In the holiday classic Christmas Vacation, family patriarch Clark Griswold is distressed that he has not yet received his bonus, which he is counting on to cover a check he wrote for a new swimming pool. Finally, on Christmas Eve, a courier arrives with a delivery. As his family looks on, Clark opens the envelope to find, not the bonus he is expecting, but a one year membership in the Jelly of the Month Club.
Naturally, Clark has an epic meltdown. Well-meaning but misguided Cousin Eddie then kidnaps Clark’s boss and drags him back to the house, so Clark can confront him about cancelling the employees’ bonuses.
“I was expecting a check. Instead I got enrolled in a jelly club. Seventeen years with the company. I’ve gotten a Christmas bonus every year but this one. You don’t want to give bonuses, fine. But when people count on them as part of their salary—well, what you did was just plain …”
“Sucks,” Clark’s son Rusty interrupts.
After looking around the room at the family’s long faces, Clark’s boss has a change of heart and announces that he is reinstating the bonuses. And it’s Merry Christmas to all, and to all a good night—until a SWAT team breaks into the Griswold home to rescue the kidnapped boss, and Uncle Lewis inadvertently triggers a sewer gas explosion.
While cancelling a bonus is a great set up for a comedy movie, year-end bonuses can give rise to legal snags that are no laughing matter for employers. Under state wage payment laws and general contract law principles, employers are legally obligated to pay bonuses when employees have met the requirements to become eligible for and earn them. Simply put, employers have to own up to the promises they make to employees about their pay. So, for example, if you tell employees at the beginning of the year that you will pay them a holiday bonus in a stated amount at the end of the year, you have to pay it to those employees who continue their employment through the year.
However, the past practice of giving discretionary Christmas bonuses does not give rise to a legal obligation to pay bonuses in any particular amount, or at all, in subsequent years. This seems simple enough. But employers can unwittingly create a legal obligation if they include the Christmas bonus in an itemization of compensation and benefits provided in an offer letter or annual compensation statement.
Year-end bonuses based on individual, department, or company productivity or profit can also create legal headaches. The key here is to have clear, well-written bonus policies that have been reviewed by your lawyer. For example, what do you do with employees who work part of the year but are no longer employed at the end of the year or at the time bonuses are calculated and paid? If your policy is not clear, these employees could be entitled to a pro rata payment for the time they worked. In addition, Kansas and many other state’s laws preclude forfeiture of earned wages. So it’s essential that your policy is drafted to be clear that the bonus has not been earned, and there is no right to payment, unless and until all specified criteria for payment have been satisfied.
Bonuses and Overtime
Year-end bonuses can also have significant overtime pay implications for non-exempt employees, who must be paid at least time-and-one-half their regular rate of pay for all hours worked over 40 in a workweek. Don’t forget that the regular rate includes not only the employee’s hourly rate, but also the value of other types of compensation, including non-discretionary bonuses. Non-discretionary bonuses include those that are announced to employees to induce them to work more steadily, rapidly, or efficiently, or to continue their employment.
Conversely, discretionary bonuses are not included in the regular rate. For a bonus to qualify for the exclusion, the employer must retain discretion both as to the fact of payment and as to the amount until a time at or near the end of the period for which the bonus is paid, without any prior agreement or promise causing the employee to expect such payment. If an employer promises in advance to pay a bonus, it gives up its discretion.
The Fair Labor Standards Act specifically excludes from the regular rate “payments in the nature of gifts made at Christmas time or on other special occasions, as a reward for service, the amounts of which are not measured by or dependent on hours worked, production, or efficiency.” Department of Labor regulations further explain that “[i]f the payment is so substantial that it can be assumed that employees consider it a part of the wages for which they work, the bonus cannot be considered to be in the nature of a gift.” However, Christmas bonuses and other gift payments may be excluded from the regular rate even if they are “paid with regularity so that the employees are led to expect it and even though the amounts paid to different employees or groups of employees vary with the amount of the salary or regular hourly rate of such employees or according to their length of service with the firm so long as the amounts are not measured by or directly dependent upon hours worked, production, or efficiency.”
Free Beer Tomorrow
The need to include bonuses and other non-wage remuneration in calculating overtime pay is driven home by the following case. A non-exempt employee sued Anheuser-Busch, his former employer, under the FLSA. The employee alleged that he received free beer as “incentive pay,” but the company failed to include the value of the beer as part of his regular rate when calculating his overtime wages, resulting in an FLSA violation for underpayment of overtime wages.
If the company in fact promised free beer to employees as a reward for performance or to encourage retention, then the employee is right. The value of the beer is wages and should have been included in calculating overtime.
It may come as a shock that an employer can incur overtime liability by giving employees free beer. Or, in Clark Griswold’s words, “If I woke up tomorrow with my head sewn to the carpet, I wouldn’t be more surprised.” But if you pause to think about the history and purpose of the FLSA, it does make sense.
So what about the Christmas bonuses paid by Clark’s employer? Clark is a food additive engineer, so presumably he’s a professional exempt from overtime. But are his non-exempt co-workers entitled to extra overtime pay based on their bonuses?
We know that Clark’s company pays bonuses every year and employees expect them and “count on them as part of their salary.” But that alone is not enough. However, if the payments to non-exempt employees are “substantial” (such as the amount of a new swimming pool), the bonuses cannot be considered gifts and thus must be included in calculating overtime pay, according to the regulations. And, regardless of whether the bonuses are “substantial,” if they are based on hours worked, production, or efficiency they have to be included.
Don’t forget that bonuses are supplemental wages and thus taxable compensation. So you must take both employer and employee payroll taxes out, just like a regular paycheck. The IRS allows employers to use a flat “supplemental rate” of 25 percent for federal withholding for most bonuses.
Gifts in the form of goods or merchandise that are of nominal value are considered de minimis fringe benefits and are excluded from employees’ wages. So the turkeys you give away, or memberships to the Jelly of the Month Club, do not have to be included in employees’ income. But, according to the IRS, cash and cash-equivalent benefits, such as gift cards, cannot be excluded from wages as a de minimis fringe benefit and must be included in employees’ wages as taxable income on their W-2’s.
Be mindful about how you structure your incentive plans and bonuses, the way you communicate them to employees, and the process in which you administer them. And, like the Griswold family, you can have the “hap- hap- happiest Christmas.”