Employee Bonuses Vs. Profit Sharing; What’s The Difference?
Every year a good number of businesses give their employees bonuses right around the first of the year, often right at Christmas time. Other companies offer profit sharing, typically distributed around the beginning of the New Year, but after the business has had time to review their accounting and access true profits for the previous year. It’s important for both businesses and employees to understand the difference between the two.
Let’s define and look at some of the differences between a bonus and profit sharing.
Bonuses are compensation for employees for work performed; they are paid in addition to salary or wages. Often business owners give out bonuses without any structured plan or objective method for determining the amount or even how the bonus can actually be earned. Although typically given out around Christmas time, bonuses can be given out any time of the year.
Bonuses are typically used and are a good way to recognize special efforts or performance by individual employees. For example if an employee comes up with a good idea that saves the company a lot of money and or time, that employee might be given a monetary bonus as a reward. The amount of the bonus is typically left up to the employer, but can also be based on some type of pre-established formula where the employee gets a certain percentage of the actual savings.
Bonuses are considered compensation if (per the IRS) they "arise out of an employment relationship or are associated with the performance of services." Bonuses are considered taxable to the employee and are considered an expense of doing business. In most cases, bonuses are a tax benefit to the employer.
Profit Sharing is an arrangement between an employer and an employee in which the employer shares part of its profits with the employee. The key difference between a bonus and profit sharing is that there must be profit before any is shared with the employee.
As payment under a profit sharing plan, employees can be given stocks or bonds, or cash (cash profit sharing plan). If the profit-sharing dollars are part of an employee's retirement plan (deferred profit sharing plan), they are received at retirement rather than now, and depending on the retirement plan they may be tax-deductible. There can be eligibility requirements for profit-sharing plans. For example, the employee may be required to work for the company for a certain period of time before he or she can partake in profit-sharing.
Other Business Considerations:
Keep in mind that depending on how a bonus or profit sharing is distributed the employer may incur additional costs over and above the dollar amount given to the individual employee. Depending on the employment relationship the company has with the employee, the business may incur the expense of payroll related taxes, liability insurance and/or workers compensation insurance on the dollars paid to employees. Its best to consult with your accountant regarding the total cost of offering a bonus or profit sharing plan before discussing with or offering either to employees.
Also, it’s a good idea to let employees know they too may have to pay payroll and income taxes on any bonuses or profit sharing they receive.
If you’re looking to start a bonus or profit sharing plan at your remodeling business give me a call or shoot me an email. I can help you develop a plan that works for your business as well as your employees. Businesses that share profits often earn more profit as a result!