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What Is Compensation? | Employer Guide

two people exchanging money to represent what is compensation

If you have employees, you need to compensate them. So, you set an hourly rate or salary. But, you might also give other types of wages to your employees. And if you do, you need to know if those other wages count as compensation. Why? Knowing what is compensation is a key part of putting together your compensation packages.

So without further ado, let’s get into compensation meaning and how to determine it.

Compensation Definition

Compensation is the total cash and non-cash payments that you give to an employee in exchange for the work they do for your business. It’s typically one of the biggest expenses for businesses with employees. Compensation is more than an employee’s regular paid wages. It also includes many other types of wages and benefits.

Types of compensation include:

What is base pay?

Base pay is the initial pay you give your employees. The base pay rate is essentially the minimum amount an employee can expect to receive before taxes and other deductions.

Base pay includes an employee’s base salary or hourly wages. It also includes shift differentials and pay for special assignments.

Base salary vs. total compensation

Base pay does not include other types of compensation, like bonuses, overtime, and commission. These types of pay are included in an employee’s total compensation but not their “base pay.”

Is base pay gross or net wages?

Gross pay is the amount an employee earns before taxes and other deductions are subtracted. Net pay is the amount the employee takes home after everything is subtracted.

An employee’s base compensation is part of the employee’s gross and net wages. But, gross and net wages might include other compensation too, such as overtime wages. An employee’s base pay might be their gross wages if there are no other compensation types to add.

Why does a strong compensation package matter?

Here’s the hard truth employers need to face in this Great Resignation: Compared to a year ago, 52% of small business owners think finding qualified people to hire has gotten harder. Yikes.

The compensation package you offer employees is a big part of attracting and retaining talent. A strong compensation package may lead to:

How to determine compensation of employees

So, how can you put together an employee’s compensation package that attracts talent? There are a number of ways to determine an employee’s compensation.

No matter how you determine employee wages, you should consider internal equity. Internal equity is when you compare the positions in your business to ensure fair pay.

1. Research

Do research on what other businesses pay their employees. Compare your business to other businesses in the area. What are other employees paid in your area? Also, pay attention to employees who have similar job titles and duties to your employees.

You can survey other businesses that are similar to your business. You can also check websites where employees self-report their wages.

Some resources you can use include:

2. Accomplishments

If a particular employee excels at their job, you can pay them increased wages. Or, you might pay an employee more if they received more education, went through advanced training, or have more experience related to their job.

3. Available funds

What does compensation mean for your bottom line? Carefully calculate how much you can spend on employees.

When determining how much an employee costs, remember the costs of taxes and benefits. And before you calculate a raise, make sure to also calculate how it fits in your budget.

4. Benefits

Employees often heavily consider employee benefits packages when looking for a job. By offering desirable benefits, you might be able to offer a lower base pay to employees.

You need to know what benefits are the most desirable in your area and industry

Compensation regulations

Compensation is governed by many local, state, and federal tax and employment laws.

You need to abide by federal minimum wage laws, which are governed by the Fair Labor Standards Act (FLSA). Many states and some cities also have their own minimum wage. You must pay all employees at least the prevailing minimum wage.

FYou must follow other FLSA rules as well. The FLSA has rules on child labor (including the child minimum wage and hiring teens), and overtime wages.

You also have equal employment opportunity responsibilities. You should give equal pay to employees who do the same work.

Compensation can be complicated when it comes to taxes. Withhold taxes from some types of compensation, but not from others. Make sure you know what taxes apply to each type of compensation.

For example, you withhold taxes on tips, regular wages, overtime wages, and commissions. You also withhold taxes from bonuses, but you will calculate the taxes differently. You won’t withhold any employment taxes for benefits.

There are also federal, state, and local laws that govern compensation. Make sure you understand your responsibilities before hiring employees.

Want to learn more about compensation?

Download our FREE guide to get the lowdown on compensation rules, how to withhold taxes, and more.

This article is updated from its original publication date of  July 9, 2012.

This is not intended as legal advice; for more information, please click here.
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