If you have some cash and expect to make a profit this year, it's a good time to pay bonuses to employees. In addition to receiving a tax deduction for the expense, you also receive much goodwill from employees, especially around the holidays. Announce the bonus as a one-time event, so you don't give the expectation that you will be giving out bonuses each year. It's funny how when you do something once, people come to expect it. When you do it twice, people see it as an employment right, not just a privilege.
Employee/owner bonuses are a legitimate business expense and can be deducted under certain circumstances. For example:
- S Corporations can deduct bonuses for shareholders and owners, as long as they own their shares at the time the bonus is paid.
- C Corporations can only deduct bonuses for shareholders/owners who have a 50 percent or higher ownership at the time the bonus is paid.
Bonuses are not considered deductible expenses for sole proprietorships, partnerships, and limited liability companies (LLCs), because the owners/partners/members are considered by the IRS to be self-employed. This is one situation in which having a corporation and being an employee of that corporation might result in more tax deductions.
Bonuses are Taxable Income to Employees
If you decide to give your employees a bonus in December, you must give them the opportunity to change their withholding authorization (on Form W-4) for that paycheck, and change it back for subsequent paychecks. Many employees like to change their bonus check withholding so they receive more of the bonus.