I really thought I had written about this previously here, but I find that so many of my clients are still confused.  Don’t beat yourselves up if you have been getting this wrong; this is a very complicated issue, and it bears a few reviews. 

Many California Labor Code sections, as well as federal wage and hour law, require that we pay our non-exempt employees based on the REGULAR RATE OF PAY (“RROP”), not the “base pay” or hourly pay that we agree to pay them.  For example, overtime (under federal and state law) must be paid at the RROP.  Meal or rest break premiums (that hour of pay that is paid to employees who do not properly get their statutory meal or rest breaks) must also be paid at the RROP.  So, too, must sick leave under state law.

WHAT IS THE DIFFERENCE BETWEEN REGULAR RATE AND HOURLY RATE?  This is it – so pay attention.  “Regular rate,” as opposed to “base or hourly rate,” includes nearly ALL other announced and expected additional compensation, regardless of how often that compensation is paid.

WHAT ADDITIONAL COMPENSATION GOES INTO THE REGULAR RATE CALCUATION?  The most common extra compensation that must be considered in the calculation of RROP is a BONUS.  Any bonus that is regularly paid to employees, whether the plan is in writing or not, will most likely need to be included in the calculation of RROP.  Many of you think that by labeling a bonus “discretionary” you can get around this issue.  But that word “discretionary” does not mean what you think it means.  Most often, if employers pay any kind of regular bonus, even if they retain the “discretion” not to pay it, it needs to be counted in the RROP.   Same rule applies with commissions, service charge income paid to employees, shift-differential pay, on-call pay, incentive pay, or an award for winning a “contest.”   Regardless of what you call it, most additional compensation you regularly pay a non-exempt employee must be included in the RROP calculation (see exceptions, below).

I know, I hear you all asking – but what if I only pay bonuses once a year?  Or once a quarter?  And how do I true up the RROP if I pay commissions monthly but pay my employees every two weeks?  The RROP calculation must be done at the time you know the amount of the bonus or commission, and then the overtime for that bonus or commission period must be RECALCULATED, using the additional compensation being paid.  At the point where you determine the true RROP for that period, all overtime and break pay that has been paid for the period in question should be recalculated and the difference paid to the employee, along with their bonus/commission/extra compensation.  And it must be correctly reflected on the wage stub accounting for the RROP recalculation.   If you are paying a quarterly bonus, you would recalculate the RROP and pay the true-up for the full quarter.  If you pay commissions monthly, it would be for that month.  And yes, if you pay an annual bonus, the recalculation overs the full year in question.

Sick pay is also paid at the RROP, but the timing is done a bit differently.  See below for those rules.

How is this recalculation done?  There is a formula that is used, and under California  case law (Alvarado v Dart Container Corporation, 2018), that formula differs when a “flat sum” bonus is involved.  The formula used under federal law (Fair Labor Standards Act or FLSA) takes all earnings in the relevant period and divides by the TOTAL NUMBER OF HOURS WORKED (INCLUDING OT HOURS) in that period, to determine RROP.   Then overtime, break pay, sick pay may be paid based on this RROP.  To the extent there is a difference between what was already paid employees for that period and what is now owed, we pay them. This is often called a “retro-pay” calculation. 

California law generally followed this FLSA formula, and then along came the Dart case.   The California Supreme Court in the Dart decision said that when an employer pays a FLAT SUM bonus (that would be a lump sum of money paid to employees versus a percentage or “production” based bonus or commission), the RROP calculation changes.   The Dart case involved a plaintiff who received a flat $15 a day attendance bonus if the employee worked on a weekend.  This was paid regardless of how many total hours the employee worked, how well the employee performed, how much money the employee normally earned, or the overall performance of the company.   It was a flat sum attendance bonus. 

The Dart Court held that because flat sum bonuses are paid regardless of the number of overtime hours worked, employers should not take those overtime hours into account when determining RROP.  Therefore, only REGULAR HOURS would be used as the divisor in these cases, not total number of hours worked. 

I am not going to get into the weeds about these formulas – if any of you are paying a FLAT SUM bonus, as compared to a performance-based bonus, or if this is all new to you, reach out.  Or reach out if you want to confirm that your payroll provider is doing the math correctly on any of these calculations  (remember what I said, do NOT assume that this is all being done for you just because you have a proper payroll company).

If I have not already made your heads spin with this topic, there is another wrinkle.  You must do a RROP calculation when you pay difference rates of pay in the same payroll period.  This is the blended rate problem.  The safest method to determine  the correct RROP when two rates are in effect is to take the weighted average, considering the number of hours worked and rates of pay worked in that workweek, and calculate an appropriate blended rate to use for overtime, break pay and sick pay.  This method is approved under the FLSA and by the California Division of Industrial Relations.  However, a recent California appellate case concluded that employers MAY use the rate in effect on the day the overtime was worked BUT ONLY if using the rate in effect results in employees being paid MORE than they would under a weighted average theory.  

As I said above, the calculation for RROP for paying sick leave is done slightly differently, under California law.  The law gives employers two methods for determining the rate in which to pay sick leave.  To determine the rate of pay for non-exempt employees taking sick leave, you may either:

• Calculate the regular rate of pay for the workweek in which the employee used paid sick leave, whether or not they actually worked overtime in that workweek (this is calculated like the “flat sum” bonus), or
• Divide your total compensation for the previous 90 days (still excluding overtime premium pay) by the total number of non-overtime hours worked in the full pay periods of the prior 90 days of employment.

Have I lost you yet?

I told you above that there are some exceptions regarding the extra compensation that must be included in the RROP calculation.  Right before the pandemic, the Department of Labor gave us some guidance and issued its final rule on what items are excluded from RROP.    This includes, most notably, vacation or holiday pay, reimbursement for reasonable expenses, employee discounts, gym memberships or wellness classes, parking benefits, and contributions to a bona-fide employee benefit plan.  Finally, one-off “thank you” payments or true gifts are NOT included in the RROP calculation.  Many of you issued a one-time extra payment to employees for working through the pandemic.  Some of you issue a holiday gift at the end of the year; for example, an employer puts a $100 bill in every employee’s holiday card or gives everyone a $25 Starbucks card, regardless of the employee’s position, performance, or compensation.  We can argue that these payments are gifts and excluded. 

Trust me, regular rate of pay and related issues are some of the hottest we see in wage and hour lawsuits, primarily because SO many employers do it wrong.  They fail to make the calculation at all, or they don’t consider all extra compensation, or they fail to do it in all the instances it is required.  For example, REPORTING TIME PAY must also be paid at the RROP.  Not all that many of you pay reporting time, but some of you do.  But split shift pay does NOT work this way.  If in doubt, again, contact us.  These technical wage and hour issues are not for the faint of heart, and this is what we do.