A Comparison of Profit Sharing and Bonuses



Can be a good strategy to attract and retain employees as well as improve morale and retention. Can be complex to set up and administer.
Can be helpful in motivating employees to work hard, offer suggestions for improvement, and help protect company profits because they have a stake in doing so. Sometimes employees cannot see the connection between their own hard work and the profit sharing dollars. This is because the profit sharing is based on the company as a whole. Employees may feel that they do not have any real control over the outcome. It may be difficult for employees to understand the many factors that impact profit, many of which are not under the employees’ control.
 Can be set up as a tax-deferred retirement plan. A properly designed profit sharing retirement plan can help keep employees working at the business long term by including a vesting schedule that requires the employee to be at the business for a certain amount of time before all or portions of the money shared becomes theirs. Employees may have difficulty relating a long-term reward with current efforts. Also, the plan could make or lose money depending on the investment strategy and market conditions.
Employees may work better as a team knowing that they are all in it together and will all share in the reward. Employees may resent the fact that all employees share in the profits, without regard to performance. Many profit sharing plans, especially those set up as tax-deferred profit sharing plans,  are tied to years of service and annual earnings.



Bonuses can be a good motivator, if the program is set up correctly. When bonus payments don’t contribute to higher morale or improved productivity, they are nothing more than an extra expense for the business.
Performance bonuses can drive high levels of productivity during a short period of time. This is particularly beneficial for companies looking to achieve year-end profit targets. The motivational effects of performance bonuses can quickly disappear once the employee receives the reward.
Performance bonuses provide instant gratification and have wide appeal compared to non-cash incentives.


Yearly bonus payments, that come to be expected regardless of performance (e.g. Christmas bonuses), can result in a company culture that breeds entitlement and resentment  and defeats the purpose of the plan.
Performance bonuses are easy to distribute since they can either be paid as cash or added to an employee’s paycheck.


Bonuses are subject to special tax withholding requirements that can significantly reduce the amount of money employees actually receive at the time bonuses are paid. According to the IRS, bonus pay is often subject to 25-percent tax withholding, and that may be as high as 35 percent for those with high incomes. When you add in Social Security tax, Medicare and state taxes, withholding on bonuses can exceed 40 percent. Employees may receive back a portion of withheld bonus pay after filing income tax returns.
Bonuses tied to specific performance objectives can fill a wage gap for employers who cannot afford to pay at market. Hiring and Turnover can be a problem if base pay is too low to attract and retain good employees.
The bonus is not a permanent increase to payroll, and so helps to control costs.
Spot bonuses and individual incentive bonuses can be a good motivator when employees would otherwise only have a cost-of-living increase to look forward to. Bonuses must be based on some tangible result; otherwise, they can lead to envy, perceptions of favoritism, and ultimately, turnover.




Complex to set up if tied to a retirement plan Fairly easy to set up and administer, once the criteria is determined
Typically only given at year end Can be awarded at any time
Could be a tax break for employees if tied to a retirement plan Needs special tax treatment
Generally based on the profits of the company as a whole Can be based on individual goals, company profits, or some combination
A long-term incentive A short-term incentive
Can be used as a retention tool, if part of a retirement plan with vesting Can be used as a short-term retention if the plan specifies “must be on payroll at time of distribution”
Once in place, the plan generally stays in place for several years The plan can be changed as often as needed