United States: Overtime Implications Of Bonus Plans Under The FLSA

Consider the following scenario: You own a manufacturing company and your profits have been steadily declining over a period of several years. In an effort to increase profitability, you decide to give your employees annual bonuses based on their attainment of predetermined, performance-based goals that are designed to measure their efficiency and productivity. Your plan works perfectly. The company has the most profitable year in its history, and employees receive generous lump-sum bonuses at the end of the year. Several months later, you hear that a group of your employees have retained an attorney and are bringing a class action against you under the Fair Labor Standards Act (the "FLSA") alleging that you owe them additional overtime pay because you gave them annual bonuses. Could they be right?

While just about every employer is aware of its obligation to pay its employees overtime at a rate of time and one-half the employee's "regular rate," many are not aware of how a bonus payment may affect this computation. This Labor Update discusses the overtime implications of bonus plans under the FLSA and outlines three types of bonus payments that may be excluded from an employee's "regular rate" for purposes of computing overtime.

Under the FLSA, nonexempt employees must be compensated for all hours worked in excess of forty a week at a rate not less than time and one-half of the employee's "regular rate."¹ The regular rate is determined by dividing the weekly compensation, excluding any overtime premiums, by the number of hours the employee worked during the week.² Generally, an employee's "weekly compensation" encompasses all remuneration paid by an employer to an employee, including bonus payments.³

Incorporating a bonus payment into the "regular rate" can be a complicated task. Initially, the employer may disregard the bonus in computing the regular hourly rate until such time as the amount of the bonus can be ascertained. Once the amount of the bonus can, in fact, be determined, it must be apportioned back over the workweeks of the period during which it may be said to have been earned. The employee must then receive an additional amount of compensation for each workweek that he or she worked overtime during the period equal to one-half of the hourly rate of pay allocable to the bonus for that week multiplied by the number of statutory overtime hours worked during the week.⁴

Thus, while the incremental overtime payments to your employees in connection with the bonus may be relatively small, the administrative burdens on the payroll process can be significant. Fortunately, Congress has carved out exceptions for certain types of bonuses, the three most common of which are: (1) gratuitous bonuses; (2) discretionary bonuses; and (3) profit-sharing bonuses.⁵ If your company's bonus payments qualify under any of the these exceptions, then such payments may be excluded from the regular rate computation.⁶

The key to a gratuitous bonus is that it "must be actually a gift or in the nature of a gift."⁷ In this respect, the FLSA provides that the bonus must be "made at Christmas time or on other special occasions, as a reward for service, the amounts of which are not measured or dependent on hours worked, production, or efficiency."⁸ "[I]f the bonus is paid pursuant to contract (so that the employee has a legal right to the payment and could bring suit to enforce it), it is not in the nature of a gift."⁹ Moreover, if "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."¹⁰ 

To qualify as a discretionary bonus, "both the fact that payment is to be made and the amount of the payment [must be] determined at the sole discretion of the employer at or near the end of the period and not pursuant to any prior contract, agreement, or promise causing the employee to expect such payments regularly."¹¹ In addition, the regulations provide as follows:

Profit-sharing bonuses are payments made pursuant to a bona fide profit-sharing plan (as defined by the regulations), which are determined without regard to hours of work, production, or efficiency.¹³ To qualify as a bona fide profit-sharing plan under the regulations, a plan must meet the following criteria:

• The plan must be a definite program or arrangement, must be in writing, and must be communicated or made available to the employees.
• Its purpose must be to distribute a share of the firm's profits to the employees over and above their regular wages or salaries, such wages or salaries not being dependent on or influenced by the profit sharing.
• The contributions or allocations must be derived solely from profits of the employer's business enterprise, establishment, or plant as a whole, or an established branch or division of the business or enterprise which is recognized as such for general business purposes and for which profits are separately and regularly calculated in accordance with accepted accounting practices.
• Eligibility under the plan must extend at least to all employees subject to the law's minimum wage and overtime standards or to such classification as the administrator may approve, although eligibility may be conditioned on such factors as length of service, number of hours, or days of work, provided such factors are specified in the plan.
• The amounts paid to individuals must be determined in accordance with a definite formula or method of calculation specified in the plan.
• The formula or method of calculation may be based on any one or more of such factors as straight-time earnings, total earnings, base rate of pay of the employee, straight-time hours, total hours worked, or length of service. Distribution may also be made on a per capita basis.
• An employee's share may not be reduced because of any other compensation he or she receives.
• The plan must provide for payment of the shares to employees within a reasonable period after the amounts are determined or for their irrevocable deposit with a trustee for deferred distribution, provided that the right of an employee to receive his or her share is not made dependent upon the employee continuing to work for the employer after the period for which the profits have been determined.

The regulations also list five features which, if present, automatically will disqualify a plan. They are:

• If the share of any individual employee is determined in substance on the basis of attendance, quality or quantity of work, rate of production, or efficiency;
• If the amount to be paid periodically by the employer into the fund or trust to be distributed to the employee is a fixed sum;
• If periodic payments of minimum amounts to the employees are guaranteed by the employer;
• If any individual employee's share, by the terms of the plan or trust, is set at a predetermined fixed sum or is so limited as to provide in effect for the payment of a fixed sum, or is limited to or set at a predetermined specified rate per hour or other unit of work or work time; or
• If the employer's contributions or allocations to the fund or trust to be distributed to the employees are based on factors other than profits such as hours of work, production, efficiency, sales, or savings in cost.¹⁴

Employers who violate the FLSA are liable for any unpaid overtime compensation.¹⁵ The FLSA also provides for liquidated damages in the form of doubling the award of unpaid overtime compensation unless the employer can demonstrate that it had reasonable grounds for believing that its act or omission was not in violation of the FLSA.¹⁶ An employer may meet this burden by showing that its officials attended seminars regarding the FLSA, reviewed the law, and consulted with counsel regarding the specific compliance issue in question.¹⁷

1. 29 U.S.C. §207(a)(1).

2. Overnight Motor Transportation Co. v. Missel, 316 U.S. 572 (1942).

3. 29 U.S.C. §207(e).

4. See 29 C.F.R. §778.209(a).

5. 29 U.S.C. §207(e).

6. The United States Supreme Court has held that these exceptions are to be narrowly construed against the employer. Mitchell v. Kentucky Fin. Co., 359 U.S. 290, 295 (1959). 

7. 29 C.F.C.  §778.212(b).

8. 29 U.S.C.  §207(e)(1).

9. Id.

10. 29 C.F.R.  §778.212(b).

11. 29 U.S.C.  §207(e)(3).

12. 29 C.F.R.  §778.211.

13. 29 U.S.C.  §207(e)(3).

14. 29 C.F.R.  §§549.1, 549.2 (emphasis added).

15. 29 U.S.C. §216(b).

16. 29 U.S.C.  260.

17. See Pautlitz v. City of Naperville, No. 89 C 8855, 1994 WL 22063, at *2(N.D. Ill. Jan. 25, 1994).

First published in July 1999