Many employers are freezing wages, telling employees that any additional pay will come in the form of a bonus if they or the company does well. A recent California decision (Marin v. Costco) serves as a reminder that paying a bonus to non-exempt employees can trigger additional overtime obligations.

In Marin, several former employees, all classified as non-exempt, sued Costco for its alleged failure to pay overtime wages on the non-discretionary bonus it paid to these employees.

Under the Federal Fair Labor Standards Act and the California Wage Orders, employers must calculate overtime based on the employee’s regular rate of pay. This rate must be computed by each work week, and becomes significantly more complex if an employee’s compensation involves more than just an hourly wage, such as profit sharing or productivity bonuses. For each work week, the employer must total all the compensation paid, but exclude overtime payments, profit sharing, discretionary bonuses and other benefit plans, and then divide the total number of hours worked, up to 40, to determine the regular rate of pay. Significantly, non-discretionary bonuses, such as those earned by meeting performance standards, are included in the regular rate calculation.

Bonus overtime stems from the fact that overtime premium pay is computed based on a multiple (usually 1.5 times) of the employee’s regular rate of hourly compensation. This regular rate is calculated by dividing the number of hours worked in the week by all compensation earned for that week. If the employee is later given a bonus that’s partially due to work performed in that week, this additional pay must be added to the total compensation for the week. This effectively causes a retroactive increase in the employee’s regular rate of pay.

For example, suppose an employee’s straight time hourly pay is $10 per hour, and that he worked 40 regular hours and 10 overtime hours in a given week. His regular weekly paycheck would include $400 as straight time pay, plus $150 of overtime pay (1.5 times his base rate, or $15 an hour, multiplied by 10 hours).

Now suppose the employer has a profit-sharing program that pays this employee $5,200 at the end of the year based on the company’s overall performance. Because the bonus is equally attributable to all weeks in the year, this payment retroactively increases his weekly compensation by $100 ($5,200 divided by 52 weeks). Under the law, this additional $100 per week payment also raises the employee’s regular hourly rate for the week retroactively by $2.50 ($100 per week divided by 40 straight time hours per week). Since the employees recalculated regular rate for this week is now $12.50 per hour, his recalculated overtime rate increases proportionately from $15 an hour to $18.75 an hour. Each employee is thus entitled to an additional $3.75 for each overtime hour worked, totaling $37.50 extra for the week in which he worked 10 hours of overtime. This is known as the retroactive effect of a non-discretionary bonus.

In contrast, the retroactive effect of a discretionary bonus creates a different outcome. Suppose the same employer paid the same $100 per week for the performance bonus based on that particular employee’s volume of production during the year (e.g., making sales, manufacturing products, etc.). The law now requires that the bonus overtime be calculated differently. Instead of dividing the $100 by 40 straight time hours to determine the regular rate for bonus overtime, the employer is allowed to divide the amount by the total of the straight time and overtime hours worked (in this case, 50 hours). As a result, the employee’s regular rate for the week rises by just $2.00 ($100 divided by 50 total hours worked). The employee would be entitled to only an additional $20 ($2.00 multiplied by 10 hours of overtime), as opposed to $37.50.

In summary, the two points to remember from the Marin case are that: (1) Additional overtime payments are triggered when a bonus is paid; and (2) the method for calculating the amount of this bonus overtime depends on whether the bonus is characterized as a non-discretionary bonus or a discretionary bonus. Calculating bonus overtime is complex and can be a headache for employers. However, employers who ignore this calculation do so at their own peril because using a mistaken formula offers fertile ground for a class action or other litigation.

The Bottom line: When formulating bonus plans, be prepared to calculate the impact of retroactive overtime pay.

Here are materials to help you calculate wage obligations related to bonuses.

- 29 CFR 778.211 – Discretionary bonuses http://www.dol.gov/dol/allcfr/ESA/Title_29/Part_778/Subpart_C.htm
- Bonus Plan Opinion Letters http://www.dol.gov/esa/whd/opinion/FLSANA/2006/2006_02_17_4NA_FLSA.htm and https://www.dol.gov/esa/WHD/opinion/FLSA/2005/2005_08_26_22_FLSA.htm
- For businesses in California, http://www.dir.ca.gov/dlse/DLSEManual/dlse_enfcmanual.pdf Section 35 on bonuses

Partial content contributed by Pettit Kohn Ingrassia & Lutz (www.pettitkohn.com).