As we enter the winter holiday season, many employers begin to contemplate paying year-end bonuses to employees.  It is a nice gesture of appreciation for work performed throughout the year and welcomed by employees.  However, the payment of bonuses continues to be an area where many employers fail to comply with the Fair Labor Standards Act (“FLSA”).  At a recent employment law webinar, the Regional Director for the Wage and Hour Division of the US Department of Labor underscored the ongoing compliance problem with employers failing to calculate the correct overtime rate.  The typical problem occurs in the calculation of the “regular rate of pay” for overtime hours worked.

The Basics

The key issue with “bonuses” — regardless of the time of year when they are awarded — is whether the bonus must be included in the “regular rate” when calculating overtime for non-exempt employees. The Fair Labor Standards Act (“FLSA”) requires that most employers pay non-exempt employees overtime in the amount of “one and one-half times the regular rate at which they are employed” for any hours worked in excess of 40 during a seven day work week. 29 U.S.C. §207(a). In many employment contexts, the regular rate is identical to the employee’s hourly rate. However, where employers offer other forms of compensation beyond an hourly rate, such as bonuses, these amounts must generally also be included in the “regular rate” for purposes of calculating the overtime rate. The regular rate is “determined by dividing [the] total remuneration for employment (except statutory exclusions) in any workweek by the total number of hours actually worked in that workweek for which such compensation was paid.” 29 C.F.R. §778.109; see also examples below. Accordingly, as the “total remuneration” figure increases so will the overtime rate owed to an employee.

As noted above, “bonuses” are usually additional wages paid to employees above and beyond their regular earnings, and should, therefore, be included within the calculation of the total remuneration unless the bonus falls within one of the limited exclusions set forth in the FLSA. See 29 U.S.C. 207(e)(1)-(8) (providing list of eight types of employer payments to employees which do not need to be included in the regular rate) and as further clarified in the US DOL’s Final Rule issued on December 12, 2019. Among those expressly excludable payments set forth are “discretionary bonuses” and “gifts and payments in the nature of gifts on special occasions.”

Discretionary Bonuses

For a bonus to qualify for exclusion as a discretionary bonus, the employer must retain discretion both as to the fact of payment and as to the amount of the end of the period for which the bonus is paid. The sum, if any, to be paid as a bonus must be determined by the employer without prior promise or agreement, and the employee must have no contract right, express or implied, to any amount. If an employer implements a policy describing the bonus or otherwise promises in advance to pay a bonus, the employer has abandoned his discretion with regard to the bonus and the bonus must be included in the employee’s regular rate. 29 C.F.R. § 778.211(b). More specifically, the regulations provide that “[b]onuses which are announced to employees to induce them to work more steadily or more rapidly or more efficiently or to remain with the firm are regarded as part of the regular rate of pay. Most attendance bonuses, individual or group production bonuses, bonuses for quality and accuracy of work, bonuses contingent upon the employee’s continuing in employment until the time the payment is to be made, and the like, are in this category” and must be included in the regular rate of pay. Id. at (c). In other words, if the bonus is announced to employees in advance and functions as a “carrot” to incentivize them, then it is a non-discretionary bonus. See US DOL Fact Sheet 56C.  In the case of non-discretionary bonuses that apply retroactively to a more than just the current pay period, the employer must recalculate the employees’ regular rate for the entire time period covered by the bonus and pay employees additional overtime premiums for any overtime hours worked during that time period.  29 C.F.R. § 778.209; see also examples below.

Gifts on Special Occasion Bonuses

Probably more on point this time of year, a bonus may also qualify for exclusion as a gift, such as gifts made at Christmas or on other special occasions; however, the bonus must actually be a gift or in the nature of a gift. If the amount of the bonus or other payment is measured by hours worked, production or efficiency, or is so large that it is an expected part of compensation, then the payment is not a gift. See 29 C.F.R. § 778.212; see also US DOL Fact Sheet 56A. Similarly, if the payment is made pursuant to a contractual obligation, it lacks the character of a gift. Conversely, if the gift criterion is satisfied, the exclusion will not be defeated by the fact that the bonus is paid with such regularity that the employees have been led to expect it. Id. For example, if a bonus is paid every Christmas or on some other special occasion as a gift or in the nature of a gift, it may be excluded from the regular rate even though it is paid with such regularity that the employees have come to expect it. Id.

Examples: Here are a few examples, because the math can become a little tricky when calculating overtime premiums following the award of a bonus.

(1) No Bonus: An employee earns $8 per hour and works a 45 hour week. The employee is entitled to $8 per hour for 40 hours ($320) and $12 ($8.00 x. 1.5=$12.00) per hour for the five hours of overtime ($12.00 x 5= $60), or a total of $380.

(2) Production Bonus (Current Pay Period): An employer announces to this same employee that if she meets a certain productivity quota for the week she will earn a $100 bonus. This is a classic non-discretionary bonus and must be included in the total remuneration calculation. Accordingly, the production bonus must be added to her straight-time earnings to determine the regular hourly rate for the 45 hour workweek. This is done by calculating the regular rate for 45 hours, or 45 hours x $8 ($360) plus the bonus of $100 ($460) divided by the total hours worked ($460 / 45 hours = $10.22). This employee is entitled to be paid a total wage of $485.45 (40 hours at $10.22 per hour plus 5 hours at $15.33 per hour (1.5 x. $10.22)). See 29 C.F.R. § 778.110.

(3) Gift: On December 15th, an employer decides to award a holiday bonus to all employees in the amount of $50. The bonus is issued with the 3rd pay period of the month. Unless there are conditions placed upon this award, it seems to meet the definition of a “gift,” and does not need to be included in the “total remuneration” calculation and, therefore, will not impact any overtime payments.

(4) Year-end Production Bonus: An employer offers an annual year-end production bonus of $500 if the Company achieves certain safety goals. An employee who works 2200 hours during the year is eligible for the bonus. The 2200 hours includes 200 overtime hours. To determine the overtime impact of the bonus, the $500 dollar amount is divided by the total hours worked during the year ($500/2200= $.23). The employee is entitled to one-half this amount ($.12) for each of the 200 overtime hours worked ($.12 x 200= $24). As a result, the employee should be paid a $24 overtime adjustment to account for the impact of the $500 bonus on the regular rate. See 29 C.F.R. §778.209 (prescribing method for inclusion of bonus when it must be apportioned back over the workweeks of the period during which may be said to have been earned and providing alternative methods for calculation of the revised rate).

The Bottom Line

Employers must carefully analyze bonus payments under the provisions of the FLSA, which requires the inclusion of all remuneration with limited exceptions. Non-discretionary bonuses and gifts may be lawfully excluded but they must satisfy all of the regulatory requirements as noted above.