As an employer, there may be many instances in which you want to provide your employees with some sort of bonus. Bonuses are usually encouraged as they provide a form of incentive for your employees to work harder and meet certain targets. But bonuses have a downside. In the UK, bonuses are taxable, as are commissions and tips. Because bonuses come with tax and National Insurance Contribution obligations, employers are often hesitant when it comes to bonuses. It is far more advantageous for both the employee and employer to find a tax-free solution for bonuses.
In this article, we explore bonuses and ways in which you can pay your employees’ tax-free bonuses.
What is a bonus?
If you are a business owner, you should already have a good idea as to how bonuses work. A bonus can be defined as any compensation that is above and beyond an employee’s usual salary, wages, or payment expectations. Bonuses can be given in the form of cash or non-cash compensation and can be given to any employee no matter their level within the company.
Bonuses are often given to individual employees for reaching certain targets and as a reward for excellent work, but employers are often expected to give yearly bonuses to all of their staff members in the form of a Christmas bonus.
Bonuses can also be given to shareholders in the form of free shares.
Are bonuses taxed in the UK?
When paying your employees bonuses, there are certain tax obligations involved, especially when it comes to cash bonuses. Cash bonuses are seen as earnings by the HMRC, and you will need to add bonuses to your employees’ regular pay. You will also need to deduct National Insurance Contributions as well as income tax through your payroll system when paying employees cash bonuses. You can also check how much tax limited companies pay.
So what sorts of bonuses are tax-free?
There are many non-cash bonuses that exempt you from paying tax. These types of bonuses can be beneficial to both you as well as your employees. Some of these tax-free bonuses include:
Medical treatments can be expensive, so employees may definitely appreciate a non-cash bonus that comes in the form of medical treatment. While not all medical treatments are tax-free, the following are exempt from tax in the UK:
- One general medical check up per every tax year.
- If your employees use screens or monitors at work, they are eligible for tax-free eye tests, contact lenses and glasses.
- Overseas medical insurance and treatments for employees working abroad.
- Insurance and treatments that cover any work-related medical issues.
- Medical treatments £500 or less if they are part of a return-to-work plan.
One of the easiest and most effective ways to reduce the amount of tax that you and your employee will pay on bonuses is to pay bonuses into a tax-deferred retirement account for your employee. Tax-deferred retirement accounts are either:
- 401(k) retirement accounts
- Individual retirement account (IRA)
This will reduce the employee’s gross income, and you will pay less tax over time. You should be aware of the different limits set by retirement accounts, which change from year to year.
While not all employees may be satisfied with this alternative, older employees looking to retire soon and those planning towards retirement should be more than open to the idea.
Health savings account
In certain cases, you may be able to make tax-free contributions to employees’ health savings accounts, which have various advantages and purposes. The contributions you make will minimise their gross income. Employees benefit by being able to withdraw from these accounts to pay their medical expenses without having to pay tax. This is definitely one of the most popular options for both employers and employees.
The limits involved in HSA contributions for 2021 are $3,600 for an individual and $7,000 for a family.
While this is not a tax-free option, it’s definitely worth mentioning. There is the opportunity to save on paying taxes by delaying the payment of bonuses until January, this only works if bonuses are set to push your employees’ income to a higher tax bracket that year, and they expect that they may make less income the next year. It is not a fool-proof plan as it is impossible to plan for the future.
Donate to charity
In order to reduce the taxable incomes of your employees, you could offer bonuses in the form of donations made to the charity of their choice. Enquire as to whether any of your employees own charities themselves and see if they would be happy for part of their bonus to come in the form of a donation to their particular charity.
There are many different types of bonuses that you could offer your employees that have nothing to do with money. Some popular non-financial bonuses include:
- The choice to work from home instead of coming into the office. This may allow your employee to spend more time with their children and reduce their transportation costs.
- Flexible work hours.
- Choice in which projects they want to work on.
You should keep in mind that not all non-financial bonuses are tax-free. If you were to offer additional paid vacation days to your employees, this might be taxed as a bonus as it may be seen as a financial bonus by the HMRC.
Accommodation, supplies and services
If you provide your employees with accommodation, supplies, and services as a bonus, you will not have to pay tax on these things so long as they are on your business premises (however, during the covid-19 pandemic, the HMRC permitted some off-site options so that employees could work comfortably from home). These types of things could come in the form of:
- Office accommodation
- Cell phones
- Equipment to help overcome disabilities
However, most employees will not see this as a type of bonus but more as an expectation for certain roles.
