Win-win: Why employee bonuses are a useful EOFY tool

Paying a bonus to one or more of your employees might seem a bit of a stretch right now — given the extraordinary circumstances — but if you consider the tax benefits to your business, and the likely boost to the deserving recipient’s morale, it could make sense.

What is, and isn’t a bonus?

If you ask the ATO, a bonus refers to “payments usually made to an employee in recognition of performance or services” that “may not be related to a particular period of work”.

There’s other one-off payment types, including relocation allowances and gifts, that while not connected to performing particular tasks, are treated similarly by the ATO in terms of allowable deductions, and tax implications for the employee (see below).

Why do it now?

Even though it can be tempting to turn a blind eye to the bare figures of your business, ‘as long as the doors are still open’, the lead up to the EOFY is a great opportunity to have an honest look at your expected revenue and profit (or lack of) over the past 12 turbulent months.

One of the best reasons for this is because — if you’re in fact going to make some sort of profit — a certain amount of last minute spending (in the form of bonuses) can help you pay less tax. 

That’s because bonuses are treated as legitimate business costs by the ATO, and are therefore tax deductible. This is where rewarding your staff prior to June 30 can become something of a tax-effective strategy.

Jyotika Rangel, client director of private business and family advisory at Pitcher Partners, explains that the bonus doesn’t even have to be paid before the end of June — it just has to be flagged.

“An employer can commit to a bonus and not pay until the following financial year — so they may commit to a bonus on June 15, and then say they’ll pay it on July 1,” she says. 

“If the amount has been calculated correctly in relation to the financial year, and they are definitely going to pay it, they can still claim a deduction for it.” 

Tax implications for employees

It’s important to keep in mind that there are tax implications for any employee who receives a bonus, and it’s up to you to keep up to speed with these.

Bonuses, like any other form of compensation, are taxable from the recipient’s income perspective. 

That is, the payments are recognised by the ATO as “ordinary times earnings”, meaning PAYG and superannuation obligations apply.

The way you calculate the amount of tax to withhold for every bonus payment on behalf of the recipient relies on the period it relates to, and the length of that period.

If it’s a one-off bonus amount that you’ve decided to pay (or commit to) before EOFY, i.e. for work that’s taken place throughout the year, over more than one pay period, the ATO provides two alternative “methods” — A and B(ii).

Method A

Jyotika Rangel says you’ll use the simpler Method A if you’re just paying the one (lump sum) bonus for the year. 

Method A calculates the withholding tax amount by spreading a single lump sum across the total number of pay periods in the financial year (weekly, fortnightly, monthly), and the average amount (per pay period) is then applied to the employee’s gross earnings for each period.

Rangel uses the example of an employee being paid a $10,000 bonus at the “end of the year”.

“If you went to calculate the withholding in isolation, and just used that [bonus] month as the only period, you could get an outcome where up to half of your bonus would be withheld,” she says.

“Whereas, if you [spread] your $10k bonus across the full year [of pay periods], it gives the employee a more realistic outcome of what their withholding should have been.”

Method B(ii)

Method B(ii) is also suitable for bonus payments that apply to multiple pay periods, but Rangel explains that this method is generally used “when you pay a couple of bonuses (or more) during the year”.

The simplest explanation as to why Method B(ii) is best for multiple bonuses is because it involves an additional calculation that adds these bonuses together before averaging them out (which Method A doesn’t accommodate).

The glorious details

1. Schedule 5 – Tax table for back payments, commissions, bonuses and similar payments