The Fair Labor Standards Act (“FLSA”) requires that non-exempt employees be compensated at a rate of 1 and 1/2 times their regular rate for hours worked over 40 in that workweek. Often, however, employers equate “regular rate” with the employee’s hourly rate, which may not be sufficient, and may subject the employer to unexpected overtime liability.

With few exceptions, an employee’s “regular rate” must include “all remuneration for employment paid to, or on behalf of, the employee,” including certain bonus payments. Thus, it is important to know which bonuses must be included as part of the “regular rate,” not only to avoid potentially significant overtime liability, but also to evaluate the actual cost of the bonus to your organization.

Employers pay bonuses for a variety of reasons: to reward company success or past performance, to induce future productivity, attendance, or performance, or to retain quality employees. Generally, such bonuses must be included in the calculation of overtime due; however, the following two common exceptions apply:

1. Discretionary bonus: Discretionary bonuses can be paid in recognition of performance, attendance, productivity, etc., and will not increase the employee’s regular rate if both of the following apply:

(a) the fact that the payment is to be made and the amount of the payment are determined at the employer’s sole discretion at or near the end of the period; and

(b) the payment is not made pursuant to any prior contract, agreement, or promise causing the employee to expect such payments regularly.

If you announce or promise the bonus in advance such that it serves as a motivational tool—even if the precise amount is left to your discretion—the bonus loses its discretionary status. Likewise, if “discretionary” bonuses are awarded on such a regular basis that employees come to expect them, the bonus may no longer be considered “discretionary.”

2. Bonus as a gift: The “regular rate” also does not include bonuses paid as gifts, such as at the holidays, even if the bonus is paid with such regularity that employees expect it. The bonus must actually be a gift, however, and cannot be measured by or dependent on hours worked, production, or efficiency. Also, it cannot be so substantial that employees view it as wages for hours worked.

If no such exceptions apply, you must include the bonus as part of the “regular rate” in calculating overtime. However, you may disregard the bonus in computing the regular hourly rate until the amount of the bonus can be ascertained. At that point, the bonus must be apportioned back over the workweeks of the period during which it was earned and included as part of the employee’s regular rate for those weeks. If the employee worked more than 40 hours, you must make up any difference between overtime already paid and overtime due based on the higher regular rate. To avoid wage and hour issues, employers would be well advised to limit their bonuses to those falling securely within an exception such as those noted above.