What Is a Discretionary Bonus?
Learn what discretionary bonuses mean (employer-determined performance rewards with no contractual obligation), how they differ from non-discretionary bonuses, tax implications, legal considerations, and best practices for fair implementation.
What Is a Discretionary Bonus?
A discretionary bonus is a voluntary payment employers choose to give employees to reward performance, celebrate achievements, or recognize contributions, with no contractual obligation or predetermined formula. The employer retains complete discretion over whether to pay the bonus, the amount, timing, and which employees receive it.
Unlike non-discretionary bonuses that are promised based on specific criteria (sales targets, attendance, productivity), discretionary bonuses are truly optional. Employees cannot demand or expect them, and employers can change or eliminate them at any time.
Quick Answer
Discretionary bonuses are optional performance rewards employers may pay without contractual obligation. Employers decide if, when, how much, and to whom. Not included in overtime calculations under FLSA. Taxed at 22% federal supplemental wage rate. Common amounts: $250-$5,000.
How Discretionary Bonuses Work
Employer Determines All Aspects
The employer holds all the cards with discretionary bonuses:
- Amount — Decide the bonus size based on budget, individual performance, team results, or whatever factors make sense
- Recipients — Choose who gets bonuses (one person, a team, the whole company)
- Timing — Pay them when it feels right (year-end, project wrap-up, or spontaneous recognition)
- Criteria — While performance usually matters, there’s no formula or guaranteed calculation
No Employee Entitlement
Here’s what makes these bonuses truly “discretionary”:
Employees can’t demand them. No promises, no guarantees, no legal obligation.
These bonuses aren’t announced beforehand, don’t appear in employment contracts or offer letters, and can be eliminated or changed year to year without notice. They’re genuinely at the employer’s discretion.
Discretionary vs Non-Discretionary Bonuses
| Aspect | Discretionary Bonus | Non-Discretionary Bonus |
|---|---|---|
| Promise | Not promised; truly optional | Promised based on specific criteria |
| Criteria | No fixed formula | Specific metrics (sales, attendance, productivity) |
| Employee expectation | Cannot expect; gift-like | Expected if criteria met |
| Employer obligation | None; can skip or vary | Must pay if criteria met |
| FLSA overtime impact | Excluded from regular rate | Must include in overtime rate calculation |
| Examples | Holiday bonus, spot bonus | Commission, production bonus, attendance bonus |
Critical difference: Non-discretionary bonuses must be included in the regular rate when calculating overtime pay for non-exempt employees under FLSA. Discretionary bonuses are excluded.
Legal Requirements and FLSA Compliance
What Makes a Bonus Truly Discretionary?
Under Fair Labor Standards Act (FLSA), a bonus is discretionary only if:
1. Not announced in advance: Employees not told they will receive a bonus or how it will be calculated.
2. No expectation created: Employer has not created pattern or practice making bonus expected.
3. Amount and payment fully discretionary: Employer decides all aspects (amount, recipients, timing) without predetermined criteria.
4. Not tied to specific metrics: Not based on hours worked, production, efficiency, attendance, or other measurable performance factors.
Overtime Calculation Impact
Discretionary bonuses: Excluded from regular rate; do not affect overtime calculations.
Non-discretionary bonuses: Must be included in regular rate for overtime weeks.
Example of non-discretionary bonus overtime impact (important for variable pay programs):
- Employee earns $20/hour, works 45 hours in bonus week
- Receives $500 attendance bonus (non-discretionary)
- Regular rate calculation: ($20 × 45 hours + $500) / 45 hours = $31.11/hour
- Overtime rate: $31.11 × 0.5 = $15.56 additional per overtime hour
- Overtime owed: $15.56 × 5 overtime hours = $77.80 additional
No recalculation needed for discretionary bonuses: They simply add to total pay without affecting overtime calculations.
Tax Treatment
Federal withholding: Discretionary bonuses are supplemental wages, typically withheld at 22% federal rate (37% if over $1 million cumulative supplemental wages annually).
FICA taxes: Full Social Security (6.2% up to wage base) and Medicare (1.45%) apply.
State and local taxes: Vary by jurisdiction.
W-2 reporting: Bonuses included in total wages on W-2.
Benefits and Challenges
Benefits for Employers
Flexibility: No obligation to pay; can adjust based on company performance or budget.
Overtime savings: Excluded from overtime rate calculations, reducing costs.
Motivation: Surprise bonuses can create strong positive feelings and loyalty.
Retention: Well-timed bonuses encourage valued employees to stay.
Challenges for Employers
Fairness perceptions: Discretionary nature can appear arbitrary or unfair if not handled carefully.
Expectation creep: Repeated bonuses create expectation, potentially making them non-discretionary.
Legal risk: Poorly administered discretionary bonuses may be challenged as non-discretionary, requiring overtime recalculation.
Discrimination claims: Inconsistent distribution could raise questions about bias.
Best Practices for Discretionary Bonuses
Maintain True Discretion
Do not promise: Avoid statements like “we plan to pay bonuses” or “bonuses are typically $X.”
No formulas: Don’t tie bonuses to specific metrics that would make them non-discretionary.
Reserve rights: Include language in policies reserving full discretion to pay, modify, or eliminate bonuses.
Vary amounts and timing: Don’t create predictable patterns that establish expectations.
Communicate Carefully
Before payment: If communicating about potential bonuses, emphasize discretionary nature and no guarantees.
Upon payment: Thank employees for contributions; explain bonus is discretionary recognition.
