Understanding Pay Options with the new DOL Regulations
- Written by Jerry Love, CPA/PFS, CFP, CVA, ABV, CITP, CFF, CFFA
This article is a follow up to the prior article which highlights the new regulations for the Fair Labor Standards Act (FLSA) from the Department of Labor (DOL) raising the standard for which an employee will qualify to be exempt from overtime. On May 18, 2016, President Obama announced the DOL’s final rule updating these regulations effective December 1, 2016 which sets the salary level at $47,476 annually for a full-year worker to be considered exempt from overtime. As covered in more depth in the prior article, there are more requirements for an employee to be exempt from overtime.
It is important for employers to understand the basic classifications start with the determination of their employees falling within two categories: exempt or non-exempt as it relates to whether an employee will be entitled to payment for overtime. See the prior article for a discussion of definition of how to classify employee as exempt or non-exempt.
In this context, many employers have long believed that exempting an employee from the overtime regulations is as simple as classifying the employee as a “salaried employee” or reaching a mutual agreement with the employee that they will be paid with a flat salary. Many employers have developed a concept there are allowed to classify employees as “salaried” or “hourly” and that as long as the employee is classified and paid on a salary basis, then the employer will not have any obligation to pay overtime if the employee works more than 40 hours in a workweek. This is not consistent with the DOL regulations.
It is important for employers to have a fundamental understanding of the options concerning how they are able to compensate employees. If an employee meets the basic criteria to be exempt from overtime, it is acceptable to pay them on a salary basis and the employer is not obligated to pay those employees overtime if they work more than 40 hours in a workweek. Compliance with the DOL regulations must be based on proper classification of the employees and to utilize proper methods to calculate their compensation. Misclassification of employees not only may expose the employer to violation of the FLSA but may also contribute to employee dissatisfaction and turnover.
When the employees are not exempt from overtime, the simple and straight-forward method of compensation would be to pay these employees on an hourly basis which would include straight time compensation for the first 40 hours worked in a workweek and paid overtime at a rate of time and half the straight time rate for the hours over 40 hours. There are other options this article will discuss. In fact, this topic can be extremely complicated if the employer is using multiple methods to pay the non-exempt employees such as paying them a year-end bonus.
The foundation of the compensation for the non-exempt employees is for the employer to establish a workweek. The workweek can begin on any day of the week and should be seven consecutive days (seven consecutive 24-hour periods). Once the workweek is established it should not be changed unless for a business reason and not changed frequently. Regardless of the method of compensating the non-exempt employees, the system should determine if the employee has worked more than 40 hours during this seven-day workweek and compensate the employee at a premium for those hours. Additionally, the compensation of the non-exempt employee must be paid at least the minimum wage based on either FLSA or the state regulations applicable to the employer’s work force.
Comp-time for non-exempt employees. DOL and FLSA do not allow an employer to use comp-time off in lieu of paying for overtime in the private sector. Some employers (including some CPA firms) have a system whereby they track the hours worked in excess of 40 hours by the employees during busy season and allow (sometimes require) the employees to take time off in the slower months. Even though this approach may be mutually agreeable with the employer and employees, the regulations do not allow this use of comp-time for non-exempt employee (whether they are paid hourly or a variation of the salary models). Essentially the regulations would require the employee have a maximum of 40 hours in the workweek and then take that “comp time” off within the same seven-day workweek. This is because DOL and the courts have essentially interpreted FLSA as requiring overtime to be figured on the basis of a single workweek.
One reason the concept of comp-time gets to be confusing to employers is DOL/FLSA allow the use of comp-time for certain public sector employees such as police officers and firefighters in lieu of overtime pay for irregular or occasional overtime work.
As I have researched the material for this and the prior article, it has become increasingly clear to me that payroll and the methods an employer is allowed to use to pay their employees is a very complicated topic. This article is due in part to some of the phone calls and emails I received after the first article was published. I will not proclaim to be an expert, but if you have questions, you are welcome to email me or call me.
Other resources to review for this topic are:
Published by Compensation.BLR.com April 7, 2003 Overtime – Everything You Need to Know”
Published by BrightHub.com October 17, 2011 Giving Employees Compensatory Time Off in Lieu of Overtime? Read this First! Written by N Nayab and edited by Jean Scheid
Regulations Part 778: Overtime Compensation
US Wage and Hour Division, Title 29, Part 778, WH Publication 1262 reprinted May 2011
The relevant sections of the Fair Labor Standards Act are as follows:
§ 778.100 The maximum-hours provisions
Section 7(a) of the Act deals with maximum hours and overtime compensation for employees who are within the general coverage of the Act and are not specifically exempt from its overtime pay requirements. It prescribes the maximum weekly hours of work permitted for the employment of such employees in any workweek without extra compensation for overtime, and a general overtime rate of pay not less than one and one-half times the employee’s regular rate which the employee must receive for all hours worked in any workweek in excess of the applicable maximum hours. The employer is prohibited from employing the employee in excess of the prescribed maximum hours in such workweek without paying him the required extra compensation for the overtime hours worked at a rate meeting the statutory requirement.