Free or subsidised meals
Let’s face it, food can be very expensive, and employees may have limited options when it comes to grabbing a meal in their lunch break. As part of a tax-free bonus scheme you could offer your employees free or subsidised meals as long as:
- The meals are given on the company premises or in the staff canteen
- The meals are of a reasonable size
- The meal plan is offered to all employees
Speak to your employees who have children and see how they would feel about receiving childcare vouchers as a form of bonus. Childcare can be very costly, so this type of bonus is often well-received by employees.
There is a tax-exempt amount of up to £55 a week. This also depends on when you joined a childcare voucher scheme and the type of childcare voucher scheme that you are a part of.
Ambitious and hard-working employees can be rewarded in the form of training schemes that help build their theoretical or practical skills. Focus on skills that they may need to obtain higher-paying roles within your business. This is usually a win-win situation as the employee gains opportunities and increases employee satisfaction and retention.
Tax-free training includes the following courses and training programs:
- Health and safety, as well as first aid courses, designed for those in the workplace.
- Employee development schemes.
- Any leadership training courses that focus on developing leadership qualities and skills.
Training courses can be provided by your company or a third party, or a mixture of both, without any changes to the tax exemption. The courses can also be full-time, part-time or intermittent.
The tax exemption of training covers a wide variety of other aspects, including travel expenses, childcare costs, examination costs, registration, course materials and books, and learning aids. This is so long as they are relevant to the training course in question.
Any assets that are bought for the course are taxable.
Supplemental pay vs. regular pay
If you are looking to reduce the taxable amounts of bonuses, something that you need to be aware of is supplemental pay. If you, as the employer, pay your employees their bonuses as part of their usual paycheck, the amount taxed will be taxed as regular pay. If the bonus is delivered separately, it is then taxed as supplemental income instead.
So what is the difference?
The difference is that supplemental income is always taxed at a flat rate. This rate is 22%.
If it’s given to your employee as a separate amount or separate check, it will be taxed as supplemental income. The difference is that supplemental income is taxed at a flat 22% while regular income is taxed at your regular rate.
Depending on the employee’s income bracket, it can be significantly cheaper to pay the supplemental rate instead of the regular rate.
Are all non-cash bonuses tax-free?
No. There are still many non-cash bonuses that are subject to taxation. A common example of this would be medical and dental insurance. If you give your employees medical or dental insurance as a non-cash bonus, you will be subject to paying 13.5% on the taxable value for class 1 NICs.
Company cars are another example of taxable non-cash bonuses, as they are taxed based on their value and emissions levels. The more emissions, the higher the tax. But taxes on company cars are capped at 37% of the listed price.
If you plan on giving your employees shares as a form of non-cash bonuses, you should note that these shares will also be taxed. Your employees will have to declare these shares under self-assessment, and not PAYE.
Recreational activities and rewards are also considered taxable.
How to make the most of tax-free bonuses given to your employees
With so many bonus options available and different tax obligations, it can be quite overwhelming to find a direct path in creating a bonus structure that benefits both you, the business owner, and your employees. Here are some tips:
Just by reading this article, you are taking a great step towards educating yourself on tax-free bonuses and the different bonus options that are available. Continue looking into the intricacies of bonuses and educating yourself through online resources.
Speak to your employees
Because there are so many different types of tax-free bonuses available, speak to your employees and see which types of bonuses they would most appreciate. Each employee is different and may have different needs, desires, and preferences when it comes to their bonuses. By speaking to them, you will show that you truly care about your employees. While most employees may prefer cash bonuses, by explaining to them that they could receive more value in the form of non-cash bonuses, they may be more appreciative of the bonuses that you plan to offer them.
Speak to a professional
There are many intricacies involved with both taxable and tax-free bonuses. A tax professional will be able to handle your tax for you and offer you very valuable advice when it comes to bonuses and taxes.
Ensure that you are compliant
Understand that there are many legal ways to avoid paying tax on bonuses to your employees. But there are also ways that will make your business non-compliant in the eyes of the HMRC. You want to ensure that everything is completely above board and that you are paying tax on the bonuses that need to be taxed. Tax avoidance can land you in a lot of trouble with the HMRC that you definitely do not want to be in.
Many business owners think that the only way to give their employees incentives and bonuses is through cash bonuses, but there are so many other ways to reward your employees without either party having to pay tax. Explore all of the options that you have available to you before coming up with an employee bonus structure.