California employers who pay bonuses to nonexempt employees should take a fresh look at the way they calculate their nonexempt employees’ overtime rates, based on the March 5, 2018 California Supreme Court decision in Alvarado v. Dart Container Corp. of California. The Court clarified that when a nonexempt employee receives a non-discretionary flat-sum bonus during a single pay period, the overtime rate should be based on the employee’s straight-time hours worked during the pay period in which the bonus is earned, and not the employee’s total hours worked during the pay period. The decision is consistent with one of the two methods for calculating the regular rate of pay that are set forth in the California Labor Commissioner’s Division of Labor Standards Enforcement’s (“DLSE”) Policies and Interpretations Manual (Section Employers who use total hours worked (as permitted under federal law) in their calculations risk underpaying the employees.

The dispute arose from the company’s policy of paying employees an “attendance bonus” of $15.00 per day for working a Saturday or Sunday shift. California (and federal) law requires the bonus amount be factored into a nonexempt employee’s time and one-half and double time rates of pay (1.5 times or 2 times the regular rate of pay). In doing so, the employer used a formula based on the federal Fair Labor Standards Act (“FLSA”), which calculated employees’ regular rate of pay by dividing their total straight-time wages plus bonuses by the total hours worked in the pay period, including overtime hours. The trial court and Court of Appeal had approved this calculation, reasoning that the DLSE’s California state law method is found only in a voided regulation and in the absence of any valid California law on point, federal law should be followed. But the California Supreme Court disagreed.

The California Supreme Court recognized that even though the DLSE’s enforcement policy is a void regulation and thus “not entitled to any special deference,” “the interpretation embodied in that policy may still be valid.” The Court held that the proper calculation should account for the fact that the flat-sum bonus is payable even if the employee works no overtime during the pay period, and thus the bonus is properly treated as if it were fully earned by only the straight-time hours in the pay period, and therefore only the straight-time hours should be considered when calculating the bonus’s per-hour value and not the total hours, including overtime hours.

Employers should consult with their employment attorneys to determine whether or not the bonus they pay are considered “non-discretionary” under federal and state laws. Many employers are surprised to learn that what they thought were discretionary bonuses are actually considered non-discretionary for purposes of computing overtime. Most bonuses that are tied to production, good performance, attendance, and to many other categories related to work performance are “non-discretionary” under California and federal law, for the purpose of calculating the “regular rate of pay” for overtime purposes, even if the bonus can be subsequently taken away or changed by the company. True discretionary bonuses that do not need to be factored in consist mainly of holiday bonuses and other bonuses not promised to employees. Without ruling, the Court also suggested that employers that pay bonuses tied to piece work or production (non-flat-sum bonuses) may still be able to use the federal calculation method for those bonuses. Section 49.2.4 of the DLSE’s Policies and Interpretations Manual provides a different formula for computing the regular rate of pay and overtime wages owed on a bonus “based on a percentage of production or some formula other than a flat amount;” this method resembles the federal law formula that requires the company to use total hours worked in the pay period, including overtime hours, and not only regular (straight-time) hours. But flat-sum bonuses must be treated differently.

As a result of this case, the proper method for calculating a California nonexempt employee’s regular rate of pay for purposes of determining overtime wages due on a flat-sum bonus is:(1) Divide the amount of the bonus by the number of straight-time hours actually worked during the pay period(s) over which the bonus was earned. This gives the employee’s regular rate of pay for purposes of calculating the overtime due on the bonus. For clarity, a flat-sum non-discretionary bonus earned over the entire year would be calculated based on the entire year’s straight-time hours worked. Hours worked does not include vacation pay, sick leave, meal or rest period premiums, split shift premiums, or reporting time pay over and above what was actually worked during the relevant period. (2) Multiply the employee’s regular rate of pay from Step One by 1.5 to get the employee’s overtime rate for time and one-half hours. Multiply the employee’s regular rate of pay from Step One by 2 to arrive at the employee’s overtime rate for double time hours.(California employers must pay an overtime premium of one and one-half times a nonexempt employee’s regular rate of pay for all hours worked over 8 hours in a workday, over 40 hours in a workweek, and for the first 8 hours worked on the seventh consecutive day of work in a workweek. The overtime premium increases to double the employee’s regular rate of pay for all hours worked in excess of 12 hours in any workday and for all hours worked in excess of 8 hours on the seventh consecutive day of work in a workweek.)(3) Multiply the employee’s total number of overtime hours worked during the pay period by the applicable overtime rate to arrive at the overtime wages due on the flat-sum bonus.(4) Payment of the bonus does not constitute base compensation for regular or overtime hours worked, such that only an overtime premium would need to be added. Therefore, in addition to the overtime wages due on the flat-sum bonus, employers must also pay employees regular and overtime wages for actual time worked.(5) An example of how this calculation works: Employee receives a bonus amount of $30.00 during the bi-weekly pay period for working weekend shifts. During the pay period, the employee worked 96 regular hours, 10 time and one-half hours and 2 double time hours. Employee’s hourly rate of pay is $15 per hour.

Step 1: $30 bonus ÷ 96 regular hours = $0.3125Step 2: Overtime rate for time and one-half hours: $0.3125 x 1.5 = $0.469 Overtime rate for double time hours: $0.469 x 2 = $0.625Step 3: Overtime due on bonus for time and one-half hours: 10 x $0.469 = $4.69Overtime due on bonus for double time hours: 2 x $0.625 = $1.25Total overtime due on bonus: $4.69 + $1.25 = $5.94

Employee’s earnings for the pay period include: (1) $30 for bonus, (2) $5.94 for overtime due on bonus, (3) hourly wages for 96 regular hours [96 x $15 = $1,440]; (4) overtime wages for 10 time and one-half hours [10 x $22.50 = $225]; and (5) overtime wages for 2 double time hours [2 x $30 = $60].

Practical Guidance The Dart decision clarifies the proper method of overtime calculation to use for California employees. Employers must use the correct method of calculation based on the type of compensation to avoid underpayment of overtime and corresponding class-wide wage claims. Now is a great time for every employer of California employees to evaluate its calculation methods for every bonus and other extra compensation that it provides to nonexempt employees. If an employer discovers that it has not been calculating the overtime rate in a manner consistent with the Dart decision, we suggest that the employer consult with California legal counsel to explore possible steps to correct any miscalculations.