§ 778.101 Maximum non-overtime hours
As a general standard, section 7(a) of the Act provides 40 hours as the maximum number that an employee subject to its provisions may work for an employer in any workweek without receiving additional compensation at not less than the statutory rate for overtime. Hours worked in excess of the statutory maximum in any workweek are overtime hours under the statute.
[46 FR 7309, Jan. 23, 1981]
§ 778.102 Application of overtime provisions generally
Since there is no absolute limitation in the Act (apart from child labor provisions) on the number of hours an employee may work in any workweek, he/she may work as many hours a week as he/she and his employer see fit, so long as the required overtime compensation is paid him/her for hours worked in excess of the maximum workweek prescribed by section 7(a). The Act does not generally require, however, that an employee be paid overtime compensation for hours in excess of eight per day, or for work on Saturdays, Sundays, holidays or regular days of rest. If no more than the maximum number of hours prescribed in the Act are actually worked in the workweek, overtime compensation pursuant to section 7(a) need not be paid. Nothing in the Act, however, will relieve an employer of any obligation he may have assumed by contract or of any obligation imposed by other Federal or State law to limit overtime hours of work or to pay premium rates for work in excess of a daily standard or for work on Saturdays, Sundays, holidays, or other periods outside of or in excess of the normal or regular workweek or workday. (The effect of making such payments is discussed in §§778.201 through 778.207 and 778.219.) [46 FR 7309, Jan. 23, 1981]
§ 778.104 Each workweek stands alone
The Act takes a single workweek as its standard and does not permit averaging of hours over 2 or more weeks. Thus, if an employee works 30 hours one week and 50 hours the next, he must receive overtime compensation for the overtime hours worked beyond the applicable maximum in the second week, even though the average number of hours worked in the 2 weeks is 40. This is true regardless of whether the employee works on a standard or swing-shift schedule and regardless of whether he is paid on a daily, weekly, biweekly, monthly or other basis.
§ 778.107 General standard for overtime pay
The general overtime pay standard in section 7(a) requires that overtime must be compensated at a rate not less than one and one-half times the regular rate at which the employee is actually employed. The regular rate of pay at which the employee is employed may in no event be less than the statutory minimum. If the employee’s regular rate of pay is higher than the statutory minimum, his overtime compensation must be computed at a rate not less than one and one-half times such higher rate.
§ 778.108 The “regular rate”
The “regular rate” of pay under the Act cannot be left to a declaration by the parties as to what is to be treated as the regular rate for an employee; it must be drawn from what happens under the employment contract (Bay Ridge Operating Co. v. Aaron, 334 U.S. 446). The Supreme Court has described it as the hourly rate actually paid the employee for the normal, non-overtime workweek for which he is employed—an “actual fact” (Walling v. Youngerman-Reynolds Hardwood Co., 325 U.S. 419). Section 7(e) of the Act requires inclusion in the “regular rate” of “all remuneration for employment paid to, or on behalf of, the employee” except payments specifically excluded by paragraphs (1) through (7) of that subsection.
§ 778.109 The regular rate is an hourly rate
The “regular rate” under the Act is a rate per hour. The Act does not require employers to compensate employees on an hourly rate basis; their earnings may be determined on a piece-rate, salary, commission, or other basis, but in such case the overtime compensation due to employees must be computed on the basis of the hourly rate derived therefrom and, therefore, it is necessary to compute the regular hourly rate of such employees during each workweek, with certain statutory exceptions discussed in §§778.400 through 778.421. The regular hourly rate of pay of an employee is determined by dividing his total remuneration for employment (except statutory exclusions) in any workweek by the total number of hours actually worked by him in that workweek for which such compensation was paid.
FLSA has provisions to compensate non-exempt employees on a salary basis when the salary method correctly compensates the employee for all hours worked. This salary model would compensate the non-exempt employees based on a fixed salary for a workweek which is unchanged based on whether the employee has worked more or less than 40 hours.
