One of the few “wins” for employers under the DOL’s new overtime rule was that employers are now allowed to apply “nondiscretionary incentive payments” to meet up to 10 percent of the new salary threshold.  This change could prove very important for employers who pay employees on a commission basis or who use other incentive-based compensation.

But what qualifies as a nondiscretionary incentive payment?  What options do employers have in changing their compensation plans to ensure compliance with the new rule?  And what could be the unintended consequences of those changes?  This post looks at this new rule and attempts to answer some of those questions.

What Does the Rule Say About Nondiscretionary Incentive Payments?

The Rule allows nondiscretionary incentive bonuses tied to productivity or profitability (such as a bonus based on the specified percentage of the profits generated by a business in the prior quarter) to be counted towards up to 10 percent of the salary threshold for white collar workers (or up to $1,186.90 per quarter).  To credit nondiscretionary incentive payments toward a portion of the standard salary level test, the payments must be paid at least on a quarterly basis.  The Rule also permits the employer to make a “catch-up” payment to maintain the exemption if an employee does not receive enough in nondiscretionary bonuses and incentive payments in a given quarter to remain exempt.

Notably, the Rule does not allow employers to use nondiscretionary incentive payments towards meeting the weekly salary threshold for highly compensated employees (HCE) (i.e. those who are exempt because they make at least $134,004 annually).  Employers may continue, however, to count bonuses, commissions, and other nondiscretionary compensation paid at least annually to the total annual HCE threshold.

What Does “Nondiscretionary” Mean?

The previous FLSA regulations related the salary basis test did not allow employers to count any bonus payments, commissions, or other incentive payments towards the weekly salary threshold, but other portions of the regulations relating to calculating overtime payments refer to discretionary compensation as payments that are determined at the sole discretion of the employer and are not pursuant to any prior contract, agreement, or promise causing the employee to expect such payments regularly.

The DOL’s FAQs on the Final Rule state that nondiscretionary incentive payments are forms of compensation promised to employees to induce them to work more efficiently or to remain with the company (such as bonuses for meeting set production goals, retention bonuses, and commission payments based on a fixed formula).  Discretionary bonuses, on the other hand, are those for which the decision to award the bonus and the payment amount is at the employer’s sole discretion and not in accordance with any preannounced standards.

While the standard seems fairly straightforward, there are a number of key issues for employers to consider.

• Many employers with seemingly nondiscretionary bonus plans that, for example, pay quarterly or monthly production bonuses, also include language that the payment is payable to employees in “good standing,” with the determination of whether an employee is in good standing to be made in the employer’s sole discretion. This type of language in a bonus plan could prevent an employer from applying such a bonus to the salary threshold because the employer retains ultimate discretion over whether the employee earned the bonus.

• Bonus plans that contain performance milestones that are not objectively achievable may also be considered discretionary if there would be a dispute between an employee and employer about when the milestone was achieved (and the bonus was earned).

• Similarly, commission plans where an employer reserves the right to determine in its discretion the appropriate split between two sales employees could be problematic under the new Rule because the employer is exerting discretion as to the amount of the commission to which each employee would be entitled.

• Commission plans in which an employer retains the right to refuse or reject any an order or source of revenue could arguably be considered discretionary. Employers should craft the language to specifically define the instances in which an order may be rejected in order to count the commissions under such a plan towards the salary threshold.

What Should Employers Do Next?

In order to apply nondiscretionary incentive payments towards the salary threshold, employers should consider the following:

• Ensure that bonus and commission plans clearly state the requirements for earning the incentive compensation and minimize any employer discretion involved in determining payouts.

• Where employers would otherwise be able to exercise discretion, provide clear definitions of how an employer would make decisions under the plan.

• Clarify that the payments will be made on at least a quarterly basis.

• Provide that if the employee makes less than a minimum anticipated threshold in any given quarter that you will make a “catch up” payment to the employee.

But Beware of Unintended Consequences

Keep in mind, though, that taking away the employer’s discretion in a compensation can have unintended consequences.  Nondiscretionary bonus or incentive payments made to nonexempt employees must be included in the regular rate when calculating overtime pay, so employers must be sure that their employees are classified properly, including under applicable exemption’s separate job duties test.

This point is important because if an employer misclassifies an employee and is later sued successfully, then it could owe even more in overtime damages because the nondiscretionary compensation would be included when calculating the regular rate for overtime.  Employers then should consider whether the rewards nondiscretionary incentive-based compensation may provide outweigh the risks off getting an on-the-line exemption decision wrong.  And remember, in doing so, consider that while only a small portion of nondiscretionary incentive compensation counts towards the threshold (less than $4,750 per year), all nondiscretionary payments count when calculating the amount of unpaid overtime.