One of the most common mistakes made by employers is the failure to properly calculate the regular rate when paying overtime compensation to employees under the Fair Labor Standards Act (FLSA). The FLSA is a cornerstone of labor law in the United States, intended to ensure that employees receive fair compensation for their work. One crucial aspect of FLSA compliance is the calculation of “time-and-a-half” overtime pay, which is designed to compensate employees for the extra hours they work beyond 40 in a typical workweek. To achieve this, employers must accurately calculate the regular rate of pay, which includes not just base wages but also non-discretionary income. Employees who are not exempt from overtime entitlement must then receive 1.5 times the regular rate for all time worked over 40 hours in a given week. In this article, we explore the importance of including non-discretionary income in the regular rate calculation and how it affects proper overtime pay under the FLSA.

Understanding the Regular Rate of Pay  

The FLSA defines the regular rate of pay as the rate an employee is paid for each hour of work during the specific workweek. This rate serves as the foundation for calculating overtime compensation. Typically, it encompasses not only an employee's base hourly wage but also certain additional compensation, such as bonuses, commissions, and shift differentials. The key distinction applied to determine whether the additional compensation must be included in the regular rate is whether the income provided to the employee is discretionary or non-discretionary.

Discretionary vs. Non-Discretionary Income  

Discretionary income is compensation that an employer can choose to provide or not. Some bonuses, gifts, and holiday benefits are examples of discretionary income (but, ONLY when their receipt is truly at the employer’s discretion — that is, the employer has not announced the benefit or communicated the benefit so that it becomes a legitimate “expectation” of the employee). When these forms of additional compensation are truly discretionary, they need not be included in the regular rate calculation because they are not guaranteed.

On the other hand, non-discretionary income is guaranteed (or promised) and earned, typically based on specific criteria or conditions. This will almost always include commissions (pursuant to communicated commission plan), performance-based bonuses (where the calculation of the bonus and specific details are communicated in advance), and certain types of wage premiums like shift differentials or weekend pay. The FLSA requires that non-discretionary income be included in the regular rate calculation.

The Importance of Including Non-Discretionary Income

There are many reasons why including non-discretionary income in the regular rate computation is important. Some of these include:

1. It’s the Law — Legal Compliance: Failing to include non-discretionary income in the regular rate calculation can result in legal trouble for employers. Violations of the FLSA can lead to lawsuits, back pay claims, and penalties, tarnishing an employer's reputation and finances. Claims by plaintiff-side class and collective action attorneys for wage and hour violations nearly always include an allegation that the employer had failed to properly calculate the regular rate (by failing to include non-discretionary compensation), thereby improperly reducing an employee’s entitlement to overtime compensation.
2. Fair Compensation: The inclusion of non-discretionary income in the regular rate is premised on the FLSA’s goal of providing fair compensation as well as a desire to eliminate an employer “gaming” of the compensatory system implemented for paying its employees. Excluding non-discretionary income from the regular rate calculation would undermine this objective by allowing employers to artificially reduce the overtime pay owed to employees who earn such income regularly.
3. Encourages Compliance: Inclusion of non-discretionary income in the regular rate calculation encourages employers to accurately report all forms of compensation and adhere to the FLSA regulations. This also further discourages attempts to manipulate the calculation to minimize overtime costs.
4. Employee Retention and Morale: Properly compensating employees, including their non-discretionary income in overtime calculations, can boost morale and encourage employee retention. Workers who feel they are being fairly compensated are more likely to be engaged and satisfied in their performance roles.

Calculating Overtime Pay with Non-Discretionary Income  

To calculate overtime pay accurately, employers should follow these general steps:

1. Determine the regular rate of pay by including all non-discretionary income earned during the specific workweek. Remember, the FLSA uses a “week-by-week” approach to compliance, and, therefore, the regular rate must be determined on a weekly basis. This may mean that an employee’s regular rate may differ week-to-week depending upon whether and in what amount non-discretionary income is provided to the employee. To calculate the regular rate, the amount of income paid to the employee for the specific workweek should be divided by the number of hours worked by the employee during that same work week.

IMPORTANT NOTE: when non-discretionary income is provided is not the key to this determination; rather, it is when the work is performed for which the non-discretionary income is provided. For example, if an employee earns a commission for sales made during the month of February but receives the commissions in March, the non-discretionary commission income should be incorporated in the regular rate calculation for the hours worked in February (not March).

1. Calculate the employee's overtime rate, which is typically 1.5 times the regular rate, for hours worked beyond 40 in a typical workweek.
2. Multiply the overtime rate by the number of overtime hours worked (number of hours worked in excess of 40 in that particular workweek) to determine the overtime pay owed.

Conclusion

Including non-discretionary income in the regular rate calculation is not just a legal requirement under the FLSA — it is a fundamental aspect of fair labor practices. Employers cannot merely pay 1.5 times the employee’s base hourly rate and ignore non-discretionary bonuses, commissions, or other payments.

Properly compensating employees for their work, including all forms of guaranteed (or promised) income, ensures that the FLSA's objectives are met, encourages legal compliance, and fosters a positive work environment. Employers should be diligent in calculating overtime pay to avoid legal consequences and maintain a workforce that feels valued and fairly compensated.