What Is Compensation?

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

The various forms of compensation are used to recruit and retain employees and encourage and reward desired performance. Compensation may be adjusted according to business goals, available resources, and the marketplace. However, it is also governed by local, state, and federal laws. Some of those laws cover:

  • Minimum Wage: The minimum wage amount varies by state. Some states don’t have a minimum wage requirement. Other states equal the federal minimum wage amount of $7.25. The highest minimum wage is $12.00 per hour in Massachusetts and Washington. Some cities have higher minimum wages than the state minimum wage.

  • Overtime Wages: Under the Fair Labor Standards Act, qualified hourly-paid 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 because of race, national origin, color, age, religion, gender/gender identity, sexual orientation, pregnancy, age, disability, or genetic information.

  • Child Labor: These laws protect the educational opportunities of youth by prohibiting their employment in unsafe or unhealthy jobs.

  • Taxes: Both state and federal taxes must be filed and paid.

    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: While federal laws as stated above are in force, some states have other 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 may use commission as 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 most small businesses don’t offer them until they reach 50 or more employees, at which time offering health insurance is mandated by law.

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

  • Other Benefits: Paid time off, vacation time, transportation discounts, and other similar benefits are other forms of indirect compensation that can be used to 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 sophisticated method 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 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.

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