“This method is called the “fixed salary for fluctuating workweeks” or “fixed sum for varying amounts of overtime” model of computing overtime. Many employers favor it because it results in a diminishing regular rate, and thus diminishing overtime pay, the more overtime hours there are in a workweek. For the same reason, many employees do not like this method. Moreover, the regular rate varies under this method from week to week, so some employers and employees do not like the unpredictability of this way of computing overtime pay. A final drawback of this method of pay is that DOL takes the position that it is incompatible with various forms of incentive pay, i.e., bonuses, shift premiums, and other types of incentives based on production or performance. Thus, it is restricted to those who are paid solely by means of a fixed salary (a commission on top of a fixed salary is not a problem, but it must be figured into the regular rate of pay before the overtime pay calculation is done).”
The DOL regulations indicate such an arrangement cannot be unilaterally established by the employer and requires the employee be informed and consent to the use of this method. This model of compensation for a non-exempt employee is only permissible when an employer and employee have clear understanding of the fixed salary, including compensation for overtime hours, which should be in writing prior to the implementation of compensation method.
§ 778.114 Fixed salary for fluctuating hours
(a) An employee employed on a salary basis may have hours of work which fluctuate from week to week and the salary may be paid him pursuant to an understanding with his employer that he will receive such fixed amount as straight time pay for whatever hours he is called upon to work in a workweek, whether few or many. Where there is a clear mutual understanding of the parties that the fixed salary is compensation (apart from overtime premiums) for the hours worked each workweek, whatever their number, rather than for working 40 hours or some other fixed weekly work period, such a salary arrangement is permitted by the Act if the amount of the salary is sufficient to provide compensation to the employee at a rate not less than the applicable minimum wage rate for every hour worked in those workweeks in which the number of hours he works is greatest, and if he receives extra compensation, in addition to such salary, for all overtime hours worked at a rate not less than one-half his regular rate of pay. Since the salary in such a situation is intended to compensate the employee at straight time rates for whatever hours are worked in the workweek, the regular rate of the employee will vary from week to week and is determined by dividing the number of hours worked in the workweek into the amount of the salary to obtain the applicable hourly rate for the week. Payment for overtime hours at one-half such rate in addition to the salary satisfies the overtime pay requirement because such hours have already been compensated at the straight time regular rate, under the salary arrangement.
(b) The application of the principles above stated may be illustrated by the case of an employee whose hours of work do not customarily follow a regular schedule but vary from week to week, whose total weekly hours of work never exceed 50 hours in a workweek, and whose salary of $600 a week is paid with the understanding that it constitutes the employee's compensation, except for overtime premiums, for whatever hours are worked in the workweek. If during the course of 4 weeks this employee works 40, 37.5, 50, and 48 hours, the regular hourly rate of pay in each of these weeks is $15.00, $16.00, $12.00, and $12.50, respectively. Since the employee has already received straight-time compensation on a salary basis for all hours worked, only additional half-time pay is due. For the first week the employee is entitled to be paid $600; for the second week $600.00; for the third week $660 ($600 plus 10 hours at $6.00 or 40 hours at $12.00 plus 10 hours at $18.00); for the fourth week $650 ($600 plus 8 hours at $6.25, or 40 hours at $12.50 plus 8 hours at $18.75).
(c) The “fluctuating workweek” method of overtime payment may not be used unless the salary is sufficiently large to assure that no workweek will be worked in which the employee's average hourly earnings from the salary fall below the minimum hourly wage rate applicable under the Act (minimum wage), and unless the employee clearly understands that the salary covers whatever hours the job may demand in a particular workweek and the employer pays the salary even though the workweek is one in which a full schedule of hours is not worked. Typically, such salaries are paid to employees who do not customarily work a regular schedule of hours and are in amounts agreed on by the parties as adequate straight-time compensation for long workweeks as well as short ones, under the circumstances of the employment as a whole. Where all the legal prerequisites for use of the “fluctuating workweek” method of overtime payment are present, the Act, in requiring that “not less than” the prescribed premium of 50 percent for overtime hours worked be paid, does not prohibit paying more. On the other hand, where all the facts indicate that an employee is being paid for his overtime hours at a rate no greater than that which he receives for non-overtime hours, compliance with the Act cannot be rested on any application of the fluctuating workweek overtime formula.
[33 FR 986, Jan. 26, 1968, as amended at 46 FR 7310, Jan. 23, 1981; 76 FR 18857, Apr. 5, 2011]
Also for more information about this pay method, you can review the DOL Fact Sheet #23.
