Retention bonus tax for employees is considered on a case-by-case basis, according to Elaine Varelas for the Boston Globe. A retention bonus is considered for tax in the year that it is paid, and it is taxed at the employee's usual tax rate. Retention bonuses are treated like any other end-of-year bonus. The FICA rules still apply to retention bonuses, so they are liable for Social Security and Medicare contributions.
Varelas explains that the tax consequences surrounding retention bonuses for companies are complex. The way a pool is handled can impact a company's entitlement to deduct bonuses at the end of a service year. If an employee forfeits her retention bonus and the employer shares that bonus with other employees, then this bonus is considered to be a part of a fixed bonus pool, and it is treated as such for the purposes of taxation. The IRS modified the rules with regard to retention provisions in 2011, and the details of the new ruling can be found under Revenue Ruling 2011-29. This ruling states that as long as an employer is contractually obliged to pay a minimum amount of bonuses at the end of a service year, it is entitled to deduct that minimum aggregate amount from its tax bill even if it is unable to calculate the specific amounts due to be paid to individual employees before the end of that financial year.