Merit increase
A merit increase is a lasting raise to an employee’s base pay, sized by individual performance and usually set during a review cycle.
A merit increase changes the employee’s base rate or salary from its effective date, so it carries into every later paycheck and into future percentage raises built on that base. It differs from a cost-of-living adjustmentCost-of-living adjustment (COLA). A cost-of-living adjustment (COLA) is a pay increase given to a group of employees to offset inflation, rather than for individual performance.Click to open the term, which raises a group’s pay to offset inflation rather than for individual results, and from a promotion, which moves the employee into a new job. Where an employer uses a merit matrix, the matrix sets the increase from the performance rating and the compa-ratioCompa-ratio. Compa-ratio is an employee’s pay divided by the midpoint of the pay range for their job, shown as a percentage.Click to open the term. The decision is yours; payroll applies the new rate.
How is a merit increase different from a lump-sum merit award?
A lump-sum merit award pays for performance once, without changing base pay. Federal rules treat the two differently. A merit increase is paid as regular wages each period. Made retroactive, it raises a non-exempt employee’s regular rate for overtime worked back to its effective date, and IRS Publication 15 lists retroactive payRetroactive pay. Retroactive pay, or retro pay, is the difference you owe an employee for past work when a rate change should have applied earlier.Click to open the term increases as supplemental wagesSupplemental wages. Supplemental wages are wage payments to an employee that are not regular wages, such as bonuses, commissions, severance pay, and back pay.Click to open the term. For an award, the label does not decide: one paid under a matrix or formula announced in advance is not a discretionary bonus, so it is not excluded from the regular rate as one.
| POINT | MERIT INCREASE | LUMP-SUM MERIT AWARD |
|---|---|---|
| What changes | Base rate or salary, from the effective date | No change to base pay; one payment |
| Federal income tax withholding | Regular wages; retroactive back pay is supplemental | Supplemental wages; the flat 22% method may apply |
| Regular rate (non-exempt) | Rises with the new rate, from the effective date | Included unless unpromised and decided at your sole discretion near period end |
| Later percentage raises | Build on the higher base | Leave the base where it was |
General information, not legal or tax advice. Apply current federal and state rules with qualified guidance.