The California Supreme Court has issued a ruling that changes the way overtime is calculated for employees who earn certain flat sum bonuses. Under California law, employers must pay overtime to non-exempt employees at a rate of no less than one and one half times the employee’s “regular rate of pay” for all hours worked in excess of 40 per workweek and in excess of 8 hours but fewer than 12 hours per workday.* The “regular rate of pay” is determined by adding together the employee’s total “remuneration” as defined by law (e.g., regular pay plus non-discretionary bonuses) for the workweek in which the employee worked overtime.

The question before the Court in the case of Alvarado v. Dart Container was whether the “regular rate of pay” should be calculated by using an employee’s total hours worked (including overtime hours) or only an employee’s regular hours during a workweek when an employee earns a particular kind of flat sum bonus (e.g. daily attendance bonus). By ruling that the regular rate of pay should be calculated by dividing an employee’s total remuneration by the number of non-overtime hours worked during the relevant pay period (40 hours) rather than the total hours (including overtime hours), the Court effectively increased the cost of overtime for employers who pay flat sum bonuses. In other words, California employers must now calculate the regular rate of pay by dividing the employee’s total remuneration by a fewer number of hours (40 hours). In contrast, federal law allows employers to divide the total remuneration by all hours worked when calculating the regular rate of pay.

While the Court held that the ruling applies retroactively to California employers, it does not apply to bonuses that are based on a percentage of production or some other formula that increases with hours worked (e.g. commissions or formula-based incentive pay). Accordingly, California employers who want to use the more favorable regular rate of pay calculation (dividing remuneration by the total number of hours worked) should consider eliminating flat rate bonuses in favor of production-type bonuses.

What does this mean for employers? The old adage “an ounce of prevention is better than a pound of cure” remains true. With the California Supreme Court’s recent decision, employers should immediately assess their overtime calculation policies and practices. Given the continued proliferation of wage and hour lawsuits in California, employers are also strongly encouraged to conduct regular wage and hour audits to ensure that they are fully complying with the many complex and technical applicable laws. And, finally, employers who receive a letter threatening a wage and hour lawsuit are well advised to immediately seek the advice of qualified employment counsel.

* Overtime at one and one half the “regular rate of pay” must also be paid for the first 8 hours worked on the seventh consecutive workday. Similarly, non-exempt employees must be paid overtime at a rate no less than twice the employee’s “regular rate of pay” for all hours worked in excess of 12 hours per workday and in excess of 12 hours on the seventh consecutive workday.