December is a month of many things: busy calendars of holiday parties and vacations, financial fiscal year wrap-ups, and a general sense of holiday season joy. December also contains year-end bonuses employers often pay out as a goodwill gesture to their hardworking employees. A note of caution, however, should accompany those contemplating bonus payouts: do not let that post-Thanksgiving turkey coma lull you into a sense of complacency and a potential Fair Labor Standards Act (FLSA) violation! While your heart may be in the right place, employers need to be careful they are not inadvertently stepping into a wage and hour violation by miscalculating overtime compensation with bonus payouts.
The FLSA requires employers to pay non-exempt employees “at a rate not less than one and one-half times the regular rate” at which an employee is employed for all hours worked in excess of forty hours in a workweek. To ensure overtime is correctly paid, an employee’s regular rate for a workweek is defined as one’s total compensation that workweek, minus statutory exclusions such as reimbursements for business expenses or costs of typical business “perks”, divided by the total hours worked in that workweek.
This fairly straightforward process becomes complicated—and this is where employers might run into trouble—when deciding whether or not to include bonuses in determining an employee’s regular rate. The main point at issue here for employers is understanding the distinction between discretionary and non-discretionary bonuses.
In a nutshell, the difference is the discretion—hence the name—with which the employer has to give the bonus. Discretionary bonuses are excludable from calculating the regular rate of pay as long as the employer (1) has the sole discretion to determine whether to pay the bonus, (2) to determine the amount of the bonus, and (3) the bonus payment must not be made according to any prior contract, agreement, or promise causing an employee to expect such payments regularly.
Examples of discretionary bonuses are those for overcoming a challenging or stressful situation; bonuses made to employees who made unique or extraordinary efforts not awarded according to pre-established criteria; employee-of-the-month bonuses; and severance bonuses. It is important to know that a label assigned to a bonus is not conclusive—ultimately the Department of Labor (DOL) will determine if a bonus is discretionary or not.
Non-discretionary bonuses, by contrast, must be included in the regular rate unless they qualify for a statutory exclusion. Examples of non-discretionary bonuses are those based on a predetermined formula, such as individual or group production bonuses; bonuses for quality and accuracy of work; bonuses announced to employees to induce them to work more efficiently; attendance bonuses; and safety bonuses. According to the DOL, these types of bonuses are non-discretionary because the employee knows about and expects the bonus. Whether the employer has the option not to pay the promised bonus still does not make the bonus discretionary.
If this sounds complicated, take ease in knowing you are not alone. While bonus payments and overtime calculations are things that every employer should consider all year long, the holiday season is particularly germane because bonus payments may also qualify for an exclusion from the regular rate of pay if it qualifies as a gift, and such gifts are often made at the end of calendar year around Christmastime. The Code of Federal Regulations (“CFR”) and the DOL further define the standards for what is considered a gift, making this a very nuanced and complex issue.
A short math example may help clarify some lingering questions. Let’s say a non-exempt employee is paid $10 per hour and receives a $50 bonus in a particular week, promised for helping to produce a special order two weeks earlier than previously scheduled (this would be a nondiscretionary bonus). That employee worked 43 hours during the week. Under these facts, an employer should compute overtime pay based on the employee’s regular rate as follows: $10 per hour x 43 hours = $430 (total compensation for straight time), plus a $50 (bonus) = $480 (total compensation). Therefore, the regular rate would be $11.16 ($480 ÷ 43 hours). At a half time premium pay rate of $5.58 ($11.16 x .5), the employee would be owed an additional $16.74 in overtime pay ($5.58 x 3 overtime hours) for a total of $496.74 due.
Now, let’s assume that same non-exempt employee also receives a $25 on-the-spot bonus that week (and because it was not pre-announced to the employee, it is an excludable discretionary bonus). The employee still worked 43 hours that week. In this case, the employer would need to use the employee’s total compensation of only $480, not $505, to determine the regular rate. While the employee may have received two different bonuses, because the second was discretionary, it can be excluded from the regular rate calculation.
The bottom line is that employers must be aware of this issue to avoid an FLSA lawsuit. If you employ hundreds of employees, the risk is even higher due to a potential class action lawsuit. If an employer treats a nondiscretionary bonus as discretionary, even inadvertently, and fails to include bonus amounts in their regular rate calculation, they may receive their own holiday gift in the form of a demand letter seeking unpaid overtime. Employers using payroll services should not assume that the payroll services are recalculating the regular rate when bonuses are paid. Employers who are in the habit of issuing bonus payments throughout the year would be wise to consult an experienced employment attorney to ensure they stay compliant with the FLSA and have an all-around happy holiday!