Practical Pointers When Using or Reviewing Retention Bonuses for HR and In-House Counsel

Retention Bonuses Are Lawful, Right?

The answer depends on how retention bonuses are structured and where they are used.

Even though the exceptionally hot post-COVID job market has largely cooled, Frantz Ward continues to review different retention bonuses and structures for clients – suggesting, at least anecdotally, that mobility within the job market persists, particularly among high-performing employees. Meaning employers are still thinking about levers that can be pulled to retain that talent, making retention bonuses a still relevant tool.

Retention Bonuses, Generally

A retention bonus is a financial incentive paid to an employee to encourage that employee to remain with the company for a specific period of time. These bonuses can be paid up-front and the employee can be asked to repay that money if they leave the company before a certain date, or these bonuses can be paid upon remaining employed through a certain date – meaning the money is promised now but paid in the future. An employer will sometimes tie compensation both to retention and certain project goals, or to an acceleration event, whether that be completion of a project, onboarding of a big customer, or sale of a plant. Employers generally have flexibility in how to structure these bonuses, and most employers don’t question the legality of these bonuses – viewing them more as a retention tool than a legal document. I’d suggest viewing them as both.

State Law

California and New York (states that generally lead the charge in legislating) have recently prohibited the use of retention or “stay-or-pay” bonuses in certain contexts. Both states, generally, prohibit employee repayment agreements or promissory notes, subject to certain exceptions like up-front bonuses or relocation assistance.

Other states have existing laws on the books that limit these agreements in specific contexts (e.g., Wyoming) or are expanding historical laws (e.g., Connecticut).

The above is certainly not an exhaustive summary, but a reminder for HR and in-house counsel to ask where its organization is using these bonuses, as state law does matter.

Other Considerations

A retention bonus can run afoul of the IRS deferred compensation regulations if it creates a “legally binding right” to compensation in one taxable year that is payable in a later taxable year. However, most simple, non-executive retention bonuses will qualify as “short-term deferrals”. Under that rule, a retention bonus, generally, does not count as deferred compensation if the payment is made to, and constructively received by, the employee within two and one-half months after the end of the taxable year in which the bonus is no longer subject to a “substantial risk of forfeiture”.

This regulation is technical but, practically, if the retention period is limited to less than 12 months, payment is tied to remaining employed through that date, and payment of the retention bonus is made timely upon remaining employed through the agreed-upon date, then it is unlikely an employer will run afoul of this regulation. But, as HR or in-house counsel, it is worth remembering this regulation exists – especially when structuring a tiered incentive program, using multiple objectives within the agreement (as this can delay payment), or using a longer retention period. In my experience, this regulation is often forgotten unless your organization is discussing executive compensation plans. But, remember, it can apply to retention bonuses given to non-executives.

Practical Advice in Structuring and Takeaways 

When structuring a retention bonus agreement, organizations should consider the following, recognizing that each situation is specific to the business:

1. What are the organization’s goals?

2. What are the employee’s concerns and goals?

3. In what state is the organization using these agreements?

4. How long is the retention period?

5. How is payment structured, and when is it earned?

6. What is the likelihood of recovering money if the employee leaves, and would the organization sue or send to collections to recover (likely answer is, no)? This answer can influence how much money your organization offers the employee. Remember, employees can leave the day after the bonus is paid, even though they promised not to.

7. Will payroll be able to process the bonus when it is due, and has accounting been made aware of this bonus? Accounting may have to “book” the bonus – and it is especially important to discuss this with accounting if bonuses will be offered to multiple employees.

8. Does the organization care if other employees learn of this retention bonus? Confidentiality is almost impossible to guarantee and may run afoul of the law to require. In practice, an employer should assume any bonuses offered to employees to be discussed at lunch, around the water cooler, or over Teams.

If you have questions about how to structure a retention bonus or are thinking about other retention plans or labor and employment law issues, please contact Travis N. Teare or another member of the Frantz Ward Labor & Employment Practice Group.