Many employers do not know that paying a non-discretionary bonus to non-exempt employees will require the payment of additional overtime. The California Court of Appeal’s decision in Marin v. Costco Wholesale Corporation is a good reminder of the need to pay overtime on such bonuses and of the fact that the method for calculating overtime on a bonus depends upon whether it qualifies as a “production bonus” or a “flat rate bonus.”

As a general matter, the payment of a non-discretionary bonus (one that is not discretionary in either the fact that it will be paid or in the formula for calculating it) to non-exempt employees triggers an additional overtime obligation because it retroactively increases the regular rate of pay for the employee receiving the bonus for the time period covered by the bonus. A non-exempt employee is entitled to be paid overtime at 1.5 times (or double, in some cases) the regular rate of pay for each overtime hour worked. With some specific exceptions not relevant here, the regular rate of pay for overtime purposes includes all compensation earned during the workweek. Thus, an employee who is paid a quarterly bonus has received additional compensation that was not included in the regular rate of pay when he or she was paid overtime for hours worked during the quarter at issue. An employer is required to resolve this issue by calculating a “regular rate” of pay on the bonus itself and then paying some portion of that regular bonus rate for each overtime hour worked during the period in which the bonus was earned. The precise method for calculating the overtime due on a bonus depends upon whether the amount of an employee’s bonus increases with each hour worked (in which case it is a “production bonus”) or whether the amount of the bonus is fixed independent of the hours worked (in which case it is a “flat rate bonus”).

More specifically, per the California Division of Labor Standards Enforcement’s Enforcement Policies and Interpretations Manual (DLSE Manual), production bonuses are those “based on a percentage of production or some formula other than a flat amount [which] can be computed and paid with the wages for the pay period to which the bonus is applicable.” Because such bonuses are earned during straight time as well as overtime hours, the “regular rate” for such a bonus is calculated by dividing the bonus by the total hours worked (including overtime hours) during the period to which the bonus applies. The overtime premium due on the bonus is then calculated multiplying one-half of the regular rate for the bonus by the number of overtime hours worked during the period in which the bonus was earned.

In contrast, where the bonus at issue is a flat sum, such as $300 for continuing to the end of the season, or $5for each day worked, the DLSE Manual indicates that the regular bonus rate is determined by dividing the bonus by the maximum legal regular hours (i.e., straight time hours) worked during the period to which the bonus applies. According to the DLSE, such flat sum bonuses are “not designed to be an incentive for increased production for each hour of work; but, instead [are] designed to insure that the employee remain[s] in the employ of the employer.” Thus, “to allow [such a] bonus to be calculated by dividing by the total (instead of the straight time hours) would encourage, rather than discourage, the use of overtime.” Consequently, the DLSE Manual states that the premium due on flat sum bonuses is 1.5 times the regular rate of the bonus for each overtime hour worked during the time period at issue.

The court in Marin v. Costco held that the portion of the DLSE Manual governing “flat sum” bonuses is a void regulation under the reasoning of Tidewater Marine Western, Inc. v. Bradshaw (1996) 14 Cal.4th 557. Specifically, that portion of the DLSE Manual is “a standard of general application interpreting the law the DLSE enforce[s],” and “not merely a restatement of prior agency decisions or advice letters.” Accordingly, it does not have the force of law.

The court then addressed the legality of the manner in which Costco was calculating overtime on the semi-annual bonus it was paying to its hourly employees. The bonus was paid each April and October to certain long-term employees and was calculated based upon the number of hours the individuals had worked during the six month period preceding the payout date. The maximum semi-annual base bonus amount varied from $2,000 for those with less than ten years of service to $3,500 for those with twenty or more years of service. To qualify for the maximum base bonus, the employee must have been paid for at least 1,000 hours in the six-month period preceding April 1 and October 1. Bonuses were prorated for those paid for less than 1,000 hours; the formula for the base bonus was thus hours paid up to 1,000/1,000 x maximum bonus amount.

Costco calculated the overtime owed on the bonus by dividing the employee’s maximum base bonus by the minimum number of paid hours required to achieve that maximum bonus (1,000). Using that number as the regular hourly bonus rate, Costco then multiplied the number of overtime hours worked during the bonus period by ½ of the regular bonus rate. In other words, Costco calculated overtime in accordance with the DLSE’s formula for production-based bonuses. Plaintiffs contended that the bonus was more akin to a flat sum bonus – such that Costco was required to calculate the regular bonus rate by dividing the base bonus by the number of straight time hours worked during the bonus period, and then multiply the number of overtime hours by 1.5 times the regular bonus rate.

The court concluded that the Costco bonus was a hybrid of the two types of bonuses identified by the DLSE. Because each hour worked up to the first 1,000 hours increased the amount of the bonus, Costco’s bonus functioned as a production bonus until the 1,000 hour threshold was met. As to hours worked after the 1,000 threshold, Costco’s bonus functioned like a flat sum bonus because the additional hours worked did not add to the amount of the bonus. Based on the DLSE’s position on the two types of bonuses, the court concluded that the Costco bonus did not “encourage imposition of overtime during the post-1,000 hour period in a way that would support the use of the DLSE’s flat sum bonus formula.” Accordingly, Costco was justified in using the production-bonus method of overtime calculation.

The court’s decision highlights how complicated it can be to correctly calculate bonus overtime under California law. However, the time and effort needed to get it right is time well spent since an employer that uses the wrong method for calculating bonus overtime is a prime candidate for a class action lawsuit that could lead to significant liability.

This blog entry was written by Marlene Muraco.