Profits, Bonuses, and Debt

This interesting discussion considers the significance of a Christmas bonus in the context of company financials and taxes. February 27, 2015

What percentage of profit will you be giving out at Christmas, and why? I am looking at an amount that is only 3.5% of estimated yearly profit, but all of the profit so far this year has gone to pay off debt. Any bonuses are just reducing the amount of debt I am able to pay off, not coming out of cash. By debt, I mean revolving credit line that was built up during the recession.

Forum Responses
(Business and Management Forum)
From Contributor G:
Hate to tell you this but if you are paying off debt, then that's not profit. I can't answer your question as I'm a sole proprietor.

From the original questioner
Tell that to the IRS. Your point is well taken, that if the cash isn't there...

From Contributor G:
You should actually tell that to your accountant. He should be able to make it so it isn't showing as profit because it needs to pay off debt that occurred during slow periods.

From Contributor D:
You really need to talk to a competent accountant about this. The interest on the debt should be deductible, and reduce your profit. The principal payment is not a deduction, and has no effect on your profit. It will sure as heck affect your cash flow. I wouldn't even dream of handing out anything more than a small Christmas bonus until you fully understand how this will work for your business. Once you understand it, then you can explain it to your workers, so that they don't think you are just being a cheapskate.

From the original questioner
I have an excellent accountant, all interest is deducted, etc. I just have debt to pay off, like lots of other people. It takes profit to pay off past losses. How fast I pay off the debt effects cash flow, of course. So like I said at first, paying more in bonuses just means sitting on some of that debt a little longer. That wasn't really the point of my post. Companies often carry debt longer than one year, losses already written off, that has to be paid out of profits, so I don't know how to answer your responses beyond that.

From contributor D:
If you take out a five year machinery lease, but take the deduction all in the first year, same thing. Those lease payments in years two-five are going to come out after profits. Of course you could probably ask your accountant to match the deductions closer to the cash outlays, but like most people, we like to take as much of the deduction up front. Similar situation I think.

From contributor F:
If you are an s-corp on accrual then dollars given to employees as a bonus (run as payroll) cost you $1 (your effective tax yield) so for sake of discussion you can give $1 to the IRS or .40 to an employee and .60 to the IRS. Itís part of a simple decision making process. The .40 can also go to section 179 equipment or any other expense that reduces in come and lowers taxes. Either way you are going to spend a dollar of cash unless you finance the .40 in equipment then you are spending .4 in the future for a .4 reduction in taxes now.

From contributor S:
I'm in a very similar situation and will give between one and two weeks' pay to each worker as a bonus. This gets run as payroll, with deductions, etc. as IRS likes it. My perspective is that folks came in and worked hard, so I'd like to give as much as I can afford. It's not their fault that things have been tough; on the other hand, there's a limit to what we can afford and it serves no one if the company is carrying too much debt and we have to make dumb decisions like not fixing things when they break.

From the original questioner
I did get a private message from someone in a similar situation - paying off debt - and they said they traditionally pay 20% of profit. (Hope you don't mind for sharing that). One week of payroll for us, taking my paycheck out of the equation, would be about 10% of before tax profit, but closer to 7% after taking tax benefit into account (I think, without thinking too hard about it!). Next year should be much better, and drive that number down a few points. I asked a similar question last year I think. This interests me because I don't recall ever getting a Christmas bonus working for someone else.

From contributor F:
When we give money it is labeled as a gift. We used to give bonuses until an employee that quit around Thanksgiving came in after Christmas looking for his bonus. We declined and he went a lawyer who based the claim on he deserved 11/12 of what everyone else got as he contributed to that yearís profits. The long and short of it we didn't pay (except our lawyer) and we now call them gifts.
A contribution to a 401k plan also helps.

From contributor A:
If a week's pay is going to reduce your annual profit by 10%, you really can't afford bonuses. If you do give a bonus, be prepared to be the villain next year if you can't afford to repeat, because the employees will be expecting a repeat of the previous bonus.

From the original questioner
To contributor A: I understand your point. I did the math again - a weekís pay for them (without me) is closer to 9% of our estimated profit this year, a profit of about 6.9%. That is not a great profit, but not terrible either, I take most of my pay in a regular salary, so it's not like I have to live off the 6.9%. A lot of blue chip companies on the NYSE make 5 and 6% profit in a year. After the comments here, I did increase the bonus amount slightly. What did get my attention yesterday is that home prices in our area are up 10% over last year. Why should we let the builders pocket all of that price increase? We will have to raise prices too.

From contributor A:
A blue chip company doing billions in sales can live with a 7% net profit. A small cabinet shop with. 7% net is one poor year from bankruptcy. Even if the 7% net is after your salary it's not much for all the headaches of being the owner.

From the original questioner
Small equals fewer than 50 people? Twenty percent profits sure leaves a lot of room for competitors to undercut you by 10%.

From the original questioner
To contributor A: I think the salary is supposed to cover the operational headaches, and the profit is supposed to be a return on investment, and a reward for financial risk taken.

From Contributor J:
I can think of several ways to offer a small bonus with no hassle. You could give as a gift which was mentioned earlier. Although I'm thinking it would be smarter to offer in the form of a paid dinner (gift card). Pay yourself a distribution if you have lots of deductions. Then hand out cash. My fatherís company simply gives a Turkey to everyone, although these workers are very part time working ten hours a week.

From contributor T:
Iím a one-employee shop barely scraping by, zero profit. I gave cash bonus equal to a week's pay last year, plus a nice holiday dinner out with wives (not to mention lunch out about once a month). I gave somewhat less this year; employee reaction so far confirming Contributor Aís point above.