Calculating the Regular Rate of Pay with a Bonus or Commission for Overtime
I have had several clients ask questions related to bonuses and commissions during the past few weeks. The goal for each employer was to provide a meaningful incentive program to employees, and allow them to benefit from their diligent service. However, in every situation but one, the client had not taken into account the effect of a bonus on calculating an employee's regular rate of pay ("RRP"). Since the RRP is used to calculate overtime, it is critical to understand the effect of a bonus on the RRP. If the RRP is incorrectly calculated, then overtime is incorrectly calculated. Failing to pay an employee correctly can subject an employer to substantial liability in unpaid wages, liquidated damages, penalties and attorneys' fees.
The RRP is used to calculate overtime. Thus, when considering bonuses or commissions, if the employee is exempt from overtime compensation, the RRP is irrelevant. However, for an employee who is not exempt from overtime compensation, calculating the RRP is essential.
For an employee who earns an hourly wage, the RRP is the same as the hourly wage. An employee who receives a weekly salary, the RRP is determined by dividing the salary by 40 hours per week. If the employee receives a salary for a month, multiple the salary by 12 months and then divide by 52 weeks for a weekly salary. Divide that by 40 hours to get the RRP.
A bonus or commission complicates the calculation of the RRP. The RRP includes all form of remuneration for employment paid to an employee. Now that's not a very helpful rule, but federal and state agencies have articulated a list of payments that must be included as remuneration, and which can be excluded. For example, a Christmas bonus that is not dependent on hours worked, efficiency or production, is not considered remuneration.
Likewise, a bonus is not remuneration if: (1) The decision to pay, and the amount, is within the sole discretion of the company; (2) is given near the end of a work period; and (3) is not subject to a prior agreement or understanding causing the employee to expect such a payment regularly. However, if the bonus does not meet these criteria, then the payment is part of remuneration.
Companies often want to tie a bonus to some form of production. It is thought that if the company explains how an employee earns a bonus, the employee will modify his/her behavior to achieve the company's goals. In contrast, merely giving employees a bonus at the end of the year may not provide the incentive and understanding for an employee to modify behavior.
If your employee is exempt, then go ahead and create an incentive-based bonus. However, if the employee is not exempt, then an incentive-based bonus (or commission), which is given pursuant to some type of formula, and not per the sole discretion of the company, is remuneration which must be included in the employee's calculation for the RRP.
Consider the employee who earns $10 per hour, and worked 50 hours during the workweek. This employee earns ($10 x 40 hours) + ($15 x 10 hours) = $550. However, let's add more facts to this hypothetical. Assume that the employee earned another $100 for the week under an incentive-based bonus plan. How is the RRP calculated, and what must the employee be paid for the week?
The California Labor Commissioner instructs employers to first determine the overtime based on the hourly rate of pay. In this hypothetical, the calculation is:
$15 x 10 hours = $150.
Then the Labor Commissioner instructs employers to compute overtime due on the bonus. An employer does this by finding the regular bonus rate by dividing the bonus by the total hours worked throughout the period in which the bonus was earned. The employee is then entitled to an additional half of the regular bonus rate for each hour worked.
The calculation is:
$100 ÷ 50 hours = $2.00 ÷ 2 = $1.00 x 10 hours = $10.00.
According to the Labor Commissioner, the employer in this hypothetical would pay:
$10 x 40 hours = $400
$15 x 10 hours = $150
OT on bonus $10
As you see from this example, the bonus (or commission) causes the employee's RRP to increase so that (s)he earns another $10 in overtime compensation. Failure to properly calculate overtime and pay that extra amount owed may subject an employer to unwarranted penalties, liquidated damages and attorneys' fees. An employer should consider the effect of any additional compensation on an employee's RRP. This might include a production bonus, piece rate, shift differential, or pay for on-call services.