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This episode of the Financially Adjusted podcast is all about paying employee bonuses the right way. Whether you’re rewarding W2 employees or 1099 contractors, the rules are different—and it's crucial to get it right to avoid headaches later. I'll walk you through the basics of employee classifications, how to pay out bonuses properly, and tips to stay compliant with IRS rules. Being generous is so wonderful, but make sure you’re doing it the right way in your practice!
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Hello there, my entrepreneurial friend Thanks for joining me today for the Financially Adjusted podcast. If you're new to me, I'm Leslie Roth, your host and I'm here to make the financial side of running your business a little bit easier.
I have a bookkeeping business and specialize in helping chiropractors. So, if that's you be sure to reach out with any questions that you have about running your practice and how to manage your money. You can simply email me at support@financiallyadjusted.com or you can DM me on Facebook or in Instagram. I am Leslie Roth, and I'm Financially Adjusted on both of these platforms so you can find me easily. Today I am getting into a topic that's super important, especially this time of year but this is often misunderstood, and it's paying employee bonuses…specifically how to do this right depending on whether someone is a W2 employee or a 1099 contractor working for you.
And spoiler alert - the rules are very different between the two so stick around to avoid making mistakes.
Many of the chiropractors that I know are incredibly generous people and wonderful to their employees and they usually want to pay them bonuses. So, that's you most likely and you are also likely thinking about doing that right at this time of year because we are coming up on Christmas very quickly. It's a couple weeks away. So, before you decide side on bonuses and initiate that payment, I want you to tune in and think about whether or not you're doing properly.
It's not necessarily common knowledge how you're supposed to do this so remember don't feel bad if you've done it wrong in the past. Now that you're listening to this podcast you have the chance to do it right.
First off, we'll talk about the basics of what a W2 employee is versus a 1099 contractor. Some quick definitions:
A W2 employee is someone who you have on your payroll and you're using your payroll processing system to pay them a wage, and you're withholding taxes like social security Medicare, and income taxes from their paycheck.
A 1099 contractor is an independent contractor who is self-employed and they're handling their own taxes and you're just paying them for whatever service is they're rendering to you.
The way that you pay bonuses depends entirely on this classification so it's important to get those definitions down to start because the IRS has strict rules around how you're paying them.
And how you pay them on a regular basis is pretty much how you're going to pay out the bonuses as well. So, for your W2 employees you can pay them bonuses. They can absolutely receive bonuses, but these have to be treated as part of their taxable wages you can't simply just write them a check and call it a day. They have to report that as earned income and pay taxes on that, so you have to do that the proper way by putting that through their paycheck.
How you're going to do this the proper way is you're just going to run a payroll like you normally would, except you're going to put that bonus amount into a specific category for bonus wages. Depending on the state, they may be taxed a little bit differently but Typically with all payment or I'm sorry with all payroll processing companies they will have a specific slot in there…a special space for bonuses that you can put that in there, and they definitely need to go through your payroll processing system That's the important part. So that they can take care of any taxes that are going to need to be withheld. Many people think that they can skirt around doing this by giving gift cards or giving out cash, but that all still needs to be accounted for. So, you're not going to be able to skirt around that. It might be fine but if you would ever happen to get audited, that's going to come back to bite you later. And this is something that you can talk about with your tax professional you can absolutely and should absolutely reach out to your tax professional to make sure that you're doing this the proper way and consult with them on this.
If you've paid employees differently in the past whether you've given them a check and they've gotten the full amount, they might be a little upset if moving forward you're doing differently. So, you might need to just be open and honest with your employee and just let them know, “hey from now on I'm going to be running your bonuses through payroll so you'll see that show up differently.. I won't just be giving you a check”.
Just let them know you're going to see that pop into your payroll. Something that you can consider doing so that they get the amount that you intended them to get is go a little bit higher with the total bonus wages so that you can cover tax that can cover taxes and what they take home then is what you intended for them to receive. So, maybe if you would normally give them a hundred dollars, maybe make that higher make it one hundred and twenty five or one hundred and fifty dollars so that those tax are covered and you know that they're going to take home likely a hundred dollars or a little bit more.
When you are entering bonuses into your payroll system, be sure to enter them as that separate category of a bonus just so you make sure that's accounted for separately and properly through the payroll processing system.
All payroll systems will likely have this and if you're struggling to find that, you can always reach out to the customer service department at your payroll processing company and they should be able to guide you through that but most of them are very straightforward. I know Gusto and ADP very well and their dashboards are very easy to use whenever you're running payroll. It's very clear that section that says bonus.
But you can easily reach out to somebody, and they can help you along with that. Okay The second thing that we're going to talk about is whether or not you can pay bonuses to 1099 contractors. Yes, you absolutely can. Most times you just want to designate that it’s for the specific service that they rendered. And even better if you have an agreement with that contractor to lay out the bonus that you're giving them and what it's based on, whether it's based on what they did for you that year just mention that it's for the service that they provided for you.
So, 1099 contractors are paid differently than W2 employees you are going to pay out a bonus for 1099 contractor the same way that you would normally pay them throughout the year which should just be simply a check that you're writing to them. Maybe an ACH transfer from bank to bank. Maybe you're paying that 1099 contractor through your payroll processing system and they're running that payment through like they should for a contractor. So, however you normally process their payment is how you're going to pay out the bonus as well.
They are then given a 1099 at the end of the year… after the end of the year I mean, you are going to pay them that bonus and that's going to be included in that total amount that you put on the 1099 that you send them after the end of the year. So, that's all going to be included. And 1099 contractors are the ones that are responsible for reporting their income on their taxes. On your end of things, it's your responsibility to send an a 1099 if that's necessary. And then it's their responsibility to report that along with their tax professional at tax time.
Okay, this is a super shorty episode so we are almost at the end.
I'm just going to summarize what I just went through.
W2 employees - you're paying bonuses through the payroll processing system, just like you normally would run payroll. You're just putting it into that bonus slot and that payroll processing company that you use is doing the job of withholding the proper taxes and filing everything that they need to.
And with the 1099 contractors, you are paying them just like you normally pay them and that bonus amount is included in the 1099 that you give them after the end of the year.
So, very short episode today just so I can inform you on how you're going to do this properly.
If you're feeling a little unsure about employee classifications and you're not sure how to handle bonuses, now is the perfect time to double check all that. Make a quick call to your accountant or your payroll provider and that can save you from making an expensive mistake down the road and causing you a lot of headaches if you happen to get audited and you haven't done that correctly.
I think it's so fantastic if you want to pay bonuses to the people who are helping you run your business. Making that magic happen for you and your business definitely requires some help.
I just love it when I see business owners taking good care of their employees and their contractors, but I don't want to see you getting in trouble because you're doing it the wrong way. It can definitely be hard to switch things up when you've been doing it the same way for many years but you can have more peace knowing that you're doing it the right way.
Just be clear and upfront with your employees about this ahead of time so if they're expecting a check just like they've always gotten a check, directly from you, just let them know “Hey that's going to be on your payroll from now on”.
That's all I have for you today. This was definitely a short episode.
Thanks for joining me and be sure to share this with an entrepreneurial friend. My goal is to help as many entrepreneurs as possible to run their business smoothly and manage their money properly.
Have a great day my friend
