Bonuses are often confused with commission wages. Usually, bonuses aren’t predicated upon the price of a particular product or service, which distinguishes them from commission wages. Another difference is that many times, a bonus is paid to individuals not engaged in sales at all.

Legal Considerations of Bonus Programs

Employers who plan on giving out bonuses must be aware that a few legal strings are attached.

A bonus is a form of wages, and employers must keep track of the amount awarded to each employee. Employers must keep payroll records for all employees for at least four years, and those records must include bonus payments, the nature of the payments and the period of employment covered by each payment.

There are generally two types of bonuses — discretionary bonuses and non-discretionary bonuses.

A discretionary bonus is generally in the form of a gratuity where there is no promise for their payment.2 A common example is a holiday bonus given by an employer at the end of the year; there is no promise that a bonus will be paid, and the bonus is not based on objective criteria, such as hours worked, productivity or efficiency.

It's possible that what is intended to be a discretionary bonus can turn into an implied contract to pay a bonus. For example, the regular payment of a bonus in past years based on objective criteria may ripen into an implied contract for compensation. However, [b]onuses which are completely discretionary, based on no objective criteria and are not routine, would not, of course, give rise to an implied bonus contract.3

A non-discretionary bonus is generally a contractually required payment where a promise is made that a bonus will be paid in return for a specific result, such as exceeding a minimum sales figure or piece quota.4

For example, in one case, an employer offered an incentive plan to certain employees, with the amount dependent on each store's profits. The formula for the plan subtracted the store's operating expenses from the revenues, which some employees argued violated state law that prohibits employers from deducting the cost of doing business from wages.5

The California Supreme Court held that the bonus plan was not an entitlement or expectation of a specific amount that was then deducted from the store's business costs. The employees all earned the amount of money that they were promised as wages for the hours they worked, regardless of the store's profit or loss. The bonus was an additional sum of money paid if the store was profitable (a discretionary bonus) and the store's plan was not a violation of California law.

Non-discretionary bonuses must be factored into the regular rate of pay for the purpose of overtime calculations for nonexempt employees. Discretionary bonuses are not included in the regular rate of pay. For more information, see “Calculating Overtime on Bonuses” on the Calculating Overtime page. Non-discretionary bonuses also give rise to issues of final pay at times of termination. For more information, see Final Pay Explained.

Finally, employers can't take adverse actions against employees who discuss bonuses with each other. Such a scenario might arise if co-workers talk about the fact that some employees received a holiday bonus but others did not.

1. DLSE Enforcement Policies and Interpretations Manual sec. 2.5.5