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How a Bonus Might Cause Unexpected Liability for an Employer

As companies continue to struggle with staffing shortages, many employers may consider offering bonuses or other incentives to employees as a means of attracting talent to their workforce.  While this may be a prudent and effective means of hiring and retaining employees, companies should be aware of the potential overtime implications arising from awarding certain bonuses to nonexempt employees.

Many companies mistakenly believe that overtime is simply calculated based on an employee’s regular hourly rate.  Yet, such an inadvertent error could expose employers to substantial overtime claims.  The federal Fair Labor Standards Act (FLSA) requires payment of overtime based on the nonexempt employee’s regular rate of pay.  Importantly, an employee’s “regular rate of pay” may include more than just the employee’s hourly pay and can include other compensation – including non-discretionary bonuses.  The FLSA divides bonuses into two categories: discretionary and nondiscretionary.  While discretionary bonuses do not have to be included in overtime calculations, nondiscretionary bonuses must be included in the overtime rate.  

Under the FLSA, a bonus is discretionary if it meets the following requirements:

  1. Employer has sole discretion to award the bonus;
  2. Employer has sole discretion to determine the amount of the bonus; and
  3. The bonus is not made pursuant to any agreement or promise to an employee who expects such payments regularly.

Some examples of discretionary bonuses include severance pay, employee-of-the month bonuses, and bonuses for overcoming a challenging or stressful situation.  Many holiday bonuses and gifts also may be classified as discretionary if they are not linked to hours worked or production.

On the other hand, employers must include all nondiscretionary bonuses in the regular-rate-of-pay calculations when making overtime payments to nonexempt employees.  When an employee knows about a bonus and expects to receive the bonus upon certain conditions being met, the FLSA defines that bonus as nondiscretionary.  Some examples of nondiscretionary bonuses include:

  1. Incentive plan bonuses;
  2. Bonuses based on a predetermined formula, such as an individual or group production bonuses;
  3. Bonuses tied to work performance;
  4. Attendance bonuses;
  5. Safety bonuses; or
  6. Bonuses based on a set of criteria.

The following examples illustrate how nondiscretionary bonuses are calculated in the regular rate of pay.

Example 1—No Nondiscretionary Bonus: Employee works 45 hours a week, and her hourly rate is $10.00/hour.  Typically, overtime is calculated as follows:

1. Calculate Overtime Rate

  • $10/hourly rate x 1.5 overtime premium = $15.00 overtime rate

2. Calculate Overtime Pay

  • $15 overtime rate x 5 overtime hours worked = $75 in overtime pay

Example 2—Nondiscretionary Bonus: Employee works 45 hours a week, and her hourly rate is $10.00/hour, and she also receives a $100.00 attendance bonus for the week.  Here, there are a few more steps in determining overtime pay:

1. Calculate the Straight Time Compensation: straight time compensation is the total hours worked multiplied by the employee’s hourly rate and adding the bonuses

  • 45 hours x $10 per hour + $100 attendance bonus = $550 straight time compensation

2. Calculate the New Regular Rate of Pay

  • $550 straight time compensation / 45 total works worked = $12.22 (the “regular rate of pay”)

3. Calculate the New Overtime Rate of Pay

  • $12.22 regular rate of pay x 1.5 overtime premium = $18.33 adjusted overtime rate

4. Calculate Overtime Pay

  • $18.33 adjusted overtime rate x 5 overtime hours worked = $91.65 overtime pay

Thus, if you compare the two examples above, the employee who received the nondiscretionary bonus must also receive an additional $16.65 in overtime pay as a result of the bonus payment.  If the employer fails to include the bonus in the overtime rate, the employer would not only be underpaying the employee by $16.65 for that week, but also likely liable for liquidated damages in an amount equal to the underpayment – bringing the potential liability for this one employee, for one week, to $33.30.  With a 2 to 3 year look-back period, and depending on the size of the employer’s nonexempt workforce, such overtime claims can add up quickly. Consequently, calculating the correct regular rate of pay is crucial to ensuring compliance with overtime laws. 

If employers are unsure whether a specific bonus must be included in overtime pay rates, it is prudent to consult with labor and employment counsel to ensure compliance with the FLSA and analogous state laws.

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