Time Is Money: A Quick Wage-Hour Tip on … How to Calculate the Correct Overtime Rate for Hourly Employees That Earn Bonuses, Commissions, etc.

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1. Introduction

If you have hourly employees that earn bonuses, commissions, or other performance payments, this article is for you.

Properly compensating such employees is often not as simple as paying “time and a half” or “double-time” for qualifying hours.  Rather, federal law, and the laws of many states, require employers to “recalculate” overtime rates to include certain types of non-hourly compensation and pay overtime at those higher rates.  Many employers fail to make such payments, and of those that attempt to pay overtime (and double-time) at rates which incorporate these additional earnings, many fail to do it correctly.  Either circumstance results in a failure to pay earned wages to employees, which may give rise to lawsuits seeking back wages, penalties, and other relief available under state and federal law.

By the end of this article, you will be able to identify many scenarios that give rise to a “true-up” obligation, understand the complexity of recalculation, and appreciate the importance to your business of complying with this highly technical requirement of state and federal law.

2. Overtime and Double-Time Obligations

State and federal laws generally require employers to pay hourly employees an increased hourly rate when employees work more than a certain number of hours in a given period of time.  Federal law uses a weekly measure, requiring employers to pay employees one-and-one-half times (1.5x) the “regular rate” after 40 hours of work in a workweek.

Most states have similar rules, as well as laws that require employers to pay an increased hourly rate in other circumstances.  California, for example, requires employers to pay employees 1.5x the “regular rate” (a) after 40 hours of work in a workweek, (b) after 8 hours of work in a workday, or (c) for the first 8 hours on a seventh consecutive day of work in a workweek.  California also requires employers to pay employees double (2x) the “regular rate” (i) after 12 hours in a workday and (ii) for all hours worked after 8 hours on a seventh consecutive workday in a workweek.

3. Understanding The “Regular Rate”

The “regular rate” is a term of art that refers to a blended pay rate that includes many forms of compensation in addition to hourly pay, including commissions, bonuses, piece-rate pay, etc.  The FLSA, for example, defines the “regular rate” as “all remuneration for employment” save specific exclusions (e.g., bona fide gifts, holiday and/or vacation pay, discretionary bonuses). (See 29 U.S.C. 207(e).)  Compensation that is not excluded from the “regular rate” is often referred to as “includable compensation,” which is the term that will be employed for the balance of this article.

The “regular rate” serves a number of public-policy objectives, including: (1) incentivizing employers to employ more workers at straight-time hours instead of fewer workers at overtime hours, and (2) requiring employers who prefer overtime work to compensate employees for the burden of working longer hours.  The “regular rate” concept addresses employers who might try to evade these public policy objectives through the payment of compensation not directly tied to workhours (e.g., commissions, bonuses) by requiring the aggregation of many such forms of compensation into a new (and higher) hourly rate, which must be paid to employees for each overtime (or double-time) hour worked.  From this it follows that when employers do not account for such forms of remuneration when calculating overtime (or double-time) rates, or do so incorrectly, an underpayment of earned wages is the likely result.

The types of pay that qualify as compensation includable in the “regular rate” often differ from state to state, as well as under federal law.  However, overtime laws have historically characterized “includable compensation” as remuneration designed to motivate productivity, retain employees, or that is routinely awarded.  In contrast, reimbursements, vacation pay, and fringe benefits payments (e.g., 401(k) contributions) have been historically excluded from many state and federal definitions of “includable compensation.”

4. Calculating the Regular Rate Presents a Trap for the Unwary

The concept of the “regular rate” is easy to grasp and, in some circumstances, easy to calculate.  Indeed, the DOL Fact Sheet #56A explains the basic calculation in the following way:

Total compensation in the workweek (except for statutory exclusions) ÷ Total hours worked in the workweek = Regular Rate for the workweek

However, many forms of “includable compensation” are not deemed earned, or calculable, within a single workweek.  For example, many commission plans aggregate monthly sales, but those commissions are not deemed “earned” until some later date – after reconciliation for returns, errors, etc.  Many bonuses are similarly not earned in a single workweek, but are attributable to performance over a much longer period of time, such as a quarter or year.  In these situations, the calculation above is not helpful because the “[t]otal compensation in the workweek” component is unknown until a later date.

In such situations, the employer must pay the overtime wages in two installments.  The first installment is for the hourly component of overtime (i.e., true “time-and-a-half”) and is paid on the next regular payday based on the hourly wages earned and paid in that pay period.  The second installment is the “true-up” on the hourly overtime wages, which cannot be paid until the delayed “includable compensation” becomes known and the difference between what was already paid can be calculated.

While the math equation is not complicated, determining the specific items that feed into the calculation can be; because they often call for fact-specific legal analysis of questions like:

  • What forms of remuneration constitute “includable compensation”?
  • When is a specific from of “includable compensation” deemed “earned” and/or “calculable” under the employment agreement and applicable laws?
  • Over what period of time should the “includable compensation” be attributed?

The complexity of calculating the second installment is magnified in some states, such as California, which requires employers to use different calculations for different types of “includable compensation.”

While California is unusual in that regard, the fact that getting the calculation correct requires both math and legal analysis is instructive for employers in all fifty states.  This is because plaintiffs in all fifty states can, and do, file lawsuits against employers seeking allegedly unpaid overtime wages (and the corresponding penalties) on the theory that employers incorrectly calculated the inputs to the “regular rate” equation.

5. Underpaying a Little Can Cost a Lot

Most overtime true-up payments are for relatively small amounts.  There are, of course, circumstances where these payments can be large, as with employees earning significant non-hourly compensation who also work many overtime hours.  Whether the amounts are small or large, failing to make true-up payments constitutes a failure to pay earned wages, which can trigger lawsuits seeking damages, penalties, and fines that well exceed the amount of unpaid wages.

For example, lawsuits under the FLSA can result in the recovery of unpaid wages, legal fees, and in some circumstances, liquidated damages (or interest) and civil penalties.  The penalty schemes in some states are more aggressive.  In California, for example, failing to pay earned overtime could give rise to claims for the unpaid wages, interest, fees, as well as waiting time penalties (i.e., up to 30 days of average daily pay for separated employees), statutory penalties for untimely payment of wages, and civil penalties under the dreaded Private Attorneys General Act.

It also bears noting that the failure to pay overtime triggered by “includable compensation” is often a company-wide issue – i.e., not an isolated instance.  As such, claims based on a true-up theory are often suitable for class treatment and/or are likely to be deemed “manageable” for trial, which means that the exposure on such claims will be significant.  So it is worth the time, attention, and resources necessary to ensure that you comply with true-up obligations, which begins with engaging competent counsel to review your policies and practices that relate to the payment of overtime (or double-time) at the correct regular rate.

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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