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An HR Glossary for HR Terms

Glossary of Human Resources Management and Employee Benefit Terms

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Compensation

What Is Compensation?

Compensation is an employee’s regular salary or hourly pay, as well as any other types of wages such as overtime , bonus pay, retirement benefits, health benefits, stock options, and other non-financial incentives.

Employers use various forms of compensation to recruit and retain employees and incentivize desired performance. Companies often adjust their compensation according to business goals, available resources, and the marketplace. However, employee compensation is also governed by local, state, and federal laws. Such of those laws help determine the following:

  • Minimum Wage: The minimum wage amount varies by state. Some states don’t have a minimum wage requirement while others stick to the federal minimum wage amount or require even more. Some cities actually have higher minimum wages than their respective state requirements.

  • Overtime Wages: Under the Fair Labor Standards Act, qualified hourly employees must receive pay for hours worked over 40 hours per workweek at a rate of 1.5 times their regular pay rate.

  • Equal Employment Opportunity: To protect job applicants and employees, there are federal laws prohibiting discrimination (including discrimination via compensation) because of race, national origin, color, age, religion, gender/gender identity, sexual orientation, pregnancy, age, disability, or genetic information.

What Are the Types of Compensation?

There are two types of employee compensation, direct and indirect.

Direct compensation can include:

  • Hourly: This is a dollar amount per hour paid to both skilled and unskilled employees. There is usually no guarantee of a set amount of hours to work per week.

  • Salary: This is the most common form of compensation for professional employees. Generally, it is set as an annual amount that is divided up by weeks and paid twice a month.

  • Overtime Pay: Besides the federal laws listed above, some states have additional overtime and labor laws that exceed those of the federal government.

  • Commission: If compensation is based on the volume of sales or a standard of performance, it takes the form of commission. This may also be called piecework or piecemeal compensation. Some of the industries that often use commission-based compensation include factories, auto dealerships, real estate, sales, and investing.

  • Tips: Tipping is custom in the U.S. in the restaurant and some personal service industries. The amount is discretionary according to each customer and shouldn’t be negotiated or dictated by an employer. If tips are given via credit or debit card, the employer must reimburse the employee for them.

  • Bonuses: To incentivize either salaried or hourly workers, financial bonuses may be offered on top of their regular compensation. Other reasons for giving bonuses could be for employee retention or for when a company meets certain goals.

Indirect compensation can include:

Insurance Benefits: These can take the form of health, dental, vision, disability, and life insurance. These benefits can be costly so some small businesses don’t offer them until they reach 50 or more employees, at which point offering health insurance is mandated by law.

Retirement Benefits: This is a low cost and simple benefit that businesses both large and small typically offer their employees.

Other Benefits: Paid time off, vacation time, transportation discounts, and other similar benefits are other forms of indirect compensation that can attract and retain valuable employees.

Incentives: Indirect incentives can be anything from a company-paid cell phone to the use of a company car.

Equity-Based Programs: A more complex form of compensation is an equity-based program where an employee is tied to a company via a percentage of ownership.

What Is a Compensation Package?

A compensation package is a total compensation statement awarded to an employee. In addition to both direct and indirect compensation, the package can also includes other things such as relocation expenses, tuition reimbursement, employee assistance, learning and development offerings, and any possible career-advancement opportunities.

What Is Nonemployee Compensation?

Nonemployee compensation (also called self-employment income) is paid to an independent contractor rather than an employee. This type of compensation includes fees, commissions, and awards for services rendered. As an employer, you do not withhold federal income taxes (this is done by the nonemployee) and do not need to pay the employer portion of FICA. If you paid more than $600 in a year, you need to report the wages to the IRS on Form 1099-MISC.

How Do Companies Use Compensation?

Since compensation is the primary reason employees work, it’s a powerful tool that employers can use for many purposes, such as:

  • To attract and retain qualified employees

  • To reward and encourage peak performance

  • To reinforce company values

  • To increase or maintain morale/satisfaction

  • To reduce turnover and encourage company loyalty

  • To assess performance, duty, and loyalty

  • To promote career advancement

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