As a follow-up to an earlier White Paper (Incentives 101 – Designing a Program that Motivates), it was mention “one legal requirement that is often misunderstood is when providing incentives to Nonexempt (hourly) employees. In those cases, if the incentive is based on performance (as opposed to subjectively provided, such as profit-sharing), the incentive needs to be recalculated back into the employee’s wages for the period earned, and a true-up for overtime may be in order. This is a complex subject, and one best left for experts to evaluate to ensure your compliance with the Fair Labor Standards Act. For more information on bonuses and overtime, click here.”

This is important concept, and one that is often overlooked (there is the “logic” behind the law, ironically). The Fair Labor Standards Act of 1938 (FLSA), the primary federal legislation surrounding compensation, was written to protect employees’ interests and rights from a compensation perspective. The logic (or reasoning) behind the following details and examples is, by calculating overtime correctly (as in the below example), the employees are ensured correct and legally mandated compensation rules.

At the most macro level, the law protects an employee who the employer might want to pay $25.00/hour ($52,000/year) but that same employer doesn’t want to pay overtime on $25.00. To minimize the cost of overtime, the employer pays $10.00/hour, and pays a monthly “bonus” of $2,600, for a total compensation of $52,000/year ($20,800 in base salary plus $2,600 X 12 = $31,200 in bonus). The employer’s logic is, with the lower hourly rate, the overtime rate reduces from $37.50/hour to $15.00/hour…quite a reduction in potential cost! However, as you can imagine, the FLSA closed this loophole quickly!

To pay your employees correctly, you must recalculate the hourly rate takin into account the bonus for the period and use this new hourly rate to pay overtime. As a simple example, for states that calculate overtime based on hours worked in excess of 40 (not hours worked in a day in excess of 8):

  1. Employee’s hourly rate =$15.00/hour
  2. Employee works 50 hours in week A
  3. Employee is paid $15.00/hour X 50 = $750
  4. Employee is paid an overtime premium of $15.00/hour X 10 X .5 = $75.00
  5. Employee earns a bonus of $500 for work done in week A
  6. The bonus per hour worked in week A is $10.00/hour ($500 / 50 = $10.00/hour)
  7. The overtime premium (for the bonus) is the bonus per hour worked ($10.00) X 10 hours of overtime X .5 = $50.00
  8. The total pay due to the employee is:

     $750.00      (regular pay)

+     $75.00   (overtime premium on regular pay)

+   $500.00   (bonus)

+     $50.00   (overtime premium on bonus)

$1,375.00   (total pay for the week)

This may be confusing, but logically it makes sense…consider the bonus as a part of earnings to recalculate the hourly rate. Put another way, if the employee was paid an hourly rate of $15.00 plus $10.00 (the bonus rate previously calculated) for an hourly rate of pay of $25.00/hour, and no bonus was paid, it would calculate to the same gross earnings for the week:

  $1,250.00      (regular pay, $25.00 X 50 hours)

+   $125.00   (overtime premium, $25.00 X .5 X 10 hours)

$1,375.00   (total pay for the week)

The key to remember is, if a bonus is tied to performance (whether individual or team), the true-up calculation needs to be performed. It can get even more complicated when, for example, employees are paid bi-weekly, and the bonus is earned over a calendar month (it is the rare exception that there will ever be a set of bi-weekly pay periods that coincide with a calendar month).

Lastly and also most complicated, while this law is not only not well known to management, it is not well known to employees. Communication and education will likely be needed for the recipients who will undoubtedly ask why they got overpaid (although most people don’t ask questions when they believe they are being overpaid!).

Remember, while this is complicated, the Department of Labor (the managing body over the FLSA) is well versed in the law…and ignorance of the law is never viewed as acceptable.

Disclaimer:        The materials contained in this paper are for informational purposes only and not for the purpose of providing legal advice. You should contact your attorney to obtain advice with respect to any particular issue or problem.

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