California labor laws generally discourage overtime work by requiring employers to pay a premium for hours worked in excess of eight hours in a workday or 40 hours in a workweek.  There are additional premiums for work on the seventh day in the workweek, or work exceeding 12 hours in a day. The premium pay obligation is found in the California Labor Code (section 510) and in Industrial Welfare Commission wage orders that regulate wages, hours, and working conditions in most industries and occupations.

The overtime premium is based on what is called the “regular rate” of pay.  The premium for hours worked in excess of 8 hours in a workday, 40 hours in a workweek, or the first 8 hours worked on a seventh consecutive workday is 1.5 times the employee’s “regular rate of pay.”  If the employee works more than 12 hours in a workday or more than 8 hours on a seventh consecutive workday within the same workweek, the employer must compensate such work at 2.0 times the employee’s regular rate of pay.  California’s overtime laws are more protective of employees than federal law, which requires only a premium for hours worked over 40 within the same workweek.

So, to correctly calculate overtime, the employer first must determine an employee’s regular rate of pay applicable to the workweek in question.  Miscalculating overtime can result in significant liability.  It therefore is worthwhile to review key concepts regarding the “regular rate.”

First and foremost, an employee’s regular rate of pay is not necessarily the same as an employee’s hourly or base rate, also known as a “straight time” rate.  The straight-time rate is the regular hourly rate that applies to the employee’s normal working hours.  The regular rate used to calculate overtime includes this straight-time rate, but also includes many forms of additional compensation that the employee earned during the pay period. 

For example, the regular rate includes hourly or piecework earnings, commissions, the value of meals and lodging, cash payments in lieu of health benefits, production bonuses, and other non-discretionary bonuses.  But not every form of compensation is included in the regular rate of pay.  Employers may exclude from the regular rate pay for time not worked (e.g., vacation, sick leave, and holidays), overtime premium pay itself, expense reimbursements, profit-sharing payments, gifts, or discretionary bonuses.

Employers must carefully consider whether to exclude a bonus on the ground it is “discretionary.” A “non-discretionary bonus,” which must be included in the regular rate, is additional compensation provided to an employee based on predetermined factors.  If the bonus arrangement is enforceable as a contract, often the case under California law, it generally must be included in the regular rate. 

On the other hand, a “discretionary bonus,” which need not be included in the regular rate, is not based on hours worked, production, or efficiency.  Both the fact of payment and the amount of the bonus neither are pre-determined nor calculated according to a formula. The employer, in its sole discretion, determines whether to award the bonus, the bonus amount, and the timing of the bonus payment.

Even after tackling what compensation is included, it can be tricky to calculate the regular rate correctly. For example, some compensation, like certain commissions, may be earned during one workweek, but not paid until a later time. Other compensation is earned across more than one pay period, such as a quarterly bonus.  These variations can lead to an initial calculation of the regular rate, and a later re-calculation that leads to additional overtime due.

A related complication is how to allocate earned compensation across the hours worked to come up with an hourly “regular rate.”  The California Supreme Court in Dart v. Alvarado Container Corp. of Cal. addressed this issue in the context of a “flat sum” bonus paid for good attendance on weekend shifts.  

Dart paid $15 to employees who completed a Saturday or Sunday shift, regardless of whether the shift resulted in overtime pay.  The bonus, therefore, is a “flat sum” because it does not change based on hours worked or production.  This bonus was required to be included as part of the regular rate. Dart divided the value of the bonus among all the hours worked during the workweek, which indeed is the general method of calculating the regular rate of pay.   

Alvarado, though, argued that the proper way to calculate the bonus’s effect on the regular rate was to divide the value of the bonus only by the straight-time hours worked, not the total hours worked.  Alvarado argued that because the flat-sum bonus did not depend on production, it diluted the impact of the bonus on overtime pay by allowing Dart to include overtime hours in the calculation.

The California Supreme Court agreed with Alvarado, in part because California’s public policy disfavors overtime, and a higher overtime premium discourages employers from requiring overtime work.  According to the Court, to determine the per-hour value of a flat sum bonus for purposes of calculating overtime, an employer must divide the bonus value by the number of non-overtime hours the employee worked during the pay period. 

The flat, attendance based bonus is properly treated as if it were fully earned only by the non-overtime hours, because the bonus is payable even if the employee does not work overtime during the workweek in question.  Additionally, as a flat sum, the bonus “does not reward the employee for each hour of work,” unlike a commission or a production or piecework bonus, which “may increase in size in rough proportion to the number of hours worked, including overtime hours.”

Employers should bear in mind that the Alvarado formula only applies when the employee receives a flat sum bonus.  A different analysis may be required for other types of non-hourly compensation.  As a result, when there are several categories of compensation in a workweek, it may be necessary to calculate overtime in a multi-step formula.

The Court in Alvarado also decided that its decision applies retroactively, so employers may be liable for past practices.  In addition to owed wages, employers may be subject to penalties for failing to provide accurate wage statements and “waiting time” penalties for failing to pay all wages owed to an employee at the conclusion of the employment relationship.  Therefore, employers who have paid flat sum bonuses unrelated to production should review their overtime pay practices immediately.  It is a good idea to work with counsel any time employees receive a bonus to ensure pay practices are compliant with legal requirements.