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What is compensation?

What Is Compensation?

You give your employees a regular paycheck. But, you might also give other wages to your employees. Do those other wages count as compensation? What is compensation?

What is compensation?

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 is typically one of 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:

  • Base pay (hourly or salary wages)
  • Sales commission
  • Overtime wages
  • Tip income
  • Bonus pay
  • Recognition or merit pay
  • Benefits (insurances, vacation leave, retirement)
  • Stock options
  • Other non-cash benefits

How to determine compensation of employees

There are many 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.


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, make sure you pay attention to employees who have similar job titles and duties that your employees have.

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


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 or advanced training related to their job.

Previous wages

You base an employee’s wages off their wages at their previous job. You might match the previous wages or offer an increase.

Available funds

What does compensation mean for your bottom line? You need to calculate carefully how much you can spend on employees. When determining how much an employee costs, remember the costs of taxes and benefits. Before you offer a job or pay raise, make sure the compensation plan will fit in your budget.


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. Employees often heavily consider employee benefits packages when looking for a job.

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.

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

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

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This article is updated from its original publication date of  7/9/2012.

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