The Perils of Calculating Regular Rate of Pay

March 14, 2017

Calculating the overtime due to a non-exempt employee under the Fair Labor Standards Act is easy — just multiply the employee’s hourly rate times 1.5 for each hour worked over 40 in a workweek. Right?

If only overtime calculations were so simple. But an employee’s regular rate of pay does not necessarily equate to that worker’s regular hourly wage. And incorrect regular-rate calculations can lead directly to class-action litigation.

Indeed, the City of San Gabriel, California, recently asked the U.S. Supreme Court to resolve a circuit split concerning the statutory exceptions to regular rate of pay and to decide whether cash paid to employees who do not use all of their allotted medical benefits must be included in the regular rate. This case illustrates the many hazards for employers in calculating regular rate of pay.

The “regular rate of pay” under FLSA includes “all remuneration for employment paid to, or on behalf of, the employee,” subject to a number of exceptions under Section 207(e), which lists eight types of payments that may be excluded from the regular rate of pay:

 

(2) payments made for occasional periods when no work is performed, payments for expenses reimbursable by the employer, and “other similar payments to an employee which are not made as compensation for his hours of employment;”

(3) certain discretionary bonuses;

(4) contributions by the employer to certain welfare plans and payments made by the employer pursuant to certain profit-sharing, thrift and savings plans;

(5) premiums paid for exceeding certain hours in a workday or workweek;

(6) premiums for weekend or holiday pay;

(7) premiums for work outside of established hours; and

(8) certain value or income from stock grants or rights. 

Despite these eight exceptions, the U.S. Department of Labor has opined that non-discretionary bonuses (but not discretionary bonuses, shift differentials and premium pay, and certain expense reimbursements) must be included in the regular rate calculation.  The result is ample gray area and potential for miscalculation.

The San Gabriel v. Flores case arises out of this gray area. There, the city offered its employees a “flexible benefits plan” under which it furnished a set amount to each employee for the purchase of medical, vision and dental benefits. When employees had alternative coverage, such as through a spouse, the city paid those employees their unused cash allotment from the plan and taxed it as wages. However, the city did not include these “cash-in-lieu-of benefits” amounts in calculating regular rate of pay, in the belief that they fell under several statutory exceptions including § 207(e)(2) as “other similar payments to an employee which are not made as compensation for his hours of employment.”

However, a group of city police officers successfully sued the city on the basis that excluding their cash-in-lieu-of-benefits payments from regular rate violated the FLSA. On appeal, the 9th Circuit Court of Appeals held that § 207(e)(2) did not apply because the cash payments were compensation for work, even though they were not determined by the number of hours worked, and that § 207(e)(4) did not exclude the payments as “contributions irrevocably made by an employer to a trustee or third person” pursuant to a bona fide benefit plan because the payments were made directly to employees.

As the city’s petition for certiorari points out, this decision is potentially at odds with how other federal courts of appeals have interpreted § 207(e)(2)’s “other similar payments … not made as compensation for hours of employment” exception. The 3rd Circuit has held that all “payments not tied to hours of compensation” are excludable under § 207(e)(2). And the 7th Circuit has interpreted § 207(e)(2) to apply to “payments that do not depend at all on when or how much work is performed,” while the 6th Circuit has found that it excludes payments  that are “unrelated to … compensation for services and hours of services.” Although these prior precedents do not directly address pay-in-lieu-of-benefits, their definitions of what forms of pay are excludable under § 207(e)(2) would cover such payments.

The San Gabriel case offers the Supreme Court an opportunity to clarify the regular-rate exceptions and possibly create a bright-line rule of what payments to employees may be excluded from regular rate. At the very least, the case illustrates that calculation of regular rate of pay remains fraught with peril and any effort at FLSA compliance should include review of regular-rate calculation.

For more information on this topic, please contact the authors, your McGuireWoods contact, or a member of the firm’s labor and employment group.

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