As a small-business owner, you know employees are your greatest asset. Quality over quantity is the name of the game for small companies. Showing your appreciation helps keep your best and brightest on the payroll. Employee bonuses serve the dual purposes of motivating employees to do their best while rewarding them for their contributions.

Before you dole out holiday bonuses and gift cards, however, you’ll need to put a plan in place. Employee bonuses might seem like a fun perk to you, but to your employees, it could mean so much more.

The U.S. Small Business Administration estimates that 35% of small-business owners offer some type of end-of-year bonus, but there is a wide spectrum of methods, amounts, and types of employee bonuses. Choosing the right strategy means getting an inside look at how, when, and why small businesses reward their employees.

The Small-Business Owner’s Guide to Types of Bonuses

I recently sat down with our accountant to go over my small business’ bonus structure. We employ a couple of different bonus strategies, and I wanted to make sure we were on par for the industry and that employees were satisfied with the way we offered and executed different types of bonuses.

My accountant and I settled on maintaining our bonus structure, which is a holiday bonus at the end of the year and “spot” bonuses on a monthly basis. It’s right for a small design firm like ours, but your small business might require a different approach. Get to know the types of bonuses before you decide what’s right for you and your employees.

Holiday Cash Bonuses

When you think of employee bonuses, you probably think of the holiday bonus. We’ve all seen the scene in “National Lampoon’s Christmas Vacation” where the Griswolds are astonished to realize their expected and long-awaited Christmas bonus is really just a jelly-of-the-month club membership. It’s hammed up for the movie, but it’s definitely a relatable theme. Employees often count on their holiday cash bonus so it’s important to set expectations and carry through or risk losing employee motivation through the rest of the year.

Holiday bonuses are typically related to gratitude rather than performance or profitability. I personally prefer the holiday cash bonus for a few different reasons. The majority of our employees have young families and the holiday bonus helps reduce some of the financial strain they feel during an expensive time of the year. It also helps keep morale high and sets the tone for the coming year. I usually combine the bonus with a little gift and a personal note to let each employee know how important they are to our success as a small company. It’s a gesture that has helped us maintain our small family business values, even as we’ve grown over the years.

Holiday Cash Bonus Best Practices

• Don’t Tie Bonuses to a Specific Holiday. Holiday bonuses should not be religion-specific. Referring to the perk as a “Christmas bonus” could alienate employees who celebrate other holidays. Instead, refer to it as a “holiday bonus” and hand them out on a holiday season-neutral date. I like to make sure employees have their bonuses in the first two weeks of December so they can use them for whatever holiday they celebrate.
• Choose Parameters. A holiday bonus shouldn’t be a dollar amount selected out of thin air. Choose the parameters for your holiday bonus, such as an amount for each year an employee has been with the company or a percentage of their salary. All employees should have the same parameters.
• Set Expectations. Don’t leave your employees guessing about their holiday bonus. Although it’s true that it should feel like just a little extra cash, employees often count on those bonuses to make up shortfalls or cover the costs of holiday gifts and travel. Set the amount ahead of time and make your policy known to all employees. Although a holiday bonus is meant to be a fun perk and token of gratitude, it still helps if employees know what to expect and how to plan for their holiday season.

End-of-Year Employee Bonuses

Bonuses that are tied to the company’s annual profitability and performance as a whole are usually framed as end-of-year bonuses. This type of bonus gives you the chance to assess your small business’ year and reward employees for the part they played in your success. They are usually only given when a small business has been profitable, so the amounts often vary from year to year. During a lean year the bonus is smaller, and the amount increases in more successful years.

Either way, end-of-year bonuses build a level of ownership with employees as they take responsibility for the size or availability of a bonus.

End-of-Year Employee Bonus Best Practices

• Tie Bonuses to Companywide Performance. End-of-year bonuses help employees see themselves as part of a team. In a small-business setting, employees should understand how they personally contribute to its success. Set companywide performance goals and offer the bonus only if those goals are met.
• Pay Before the End of the Calendar Year. According to the Internal Revenue Service, you can count employee bonuses as expenses you can deduct on your small-business taxes as long as they’re paid out before or on December 31 of the previous year. The end-of-year bonuses for 2020, for example, can be deducted on your 2020 tax return if they’re paid out by December 31, 2020. If bonuses are given out after that date, they’ll be counted as a 2021 expense and you’ll need to wait until 2022 to file and receive the deduction.
• Style Bonuses as Profit Sharing. Because end-of-year bonuses are tied to your company’s annual profitability, styling them as “profit sharing” gives employees even more ownership of their own bonus. Choose a percentage of the profit — one that your business has the cash flow to afford, naturally — that each employee will get at the end of the calendar year. If you made more profit than usual, the bonus will be bigger than usual. Profit sharing helps motivate employees to contribute to your company’s success as much as possible. It also helps drive employee retention because employees have a reason to stick around until (at least) the end of the year.

Performance Bonuses

There are two types of employee bonuses: those that thank and those that motivate. Performance bonuses are meant to increase employee motivation. Tied to individual results, a performance bonus is only given when a specific team member reaches their goals. It’s one of the most common types of bonuses. According to a survey by HR consultancy Korn Ferry, 49% of employees say their annual bonus is tied to their individual performance.

Performance bonuses are more flexible than other annual bonus structures because they can be paid whenever it’s best for your small business. They can also be used to help push through a hard year of COVID-19 fatigue and an ever-changing workplace landscape, as small business employees often