It’s bonus season, which raises many questions for employers — and while these considerations can often feel routine, they carry significant legal and operational risks.
This guide explains what employers need to know to navigate year-end bonus obligations in New York and beyond, including compliance with wage laws, Section 409A deferrals, and the strategic use of retention bonuses to maintain key talent.
Here’s what to keep in mind as you close out the year and plan for 2026.
When Is a Bonus Earned and Payable?
Bonus season presents a critical question for employers: Do you owe this year’s bonus to an employee who is fired before payout?
In New York, the answer may be yes. Even if bonuses aren’t distributed until the following year, employees who have completed the performance period may be entitled to payment. That principle was reaffirmed on May 2, 2025, when a New York appellate court ruled that an unpaid bonus to a former law firm employee constituted “vested and mandatory” compensation that was considered wages required to be paid to the employee.
Eligibility Despite Termination
In William Matter P.C. v. Riley, the employee was terminated prior to her bonus payment date, but she had satisfied the requirements necessary for her employer to calculate the value of her bonus. Her employment documents entitled her to a base salary and bonuses. The bonuses were calculated according to the fees she generated during her employment and were paid subject to her continuous employment through the date the generated fees cleared the firm’s account.
The court concluded that because the employee’s bonus was reasonably certain and calculable based on the employment documents, it constituted non-discretionary wages that were required to be paid to the employee upon her termination. Thus, the employer’s failure to pay the former employee violated public policy and was an unlawful deduction from the employee’s wages under applicable New York labor law.
This result was surprising to New York employers because, in addition to the production formula based on employee-generated fees, her contract required continued employment through the payment date, and the latter condition was not given weight by the court in this case. In addition, the fact that the employer initiated the employment termination rather than the employee may have influenced the court in the case.
What Makes a Bonus ‘Wages’?
The ruling clarified that the key factor in determining whether compensation constitutes wages is not the labeling used in a compensation plan, but whether the payment is “vested and mandatory” as opposed to “discretionary and forfeitable.” A bonus tied to objective, formula-based criteria and calculable with reasonable certainty constitutes mandatory rather than discretionary compensation.
In William Matter v. Riley, the court found that the fees the employee generated were readily ascertainable by the employer, and the employer’s receipt of those fees had no bearing on the employee’s right to a bonus. Accordingly, the bonus became mandatory wages once the amount of fees generated was determinable. This means bonuses that are objectively calculable, nondiscretionary or contractually guaranteed may be deemed “wages” under New York law and cannot be withheld, even if the employee departs before the payout date.
Employer Obligations and Risks
If employers withhold nondiscretionary bonuses from employees who leave before the bonus payment date, they may be required to pay the withheld bonuses, reimburse the employees’ legal fees. and, if the violation is found to be willful, pay additional damages.
Employers may need to reconsider the common practice of conditioning bonus payments on continued employment through the payout date, particularly for employees working in New York, where certain bonuses may be deemed vested and mandatory under applicable labor law. While the court’s ruling does not require employers to accelerate bonus payment schedules, it does mean that a New York-based employee entitled to a nondiscretionary bonus must receive that bonus upon termination, at the same time as other final wages are paid.
When determining year-end bonus payments, employers should consult employment counsel to assess whether state wage laws mandate payment of earned bonuses upon termination. Employers should likewise review bonus plan documents, handbooks, and related policies with their compensation advisors to confirm compliance obligations.
Is It Too Late for Bonus Deferrals?
As this year’s bonuses wrap up, it’s a good time to remind employees about next year’s bonus deferral deadlines. Under Section 409A of the Internal Revenue Code, employees must generally make irrevocable deferral elections by the end of the taxable year before the bonus-generating services are performed.
This means employees should make their elections by Dec. 31, 2025, if they’d like all or a portion of next year’s bonus to be deferred under a non-qualified deferred compensation plan. Employees who miss this deadline should receive next year’s bonus, if any, at the same time annual bonuses are paid to the general employee population. The bonus, along with applicable taxes, will be included in income and taxed in the year it is paid.
Failure to comply with Section 409A’s deferral election requirements can expose employees to significant tax penalties, including a 20% excise tax on deferred compensation required to be included in gross income, plus additional interest-based taxes. Accordingly, employers generally should not honor irrevocable deferral elections submitted after the Dec. 31 deadline for next year’s bonuses and should instead pay those amounts in the ordinary course.
There are exceptions for newly eligible employees and certain performance-based compensation, which may change the deadline for certain employees. Employers should consult with their compensation counsel to confirm that any changes and elections under a non-qualified deferred compensation plan do not run afoul of Section 409A.
Retention Bonuses: Keeping Key Employees Through Critical Periods
Retention bonuses are a strategic tool used to encourage key employees to remain with the company during important periods, such as mergers and acquisitions, leadership transitions, or major project completions. Retention bonuses are typically tied to continued employment through a specified period or the achievement of specific milestones.
When and Why to Use Retention Bonuses
Retention bonuses are generally deployed when employee departures could disrupt business continuity or when the company needs to ensure stability during a transition. They are not intended to reward past performance, as typical year-end bonuses do, but to provide an incentive for employees to stay through a defined period. Employers should carefully assess which employees are critical to ongoing operations and consider whether a retention bonus is warranted.
Structuring Retention Payments
Retention bonuses can be structured in lump-sum payments distributed at the end of a retention period or after achieving a milestone, or in staged payments distributed in installments to maintain ongoing incentive for continued employment. The chosen structure should balance financial impact with the likelihood of achieving the retention goal.
Legal and Practical Considerations for Retention Bonuses
Retention bonuses should be clearly documented in a written agreement that outlines the conditions for payment. Employers should consider potential implications under applicable wage laws and tax laws and regulations, including the deferred compensation rules of Section 409A. Employers should also consult employment and compensation counsel to ensure that retention agreements are enforceable.
Retention Bonuses vs. Year-End Awards
Unlike discretionary year-end bonuses, retention bonuses are typically contractually obligated once the employee meets the retention criteria and are not discretionary bonus payments. They serve a distinct strategic purpose by supporting workforce stability during critical periods rather than rewarding historical performance, and are generally clearly defined amounts intended to provide a guaranteed value on a specified date. Properly structured retention bonuses can reduce turnover risks and provide a clear framework for succession and transition planning.
Bonuses As a Strategic Tool
Year-end bonuses and retention incentives aren’t just numbers on a document; they’re tools to manage risks, retain talent, and keep your business running smoothly. Make sure all earned bonuses are paid on time, Section 409A deferrals are handled correctly, and retention agreements are structured with clear expectations. Work closely with employment and compensation counsel to confirm compliance, protect your business, and keep transitions seamless.