(This is part two of a two-part article.  Part one was published last month.)

As we discussed in last month’s column, calculating the regular rate of pay can be complicated, and failure to do so correctly can result in significant liability for employers.

Calculating Overtime When Employees Receive Incentive Pay

The regular rate calculation is particularly complicated when employees earn other forms of pay, like bonuses and commissions, especially because those payments are often not entirely earned and paid in the same workweek. These earnings require the employer to allocate the payments to the workweek they were earned, and then adjust overtime they previously paid in that workweek to account for the additional compensation.

It can be challenging or even impossible to allocate an incentive that is earned over a longer period, like a monthly or quarterly bonus, to the workweeks in which it is earned. In that case, an employer generally may allocate the incentive in a manner that is “reasonable” and “equitable.” Depending on the terms of a monthly bonus, for example, it might be reasonable and equitable to allocate it equally to each hour worked in the month. The employer would then adjust overtime (and other compensation based on the regular rate of pay) in any of the workweeks in that month, to account for the increase.

Exceptions to the Above Rules

Generally, unless the law creates a specific exception, all compensation is included in the regular rate of pay calculation in the manner described above.  Amounts excluded from the regular rate include reimbursements for actual expenses, truly “discretionary” bonuses, gifts, and payments that do not compensate for hours worked (e.g., vacation, paid time off). Other common exclusions include premium pay for missed meal and rest breaks, reporting and call-back pay, employer contributions to certain benefits plans, tips, and predictability pay.  Also, in some cases, a “flat sum” bonus that are not based on hours worked (e.g., a set amount for working an undesirable shift), are factored into the regular rate by dividing over non-overtime hours only.  

Key Takeaways

Of course, failing to follow the rules explained above can be costly. Particularly if employers calculate overtime the same way for a large number of employees, getting it wrong can mean unexpected costs later, whether in fixing pay errors or in the worst case, responding to legal claims.

So, how does an employer navigate these confusing rules? The first step is understanding the obligation. Employers who find the prospect of calculating the regular rate to be too daunting may choose (appropriately so!) to pay only a base hourly rate, or to structure compensation so it is easier to calculate the regular rate of pay—for example, by reducing the number of bonus plans, or developing incentives that can be easily allocated to the correct workweek.

Fortunately, even for employers who have more complex pay schemes, there are many resources available to help them correctly calculate the regular rate of pay. The California Department of Industrial Relations provides online guidance to explain how to properly calculate overtime. Internal payroll experts may have the required knowledge and capability to handle more challenging issues, and some payroll providers also have this type of expertise and can even help employers program and utilize their payroll systems to streamline the calculations. Finally, attorneys with experience auditing wage practices or defending employers in wage and hour lawsuits often can provide additional expertise.