Discretionary vs Non-Discretionary Bonuses

Related legal obligations

Employees love to receive them, and employers may even love to give them, but rewarding good performance with bonus pay is not always a straightforward, isolated transaction.

Most employers are familiar with the legal requirement to pay non-exempt employees, i.e. hourly employees (and even some who aren’t), for overtime hours at a rate equal to time and one-half the workers’ “regular rate.” But that basic overtime rule is just the proverbial tip of the iceberg when it comes to regulatory compliance under the Fair Labor Standards Act (FLSA). If you need a refresher on the FLSA, please check out these articles: Overview of the Fair Labor Standards Act and A Plaintiff Lawyers Perspective on the Fair Labor Standards Act FLSA.

Regular rate calculation

For the purposes of overtime calculations, the regular rate is based on an employee’s “total compensation” and includes almost all remuneration paid to the employee, both in the form of cash and some non-cash compensation. Quite often, that formula will involve more than just the employee’s straight hourly pay, and exceptions to the rule are more limited than you might expect.

The regular rate is calculated by first adding up all of an employee’s non-overtime compensation for each workweek – including both straight-time wages and additional qualifying compensation, like commissions – then dividing the total compensation by the total hours actually worked during the workweek.

Logically, employers don’t usually give bonuses in anticipation of future performance or productivity. Therefore, non-discretionary bonuses are part of an employee’s total compensation, awarded after they are earned, and must be included in the regular rate calculation. In the case of variable quarterly or annual non-discretionary bonuses, the overtime rate must then be retroactively adjusted and paid out to employees, even if payroll has already been distributed for the applicable period.

Call it what you want

Avoiding this administrative undertaking isn’t as simple as adding the word “discretionary” to your bonus policy. Any advanced notice creates the appearance that the bonus is a motivator or incentive, implying that meeting certain levels would guarantee a bonus or reward. And retaining the option of whether to pay the bonus does not, by itself, make the bonus discretionary. No matter what you call it, if the amount or the criteria is determined in advance, and/or employees expect to earn it, the bonus is non-discretionary and should be included in the regular rate.

Truly discretionary bonuses

A qualifying, truly discretionary bonus may be excluded from an employee’s regular rate. A truly discretionary bonus only exists when an employer determines after the fact that circumstances justify the expenditure (e.g. reaching financial goals) or when an employer chooses to reward an individual employee after that employee has demonstrated exceptional performance.

Gifts

The gift exception is narrow, but it does include sums given on special occasions, or as rewards for service (e.g. baby showers, weddings, retirement). Sums given at or near Christmas are not bonuses, even if they happen with expected regularity, because they are considered to be “in the nature of gifts” due to their timing.

The good news

A non-discretionary bonus formulated as a percentage of total compensation (not of hours), does not require regular rate recalculation. A percentage bonus based on both straight-time and overtime wages would simultaneously include all overtime compensation due on the bonus.

Correcting the calculation

If this information comes at a surprise, you are not alone. But please note that simply correcting the issue going forward and ignoring the potential retroactive liability isn’t exactly a risk-free strategy. The FLSA provides either a two- or three-year statute of limitations for back pay recovery. Keep in mind that violations can result in considerable liability beyond the payment shortfall, including penalties and attorney’s fees. While employers can correct the issue retroactively by paying employees what is owed, settling FLSA issues internally will not release the company from liability, even if the employees sign a waiver.

Ultimately, the strategy for and mechanics of correcting this problem in your workplace are complex and best handled under the guidance of experienced employment counsel.

Source: Stanton law attorneys: www.stantonlawllc.com

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