Rising costs. Tighter margins. Inflation eating into your budget.
If you're a small business owner trying to figure out holiday bonuses this year, you're probably asking yourself some tough questions:
- Can I even afford to give bonuses?
- Will my team be disappointed if I give less than last year?
- How do I make sure this money actually helps them during the holidays?
You don't actually need a massive budget to give a meaningful bonus. What you need is a smarter approach to how you process it.
At Whirks, we've helped hundreds of small businesses maximize the impact of their holiday bonuses through strategic payroll processing.
In this article, you'll learn the exact bonus processing method we recommend to make sure your team keeps more of their holiday bonus, without costing you an extra dime.
What the IRS Considers a Holiday Bonus
A bonus is any extra money you give employees beyond their regular wages. Whether it's holiday bonuses, year-end bonuses, or performance bonuses, they're all treated the same way by the IRS.
Bonuses are often used to:
- Reward employees for exceptional work
- Show appreciation during the holiday season
- Incentivize retention during busy periods
- Boost morale when budgets are too tight for raises
For this article, we're focusing on cash bonuses paid by check or direct deposit. These give you the most control over how much your employees actually take home.
Curious about the difference between bonuses and commissions?
Check out our article, "What's the Difference Between a Bonus and a Commission."
How Taxes Eat Up Your Generosity
You've probably heard employees complain: "I got a $1,000 bonus, but only took home $700. Where did the rest go?"
The answer? Federal withholding.
When you give someone a bonus, the IRS requires you to withhold taxes before the money hits their account. And what’s even more frustrating is that depending on how you process that bonus, your employee might lose 30% or more to withholding, even if their actual tax rate is much lower.
When it comes to federal withholding on bonuses, the good news is that you have three legal ways to calculate it. And one of them puts significantly more money in your employees' pockets.
The 3 Ways to Calculate Federal Withholding on Bonuses
Before we dive into the three withholding methods, one term you should understand is bonus check frequency. This IRS-approved method allows you to treat a bonus as its own paycheck, processed separately from regular wages. Doing so often results in significantly lower withholding, which means your employees take home more without costing you extra.
Now, let's look at all three methods.
Method 1: Regular Paycheck Frequency (Highest Withholding)
This method treats the bonus like it's part of a regular paycheck. The IRS looks at the combined amount (regular wages + bonus) and assumes that's what your employee earns every pay period.
The problem: This almost always results in over-withholding because it inflates their projected annual income.
Method 2: Flat 22% Rate (Middle Ground)
The IRS allows a flat 22% withholding rate for bonuses up to $1 million. This is simple and predictable, but it still might withhold more than necessary depending on your employee's actual tax bracket.
Method 3: Bonus Check Frequency (Best Option for Employees)
This method calculates withholding based on the bonus as a standalone payment with its own frequency schedule. By separating the bonus from regular wages, you significantly reduce withholding.
This is probably the least-known method, but it's the one that makes the biggest difference.
So, How Much More Will Your Employees Keep?
Let's look at a real example.
Meet Sarah, a restaurant manager who earns $48,000 per year and gets paid biweekly (26 times per year). Her regular gross paycheck is $1,846.15, and she typically takes home $1,504.15 after taxes.
You decide to give Sarah a $1,000 year-end bonus. Here's what happens under each method:
Using Regular Paycheck Frequency:
When you add the $1,000 bonus to Sarah's regular $1,846.15 paycheck, the IRS thinks she earns $2,846.15 every two weeks (or $74,000 per year).
Result: Sarah takes home only $703.64 from her $1,000 bonus.
Using Bonus Check Frequency:
When you process the bonus as a separate check with its own frequency, the withholding calculation treats it independently.
Result: Sarah takes home $923.50 from her $1,000 bonus.
That's $219.86 more in Sarah's pocket, with zero extra cost to you.
For many employees, that extra $220 could mean:
- An extra gift under the tree
- Helping with holiday travel expenses
- Covering an unexpected bill during an expensive season
What About the "Gross-Up" Option?
If you want to guarantee your employee receives exactly $1,000 after taxes, you can use the gross-up method. This is where you calculate backward from the desired net amount and increase the gross bonus to cover all withholding.
Example: If you want Sarah to take home exactly $1,000, you'd need to give her a gross bonus of approximately $1,300, depending on her tax situation.
The tradeoff: This costs you more as the employer, but it creates an incredibly positive employee experience. Some businesses use this for top performers or key retention bonuses.
When Should You Pay Holiday Bonuses?
Timing sometimes matters more than you think. Based on what employees value most, here's what works best:
- Early December (recommended): Gives employees time to use the money for holiday expenses, travel, or gifts. Most appreciate having the cash before the holiday rush.
- Late November: Works well if your team has Thanksgiving travel expenses or wants to take advantage of Black Friday shopping.
- Late December/Early January: Better for retention purposes (employees stick around for the bonus), but less helpful for immediate holiday expenses.
If you're worried about retention, communicate the bonus in November but pay it in mid-December. This gives employees planning time while keeping the money fresh during the holidays.
Should You Give Everyone the Same Amount?
This is one of the toughest questions small business owners face. Here's what works for most businesses:
Same amount for everyone (most common)
- Creates a sense of fairness and team unity
- Avoids awkward conversations and hurt feelings
- Easier to budget and communicate
Performance-based amounts
- Rewards top performers
- Can motivate improvement
- Requires clear, documented performance criteria to avoid favoritism concerns
Tenure-based amounts
- Rewards loyalty and longevity
- Easy to calculate and defend
- May discourage newer employees
Most small businesses choose the first option because it's simpler and prevents the morale issues that can come from perceived unfairness. Whatever you choose, be consistent and transparent about your approach.
Making Every Dollar Count When Giving Holiday Bonuses
When budgets are tight, you can't afford to waste a single dollar of your holiday bonus on unnecessary tax withholding. The bonus check frequency method ensures your generosity reaches your employees the way you intended.
Remember, your team doesn't expect you to match the big corporations. They just want to know you value their work and you thought about how to help them during an expensive season.
By processing bonuses strategically, you show them you care enough to make sure they keep as much as possible. That message might matter more than the amount itself.
Final Thoughts on Giving Effective Holiday Bonuses
Now you understand how to structure holiday bonuses in a way that actually helps your employees without increasing your budget.
Holiday bonuses don't have to break your budget to make a difference. This time of year is financially stressful for many teams, and tight margins can make giving feel impossible. But the real value isn’t in the size of the bonus, but rather it’s in how thoughtfully it's processed and timed.
At Whirks, we help small businesses make smart payroll decisions that benefit everyone. Whether you're figuring out year-end bonuses, planning for growth, or just trying to get one step better every day, we're here to help.
Want more ways to show appreciation for your team? Check out these articles:
- “5 Non-Cash Ways to Motivate and Appreciate Your Employees.”
- “How to Build the Ideal Small Business Benefits Package.”
Not sure how to process bonuses correctly in your system?
Ask your current payroll provider about the bonus check frequency method. If they can't help (or you're tired of figuring this stuff out on your own), let's talk. We'll show you how payroll should actually work for your business and your people.
