Instead of small wage increases, small business owners can offer nontraditional benefits.

Companies that have survived the economic downturn of the past several years may be in a position now to reward employees that hung in during tough times, according to the US Small Business Administration (SBA). Many workers have not had raises or have even seen wages and benefits cut. Before you jump to offer a raise, think about the best way to reward your staff from a tax perspective.

When you increase a worker’s pay, it costs the company more than the actual addition to the paycheck. The company must factor in the following:

  • The employer’s share of FICA (to cover Social Security and Medicare taxes)
  • State unemployment insurance. Each state sets its own rates for this cost, which is collected as a tax on wages paid. (The federal unemployment tax (FUTA) is assessed only on the first $7,000 of wages, so a pay increase likely won’t impact this employer cost.)
  • Benefit formulas. For example, if you make contributions to a qualified retirement plan, it is based on compensation. Say you contribute 10 percent of employees’ compensation to the plan each year. A $2,000 wage increase means an additional $200 cost to the company.

The bottom line for the employer in giving a wage increase, according to SBA, is that you must figure anywhere between 15 percent and 50 percent of that increase as an extra cost to the company. In other words, a $2,000 wage increase really costs you $2,400.

From the employee’s perspective, a wage increase is really worth only as much as they can keep after tax. For example, if an employee is in the 25 percent tax bracket, a $2,000 wage increase nets $1,500 after income tax (even less when the employee’s share of FICA is factored in).

So instead of giving a wage increase, why not offer a fringe benefit? The benefit can cost the company less — there may be no employment taxes on the benefit—while providing a valued item or service to the employee.

Don’t forget that benefits can include any of the following and are often largely appreciated by your employees.

  • More flexible work schedules
  • More vacation time
  • Upgraded work tools
  • A better job title