As an employer calculates the rate of pay for the overtime premium, it is important to consider all elements of the employee's compensation augments such as nondiscretionary bonuses (including promised bonuses or announced recurring bonuses).
§ 778.208 Inclusion and exclusion of bonuses in computing the “regular rate”
Section 7(e) of the Act requires the inclusion in the regular rate of all remuneration for employment except eight specified types of payments. Among these excludable payments are discretionary bonuses, gifts and payments in the nature of gifts on special occasions, contributions by the employer to certain welfare plans and payments made by the employer pursuant to certain profit-sharing, thrift and savings plans. These are discussed in §§778.211 through 778.214. Bonuses which do not qualify for exclusion from the regular rate as one of these types must be totaled in with other earnings to determine the regular rate on which overtime pay must be based. Bonus payments are payments made in addition to the regular earnings of an employee. For a discussion on the bonus form as an evasive bookkeeping device, see §§778.502 and 778.503.[33 FR 986, Jan. 26, 1968, as amended at 76 FR 18858, Apr. 5, 2011]
§ 778.209 Method of inclusion of bonus in regular rate
(a) General rules. Where a bonus payment is considered a part of the regular rate at which an employee is employed, it must be included in computing his regular hourly rate of pay and overtime compensation. No difficulty arises in computing overtime compensation if the bonus covers only one weekly pay period. The amount of the bonus is merely added to the other earnings of the employee (except statutory exclusions) and the total divided by total hours worked. Under many bonus plans, however, calculations of the bonus may necessarily be deferred over a period of time longer than a workweek. In such a case the employer may disregard the bonus in computing the regular hourly rate until such time as the amount of the bonus can be ascertained. Until that is done he may pay compensation for overtime at one and one-half times the hourly rate paid by the employee, exclusive of the bonus. When the amount of the bonus can be ascertained, it must be apportioned back over the workweeks of the period during which it may be said to have been earned. The employee must then receive an additional amount of compensation for each workweek that he worked overtime during the period equal to one-half of the hourly rate of pay allocable to the bonus for that week multiplied by the number of statutory overtime hours worked during the week.
Therefore, including non-exempt employees who are paid on either of the salary methods described becomes an intense effort to recalculate the compensation for all overtime hours paid during the period the bonus is applicable. This would mean if an employer pays an employee an annual bonus, they would have to recalculate the amount paid to the employee for all overtime hours during the year.
If an employer implements this fixed salary compensation model, the employer must have a system to track and record the hours worked by the non-exempt employee during each workweek. See DOL Fact Sheet #21 Recordkeeping Requirements under FLSA.
Also see DOL §778.310.
§ 778.310 Fixed sum for varying amounts of overtime
A premium in the form of a lump sum which is paid for work performed during overtime hours without regard to the number of overtime hours worked does not qualify as an overtime premium even though the amount of money may be equal to or greater than the sum owed on a per hour basis. For example, an agreement that provides for the payment of a flat sum of $75 to employees who work on Sunday does not provide a premium which will qualify as an overtime premium, even though the employee's straight time rate is $5 an hour and the employee always works less than 10 hours on Sunday. Likewise, where an agreement provides for the payment for work on Sunday of either the flat sum of $75 or time and one-half the employee's regular rate for all hours worked on Sunday, whichever is greater, the $75 guaranteed payment is not an overtime premium. The reason for this is clear. If the rule were otherwise, an employer desiring to pay an employee a fixed salary regardless of the number of hours worked in excess of the applicable maximum hours standard could merely label as overtime pay a fixed portion of such salary sufficient to take care of compensation for the maximum number of hours that would be worked. The Congressional purpose to effectuate a maximum hours standard by placing a penalty upon the performance of excessive overtime work would thus be defeated. For this reason, where extra compensation is paid in the form of a lump sum for work performed in overtime hours, it must be included in the regular rate and may not be credited against statutory overtime compensation due.
[46 FR 7314, Jan. 23, 1981]
Illustration of the Non-Exempt Compensation
|Fixed Salary for Flutuating Hours in the Workweek|
|Hourly rate based on 2080 hours||$14.42|
|Base Salary||Additional Pay for OT Hours||Total Gross Pay|
|Compared to Straight
|OT Hours||OT Rate||Total Gross Pay|
Jerry Love is the sole owner of Jerry Love CPA, LLC in Abilene, Texas. Love graduated from Abilene Christian University. In addition to being a CPA, Love has also earned the designations of PFS, CFP, CVA, ABV, CITP, CFF, and CFFA. In 2006-07, Love was the Chairman of the Texas Society of CPAs.