Written policies: Document that bonuses are discretionary, not guaranteed, and subject to change.
Avoid creating expectations: Don’t make statements suggesting bonuses are annual or guaranteed.
Apply Fairly
Objective reasoning: Even discretionary bonuses should have rational basis (performance, tenure, role impact).
Document rationale: Note why specific employees received specific amounts for potential legal defense.
Avoid discrimination: Ensure distribution doesn’t disproportionately exclude protected classes.
Consistency within roles: Similar performers in similar roles should receive similar treatment.
Budget Appropriately
Set aside funds: Budget for bonuses annually based on expected company performance.
Company performance link: Scale total bonus pool to company profitability or performance.
Individual amounts: Typical discretionary bonuses range $250-$5,000; varies by role and company size.
Timing: Many employers pay discretionary bonuses in December (holiday bonuses) or early Q1 (year-end performance).
Common Discretionary Bonus Scenarios
Holiday Bonuses
Typical amount: $250-$2,000 per employee (varies by tenure, role, company size).
Timing: December or early January.
Best practice: Vary amounts or skip years to maintain discretionary nature; communicate bonus is not guaranteed annual benefit.
Spot Bonuses
Typical amount: $100-$1,000.
Timing: Immediately after exceptional contribution.
Best practice: Keep process simple; empower managers to award small spot bonuses; document reason.
Year-End Performance Bonuses
Typical amount: $500-$10,000+ (varies significantly by role and seniority).
Timing: End of fiscal year or early following year.
Best practice: Even if based on performance review, avoid specific formulas; emphasize discretionary nature; vary amounts year to year.
When Discretionary Bonuses Become Non-Discretionary
Warning signs that a bonus program may have lost discretionary status:
Announced in advance: “We will pay bonuses in December based on company performance.”
Fixed criteria: “Employees meeting attendance standards receive $500.”
Regular pattern: Paid every year for 5+ years at similar amounts.
Employee expectation: Employees assume they will receive it.
Promised in writing: Included in offer letters, employee handbook as guaranteed benefit.
Formula-based: “Bonuses equal 5% of annual salary.”
Consequence: May need to include in overtime calculations; may be legally obligated to pay.
Documentation and Policies
Employee handbook language (example):
“The Company may, in its sole discretion, pay discretionary bonuses to recognize exceptional performance or contributions. Discretionary bonuses are not guaranteed, not part of any employee’s compensation package, and may be modified or eliminated at any time without notice. The Company determines all aspects of discretionary bonuses, including amount, timing, and recipients. Employees should not expect or rely on discretionary bonuses for financial planning. Payment of a discretionary bonus in one year does not create any obligation or expectation for future bonuses.”
Offer letter language: Do not include discretionary bonuses in offer letters. If mentioned, clearly state they are discretionary and not guaranteed.
Sources
- U.S. Department of Labor – Fact Sheet #56A: Overview of the Regular Rate
- Internal Revenue Service – Supplemental Wages
- Society for Human Resource Management – Discretionary vs. Nondiscretionary Bonuses
Further Reading
Frequently Asked Questions
What is a discretionary bonus?
A discretionary bonus is a voluntary payment employers choose to give employees based on performance, with no contractual obligation or predetermined formula. Employers decide if, when, how much, and to whom bonuses are paid. Employees cannot expect or demand them. Not included in overtime rate calculations under FLSA.
What is the difference between discretionary and non-discretionary bonuses?
Discretionary bonuses: employer decides amount and recipients; not promised in advance; excluded from overtime calculations; truly optional. Non-discretionary bonuses: promised based on specific criteria (attendance, productivity, sales); employees expect them; must be included in overtime rate calculations; employer obligated to pay if criteria met.
Are discretionary bonuses taxed?
Yes. Discretionary bonuses are taxable income, typically withheld at 22% federal supplemental wage rate (37% if over $1 million annually). FICA taxes (Social Security 6.2%, Medicare 1.45%) also apply. State and local taxes vary. Bonuses included in W-2 wages and taxed at employee’s actual tax rate when filing annual return.
Do discretionary bonuses affect overtime pay?
No. True discretionary bonuses are excluded from the regular rate when calculating overtime under FLSA. However, if a bonus is promised based on specific criteria (hours worked, productivity, attendance), it becomes non-discretionary and must be included in overtime calculations, increasing the overtime rate and total pay owed.
Can you refuse a discretionary bonus?
Employees can refuse bonuses, though it’s rare. Employers cannot force employees to accept compensation. However, refusing may have tax implications and could be seen as unusual. Most employees accept discretionary bonuses as additional compensation.
Can an employer take back a discretionary bonus?
Generally no, once paid. However, employers may include clawback provisions allowing recovery if employee is terminated for cause, commits fraud, or violates policy shortly after payment. Such provisions must be clearly documented in writing before payment.
How much is a typical discretionary bonus?
Varies widely: $250-$1,000 for holiday bonuses, $100-$500 for spot bonuses, $500-$5,000+ for year-end performance bonuses, $500-$10,000+ for project bonuses. Depends on company size, profitability, employee role, and performance. Executive bonuses can be much higher.
Can discretionary bonuses create legal obligations?
Yes, if poorly managed. Regular, predictable bonuses can create legal expectation. Bonuses tied to specific criteria become non-discretionary, requiring inclusion in overtime calculations. Inconsistent distribution could raise discrimination concerns. Maintain true discretion and document rationale to avoid legal issues.
