Year-End Bonuses: A Trap for the Unwary?

December 21, 2015

Federal and state law requires that overtime be paid to nonexempt employees who work more than 40 hours in a workweek at 1½ times their “regular rate.” What do bonuses have to do with the regular rate and overtime? That depends on whether the bonuses are discretionary or nondiscretionary. Here is what you need to know as 2015 comes to an end and you distribute bonuses and other incentive payments.

Discretionary vs. Nondiscretionary

Bonuses are the exception rather than the rule when it comes to how the Fair Labor Standards Act (FLSA) and the U.S. Department of Labor (DOL) define discretionary and nondiscretionary. For a bonus to be discretionary, both the payment of the bonus and the amount of the bonus must be at the sole discretion of the employer at or near the end of a set period. The bonus may not be paid in accordance with a contract, agreement, announcement, or promise that causes employees to expect the payment regularly. In other words, the employer must retain discretion about not only how much to pay but also whether to pay the bonus at all.

A custom or practice of paying a bonus at the same time year after year suggests an implied understanding that the employer will provide a nondiscretionary bonus. If an employer forgoes its discretion regarding the payment of a bonus or the rate of payment by word, action, custom, or practice, the bonus becomes nondiscretionary. For instance, if an employer retains discretion regarding the amount of a bonus, a practice of regularly paying a bonus at the end of each quarter or year would still render the bonus non discretionary because employees would come to expect some type of regular payment.

Likewise, basing the amount of a bonus on employees meeting measurable criteria is enough to remove the necessary discretion. Applying requirements based on attendance, quality, production, longevity, or the attainment of company goals to most types of incentive-based bonuses renders the payments nondiscretionary. Any type of regularly paid bonus that is based on measurable criteria will not qualify as discretionary. Those types of bonuses are akin to wages that are earned through employees’ service, productivity, or efficiency, and employers must include them in employees’ regular rate for overtime purposes.

Overtime Implications of Nondiscretionary Bonuses

Nondiscretionary bonuses must be included in employees’ regular rate of pay for overtime purposes. When a bonus is intended to cover an extended period of time (e.g., a quarter or year), the payment must be apportioned over the workweeks of the period in which it was earned. An employee must be paid additional overtime compensation for each workweek he worked overtime during the period covered by the bonus.

The DOL’s overtime regulations provide alternative methods for calculating overtime for bonuses that are not allocated to specific workweeks and cover multiple workweek periods. For example, if an employee earns an equal portion of a bonus each workweek, the employer may divide the amount of the bonus by the number of workweeks in the period. Additional overtime can be calculated by dividing the weekly bonus amount by the total number of hours worked that week (to determine how much the employee’s regular rate increased because of the bonus) and multiplying the result by half the overtime hours worked that week.

If an employee earns an equal portion of a bonus for every hour worked during the bonus period, you can calculate the increase in the employee’s regular rate by dividing the amount of the payment by the number of hours worked during the period. Then, multiply the number of statutory overtime hours worked in each workweek during the period by one-half the hourly increase.

For employers that want to avoid having to go back and make calculations, a contract or plan for paying bonuses may provide for simultaneous payment of overtime on the bonus. For example, a contract may state that a bonus will be paid as a percentage of a nonexempt employee’s straight-time and overtime earnings during the bonus period. The overtime regulations allow for such contracts to be entered into before services are performed as long as the arrangement is not used as a way of evading overtime requirements.

What About Special Bonuses?

Bonuses or items provided as gifts during the holidays or at special occasions need not be included in employees’ regular rate if they are not measured by or dependent on hours worked. For instance, the value of a holiday gift card need not be included in an employee’s regular rate for overtime purposes.

Bottom Line

Nondiscretionary bonuses cause nonexempt employees’ regular rate to increase. Failing to include nondiscretionary bonuses in overtime calculations can subject an employer to the same types of penalties as other overtime violations, including liquidated damages and attorneys’ fees. Underpayments resulting from bonuses tend to be relatively small, but the potential legal exposure far exceeds the amount of unpaid overtime. Don’t neglect to pay overtime on nondiscretionary year-end bonuses.

This article, slightly modified to note recent updates, was featured in the December 2015 issue of the Wisconsin Employment Law Letter, which is edited by Axley Brynelson Attorney Saul Glazer and published by BLR®—Business & Legal Resources. Reproduced here with the permission of BLR®—Business & Legal Resources.

Leslie Sammon
Leslie Sammon