by Boyd Byers
In the holiday classic National Lampoon’s Christmas Vacation, family patriarch Clark Griswold is distressed because he has not yet received his Christmas bonus, which he is counting on to cover a check he wrote for a new swimming pool. Finally, on Christmas Eve, a courier arrives with a delivery. As his family looks on, Clark opens the envelope to find a one-year membership to the Jelly of the Month Club, not the bonus he is expecting.
Naturally, Clark has an epic meltdown. Well-meaning but misguided Cousin Eddie then kidnaps Clark’s boss and drags him to the family’s home so Clark can confront him about canceling employees’ bonuses: “I was expecting a check. Instead, I got enrolled in a jelly club. Seventeen years with the company. I’ve gotten a Christmas bonus every year but this one. You don’t want to give bonuses, fine. But when people count on them as part of their salary—well, what you did just plain . . .”
“Sucks,” Clark’s son, Rusty, interrupts.
After looking around at the family, the boss has a change of heart and announces that he is reinstating the bonuses. And it’s Merry Christmas to all and to all a good night—until a SWAT team breaks into the family’s home to rescue the boss and Uncle Lewis inadvertently triggers a sewer gas explosion.
Although canceling employee bonuses is a great setup for a comedy, year-end bonuses can lead to legal snags that are no laughing matter for employers. Under many states’ wage payment laws and general principles of contract law, employers are legally obligated to pay bonuses when employees meet the requirements to become eligible for and earn them. Simply put, employers must own up to promises they make to employees about pay. For example, if you tell employees at the beginning of the year that you will pay them a holiday bonus of a set amount at the end of the year, you must pay the bonus to employees whose employment continues throughout the year.
However, a past practice of giving discretionary Christmas bonuses does not give rise to a legal obligation to pay bonuses of a particular amount, or at all, in subsequent years. That seems simple enough. But employers can unwittingly create a legal obligation if they include a Christmas bonus in an itemized list of compensation and benefits in an offer letter or annual compensation statement.
Year-end bonuses based on individual, department, or company productivity goals or profits can also create legal headaches. The key is to have clear, well-written bonus policies that have been reviewed by your lawyer. For example, how do you handle employees who work part of the year but are no longer employed at the end of the year or at the time bonuses are paid? If your policy is not clear, those employees may be entitled to a prorated payment for the time they worked. In addition, laws in Kansas and many other states preclude the forfeiture of earned wages. Thus, it’s essential that your policy is clear that a bonus has not been earned—and employees have no right to payment—unless all criteria have been satisfied.
Bonuses and overtime
Year-end bonuses can have significant overtime implications for nonexempt employees, who must be paid at least 1 ½ times their regular rate of pay for all hours worked over 40 in a workweek. Don’t forget that the regular rate includes not only an employee’s hourly rate but also the value of other types of compensation, including nondiscretionary bonuses. Nondiscretionary bonuses include bonuses that are meant to induce employees to work more steadily, rapidly, or efficiently or to continue their employment.
Conversely, discretionary bonuses are not included in an employee’s regular rate. For a bonus to qualify for the exclusion, the employer must retain discretion over both whether the bonus will be paid and the amount of the bonus until a time at or near the end of the period for which the bonus is paid without any previous agreement or promise that causes the employee to expect the payment. If an employer promises to pay a bonus in advance, it gives up its discretion.
The Fair Labor Standards Act (FLSA) specifically excludes from the regular rate “payments in the nature of gifts made at Christmas time or on other special occasions, as a reward for service, the amounts of which are not measured by or dependent on hours worked, production, or efficiency.” U.S. Department of Labor (DOL) regulations explain that “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.”
However, a Christmas bonus or gift may be excluded from the regular rate even if it is “paid with regularity so that the employees are led to expect it and even though the amounts paid to different employees or groups of employees vary with the amount of the salary or regular hourly rate of such employees or according to their length of service with the firm so long as the amounts are not measured by or directly dependent upon hours worked, production, or efficiency.”
Free beer tomorrow
The need to include bonuses and other nonwage remuneration in overtime pay is driven home by the following case. A nonexempt employee sued his former employer, Anheuser-Busch, under the FLSA. The employee alleged that he received free beer as “incentive pay” and that the company failed to include the value of the beer as part of his regular rate when calculating his overtime wages, resulting in an FLSA violation for underpayment of overtime. If the company promised free beer to employees as a reward for good performance or to encourage retention, then the employee is right. The value of the beer is considered wages and should have been included in overtime calculations.
It may come as a shock that an employer can incur overtime liability by giving employees free beer. Or, in Clark Griswold’s words, “If I woke up tomorrow with my head sewn to the carpet, I wouldn’t be more surprised.” But if you pause to think about the history and purpose of the FLSA, it does make sense.
So what about the Christmas bonuses paid by Clark’s employer? Clark is a food additive engineer, so he’s presumably a professional who is exempt from overtime. But are his nonexempt coworkers entitled to extra overtime pay because of the bonuses?
We know that Clark’s company pays bonuses every year and that employees expect them and “count on them as part of their salary.” That alone is not enough. However, if the payments to nonexempt employees are “substantial” (e.g., the amount of a new swimming pool), the bonuses cannot be considered gifts. Thus, according to the regulations, the bonuses must be included in overtime calculations. Also, if the bonuses are based on hours worked, production, or efficiency, they must be included in overtime calculations, regardless of whether they are “substantial.”
Don’t forget that bonuses are supplemental wages and are thus taxable compensation. That means you must take both employer and employee payroll taxes out, just like with regular paychecks. The IRS allows employers to use a flat “supplemental rate” of 25 percent for federal withholdings for most bonuses.
Gifts in the form of goods or merchandise that are of nominal value are considered de minimis (minor) fringe benefits and are excluded from employees’ wages. So the turkeys—or memberships to the Jelly of the Month Club—you give away do not have to be included in employees’ income. However, according to the IRS, cash and cash-equivalent benefits (e.g., gift cards) cannot be excluded from wages as de minimis fringe benefits and must be included on employees’ W-2s as taxable income.
Be mindful about how you structure your incentive plans and bonuses, the way you communicate them to employees, and the process you use to administer them. And, like the Griswold family, you will have the “hap-hap-happiest Christmas.”