On March 5, 2018, the California Supreme Court changed the test for factoring flat sum bonuses into the overtime rate in Alvarado v. Dart Container Corporation of California, ordering a calculation that will increase the costs of overtime for employers who pay such bonuses. Under the federal formula, an employer must divide an employee’s total weekly pay (including non-discretionary bonuses) by the total number of hours the employee worked in a week to get the regular rate; the employer then must pay time-and-a-half that rate for all overtime hours. But under the Alvarado court’s formula, the employer must divide the total weekly pay by only “the number of nonovertime hours the employee [actually] worked during the pay period.” That smaller divisor will lead to higher overtime rates.

Take an example: An employee who makes $20 an hour worked 45 hours in one week for a total of $900 in straight hourly wages. (Assume the employee worked 8 hours a day Monday through Friday and 5 hours on Saturday, avoiding California’s daily overtime rules.) In the same week, the employer paid the employee a $100 flat sum bonus.

  • Under the federal formula, the employer owes $1055.55 ($1000 total pay ÷ 45 hours = $22.22 regular rate x .5 = $11.11 halftime rate x 5 hours = $55.55 + $1000).
  • Under the California formula, the employer owes $1062.50 ($1000 total pay ÷ 40 hours = $25 regular rate x .5 = $12.50 halftime rate x 5 hours = $62.50 + $1000).

Significantly, the Alvarado court distinguished between (1) the number of “nonovertime hours the employee worked during the pay period” and (2) “the number of nonovertime hours that exist in the pay period, regardless of the number of hours the employee actually worked.” The court held that the employer must divide by the first, smaller number. That distinction makes a significant difference in California, where state law requires time-and-a-half pay for all hours over 8 worked in a day, double time for all hours over 12 worked in a day, and additional premium pay for any hours worked on the seventh consecutive day of work in a week.

Take this example: In one week, an employee worked only Monday and Tuesday, 10 hours each day at $20 an hour, for a total of $400 in straight hourly wages. The employer paid the same $100 flat sum bonus.

  • Under the federal formula, the employer pays no overtime premium because the employee did not work more than 40 hours in a week. The employer owes a total of $500 in pay.
  • Under the California formula, the employer owes a total of $562.52 ($500 total pay ÷ 16 regular hours worked = $31.25 x .5 = $15.63 halftime rate x 4 hours of overtime = $62.52 in overtime premiums + $500).

The Alvarado court “limit[ed its] decision to flat sum bonuses comparable to the attendance bonus at issue here.” The court wrote: “Other types of nonhourly compensation, such as a production or piecework bonus or a commission, may increase in size in rough proportion to the number of hours worked, including overtime hours, and therefore a different analysis may be warranted.” Thus, how this decision impacts other types of bonuses remains to be seen, but we anticipate a flurry of wage-hour class actions seeking to test the limits of the Alvarado decision.

Key Takeaway: Employers with operations in California need to adjust their overtime calculation formulas immediately to appropriately account for flat sum bonuses in those locations. Employers should also evaluate how the decision impacts other types of bonus programs. The Alvarado decision applies retroactively, thus employers need to consider whether they are liable for past pay practices and whether they can take steps to minimize that liability now.