How to Calculate Overtime Pay Correctly

by Jim Spencer

As Lady Gaga found out the hard way, the Fair Labor Standards Act (FLSA) is cracking down on employers who fail to pay their employees overtime in accordance with state and/or federal law. Her personal assistant sued the Poker Face singer for $400,000 under the New York state law and the FLSA alleging the pop superstar failed to pay her for several hours of overtime. This is certainly not an isolated incident as several celebrities have come under fire for alleged overtime hours that were not paid. But it’s not just celebrities being taken to court. As we all know, businesses have also been severely penalized for not calculating the correct overtime.

Let’s examine the proper way to calculate overtime pay and when it’s required by law. By using these tips, you should be able to avoid a potential lawsuit like Ms. Gaga’s. But then again, unlike Ms. Gaga, I’m sure you don’t request your personal assistant to sleep in bed with you. If so, that’s another serious issue.

Let’s start with the issue of properly classifying your employees as exempt or non-exempt, because that’s very important. The significant difference between exempt and non-exempt is that non-exempt employees are entitled to overtime compensation of 1.5X their regular rate. Their job duties will primarily determine if the employee is exempt from overtime. Please note that even if you pay a non-exempt employee a salary, that does not make them exempt from overtime pay. If a non-exempt employee is paid a salary, the employer will have to convert their salary to a regular hourly rate to determine what their overtime rate is.

It is very important to also understand what exactly goes into that regular rate of pay calculation. First, it’s based on hours actually worked. So it does not include holiday, PTO/vacation time, or other fringe benefit payments such as gifts, discretionary bonuses, benefit plan contributions, certain premium payments, certain stock related income, or reimbursement for work-related expenses. However, it does include wages, commissions, non-discretionary bonuses, shift differentials, and some on-call payments.

There is one piece of this that I know causes a lot of questions — or as I like to say, heartburn — and that’s the difference between a discretionary and non-discretionary bonus. Let’s clarify this before moving on. To qualify as a discretionary bonus (and therefore not be included in the regular rate of pay), the amount of the payment must be determined within the sole discretion of management. A key to maintaining the discretionary status of a bonus is to vary the bonus amounts to coincide with company performance. In other words, it is similar to a profit-sharing bonus. I would also advise against paying a discretionary bonus that is regularly paid each year (for example, a Christmas bonus) as it may lose its discretionary status after some period of time if the employees come to expect the payments.

Conversely, a non-discretionary bonus would include: production bonuses (encourage the employee to work steadily, rapidly, or efficiently), retention bonus, attendance bonus, quality assurance bonuses, cost of living bonus (usually given in lieu of a cost of living adjustment), or finally a bonus that is intended to attract employees to an isolated or less desirable job or job site. The easiest way to spot a non-discretionary bonus is if it is tied to some type of metric. If it is, it must be included within the regular rate of pay and will then increase the amount of overtime pay that will be owed.

Another important concept to explain when discussing overtime pay is compensable time or hours worked before we discuss how to calculate overtime pay. The FLSA has a continuous workday principle where all hours between the beginning and the end of the workday must be paid. Sure that makes sense and that’s only logical . . . right? Well, defining when the workday starts and ends is not as easy as just clocking in and out. It includes ANY hours the employer has required work or the employee has been allowed to work. This includes, donning and doffing (the putting on and taking off protective gear, clothing, uniforms), preliminary and postliminary activities, travel time, waiting or on call time, training and testing.

Non-exempt employees must record all hours worked on a daily basis. Employers should ensure accuracy of these records by having the employee sign their time records. It would also be a prudent idea to have a time and attendance policy that requires them to record all hours worked. In the policy, require that the employees and supervisors sign off on any changes made to time records. Also, train your managers and employees on the policy and the practice of recording their time and train them to understand “off the clock” and to recognize what are recordable working hours. By having your pay practices in writing and having them signed off by the employee, you will be able to show that the employee understands the policy and will report any errors immediately for resolution.

Ok, so now, let’s get into the teeth of this blog and that’s how to pay overtime. First, overtime must be calculated on a workweek basis which is defined by a fixed, regularly occurring, 7-day period (or 168 hours). Please note that you cannot average hours over a period of two weeks or more. So even if your company pays on a bi-weekly or semi-monthly basis, you must calculate overtime by the 7-day workweek. Employees can be paid on a piece rate, commission, or some other basis, but all the earnings must be converted to an hourly rate (a.k.a. the regular rate). The regular rate is typically calculated by dividing the total pay in a given workweek by the total number of hours actually worked in that workweek.

Let’s look a “quick” example. Let’s say John makes $12/hour. He works 56 hours in a workweek and earns $50 in commission (or bonus). Let’s look at the math for that:

  • Straight time (ST) compensation is 56 hours x $12 an hour + $50 bonus = $722 (total ST compensation)
  • $722 (ST)/ 56 hours worked = $12.89 (regular rate)
  • $12.89 (regular rate) x ½ = $6.45 (half time premium)
  • $12.89 (regular rate) + $6.45 (half time premium) = $19.34 (overtime rate)
  • 40 hours straight time x $12.89 (regular rate) = $515.60 (ST earnings)
  • 16 overtime hours x $19.34 (OT rate) = $309.44 (OT earnings)
  • $515.60 (ST earnings) + $309.44 (OT earnings) = $825.04 (total weekly earnings)

Let’s look at another example, this time using a bonus. Everyone knows the difficulty in attracting nursing staff. There are job postings all over the place. So, let’s say in order to attract nursing candidates you decide to give hourly LPN’s and RN’s a $2,000 bonus after being employed for 6 months. This would be considered a non-discretionary bonus (i.e., it’s tied to a metric) so it must also get factored into the regular hourly rate of pay. Let’s also say that this is a deferred bonus that will be paid out over a series of pay periods.

A retention bonus was earned over 6 months of 26 weeks for a weekly equivalent of $76.92 ($2000/26 weeks). If the employee worked OT during the 26-week period, the increase in the regular rate is calculated by dividing $76.92 by the total hours worked during the overtime week.  If the employee worked 10 hours of overtime in their 9th week, the employee would be due an additional $7.70 of overtime earnings as follows:

  • $76.92 / 50 hours -$1.54 (increase in regular rate)
  • $1.54 x ½ = $.77 (increase in half time premium)
  • $.77 x 10 hours of OT worked = $7.70 (increase in OT earnings due to bonus)

Believe it or not, wage and hour violations are the number one litigated employment law topic right now in the country. In addition, the DOL was given extra money as an initiative to crack down on wage and hour violations. They are targeting five (5) industries as part of this initiative. That means if you are in one of them, you are at a higher risk of getting an audit and having to pay all those fines if you are not compliant.

The top five (5) industries at risk for wage and hour violations and an audit by the DOL are:

  1. Hospitality & Food Services
  2. Healthcare & Social Assistance
  3. Retail
  4. Construction
  5. Manufacturing

Failure to follow these rules can result in large fines and damages including back pay for up to three years for unpaid wages and overtime owed but not paid, liquidated damages (up to two times the original amount owed), attorney’s fees and court costs. In addition, wage and hour violations are one of the few employment laws that can result in personal liability to the owners and decision makers who violated the law. Lastly, most insurance policies do not pay for any of the damages associated with violating wage and hour law.

If you’re unsure about how to remain compliant with overtime laws, ECRM’s Human Resources professionals are ready to help!  Employers can reach us by calling (724) 864-8745.

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