non-discretionary bonus (included in regular rate)
- Employee works 50 hours at $10.00/hour
- Receives $500 non-discretionary bonus
Calculation:
- Regular rate of pay = ($500 regular wages + $500 bonus) ÷ 50 hours = $20.00/hour
- Overtime wages = $20 × 0.5 × 10 = $100
- Total gross wages = $500 regular + $500 bonus + $100 OT = $1,100
System considerations
Payroll systems should either:
- Allow employers to input a regular rate of pay, or
- Automatically calculate regular rate when non-discretionary bonuses apply
Make sure bonus types are clearly labeled in the system to avoid incorrect wage calculations and potential compliance risks.
References
Last updated on June 7, 2025