By Ellen Schlosser, Senior Consultant for Compensation and Technology, The HR Group, Inc  

Pick up any article related to pay for performance, flexible work arrangements, or compensation and you will find suggestions for creative ways of paying employees for better results or for accomplishing challenging tasks.  Many of these suggestions are for variable pay programs that include various types of bonuses, on-call pay, quality bonuses, attendance rewards, etc.  Did you know that, in most circumstances, these types of payments increase the rate you must pay for overtime to your non-exempt employees?

As a quick test of your knowledge of overtime requirements, take a look at this example: 

Joe, your hourly-paid production worker has a base pay rate of $10.00 per hour.  He worked 42 hours last week.  He also was paid $50.00 for on-call pay for the weekend.  According to the Fair Labor Standards Act (FLSA), what is the correct amount of earnings for Joe's two hours of overtime?

A.      $20.00 (2 hours at $10.00)

B.      $30.00 (2 hours at $15.00)

C.      $31.19 (2 hours at $15.595)

You may be surprised to see that the answer is not $30.00 (base rate times time-and-a-half).  As is the case with so many things related to human resources, the more complicated answer is the correct one:  $31.19 (C).

According to the FLSA, overtime is to be paid at a rate that is one-and-one-half times the regular rate of pay for all hours worked over 40 hours in a workweek.  The FLSA defines the regular rate of pay to include "all payments made by the employer to or on behalf of the employee (except for certain statutory exclusions)".   In general, the variable pay components mentioned above must be taken into consideration when computing the regular rate of pay and the resulting overtime rate of pay.

In Joe's case, the calculation works like this:

• Joe is paid $10.00 per hour for each of the 42 hours he worked ($420.00) plus he is paid $50.00 for his on-call pay bonus, giving him a total of $470.00 of straight-time pay for the 42 hours he worked. His regular rate of pay is computed by dividing the $470.00 by 42 hours to get $11.19.

• The overtime premium is then computed by multiplied by 50% to get the premium of $5.595. When the overtime premium is added to the base rate of $10.00, Joe's overtime rate is $15.595.

• When multiplied by the hours worked over forty (42 minus 40 = 2), the total overtime pay for Joe is $31.19.

In general, payments that are made to overtime-eligible employees should be considered in calculating the regular rate of pay unless payments qualify as discretionary bonuses.  In order to qualify, the bonuses must be paid solely at the discretion of the employer and the employee would have no reasonable basis on which to expect such a payment. 

Non-discretionary payments are those that are promised to employees based on achievement of certain goals or performance of specific tasks.  An example of a non-discretionary bonus would be one based on a published announcement that promises to pay each employee $100.00 in January of the following year if the company achieves a minimum level of profit for the current year.  By announcing the program, the company has created an expectation for its employees that a bonus might be coming.  When the bonus is paid in January, it must be considered in calculating overtime for the non-exempt employees.

On the other hand, if the company had waited until after the end of the year and then decided that, as a surprise reward for its employees, it would pay every employee $100 on a one-time basis, the payment would be considered discretionary and would be excluded from the overtime pay calculation.  Again, the key is that the employees had no reason to expect the bonus. 

There are many reasons to implement non-discretionary variable pay programs, most of which are related to motivation for employee performance.  The overtime "penalty" associated with non-discretionary bonuses should not, in and of itself, be reason to avoid these programs.  It should, however, be a factor in the evaluation of the cost of the programs.  Of course, there is also the need to stay in compliance to FLSA and other regulations.

Questions about Incentive Plans or other compensation issues?  Call Ellen Schlosser at 336-292-1911