Benefits and Compensation, HR Management & Compliance

Bonus Coverage: Discretionary vs. Nondiscretionary

Many companies annually prepare business goals and establish incentives for employees if the goals are met. One common incentive is the quarterly or annual bonus. While the reward process seems straightforward, it can come with unexpected obligations and complicated calculations under the Fair Labor Standards Act (FLSA). Let’s take a closer look at exactly which bonuses must be included when you’re making the calculations.

FLSA

Discretionary vs. Nondiscretionary Bonuses

Many employers view bonuses as extra payments to employees they aren’t obligated to provide. Accordingly, they don’t think about the potential FLSA implications.

When an employee works overtime in a given week, the FLSA requires the overtime rate to be calculated based on the regular pay rate, which includes with a few notable exceptions any and all compensation paid to an employee in a particular workweek, not just the hourly wage. Whether bonuses paid to employees must be included in the regular rate calculation turns on whether the bonuses are discretionary or nondiscretionary.

Discretionary. According to the FLSA regulations and DOL guidance, discretionary bonuses don’t have to be included in the regular rate calculation. To be deemed discretionary, however, all of the following requirements must be met:

  • The employer must have the sole discretion at or near the time of payment to determine whether to pay it;
  • The employer must have the sole discretion at or near the time of payment to determine the bonus amount; and
  • The bonus isn’t paid according to any previous contract, agreement, or promise causing an employee to expect such payments regularly.

Examples from the DOL of bonuses that may be deemed discretionary include those paid to employees for overcoming a challenging or stressful situation or making a unique effort and not based on previously established criteria. Assuming all three requirements were satisfied, the examples could include the COVID-19 bonuses that many employers paid to employees in 2020 in recognition of the unique challenges and stress the pandemic presented and the workers’ efforts to deal with them.

Nondiscretionary. Any bonus that doesn’t meet all of the requirements to be discretionary is by default nondiscretionary, the DOL’s guidance says. Here are some  examples:

  • Bonuses based on a predetermined formula;
  • Bonuses paid for quality and accuracy of work;
  • Bonuses announced to employees to induce them to work more efficiently;
  • Attendance bonuses; and
  • Safety bonuses.

The common thread running through all of the bonuses is they aren’t discretionary about either (1) the fact of payment (i.e., the employer has made a previous contract, agreement, or promise causing an employee to expect them) or (2) the amount of payment (i.e., the amount was determined well in advance of the time of payment). On the latter point, the DOL explains “the understanding of how an employee earns [a bonus] may lead to an expectation to receive [it] regularly.”

5th Circuit Case

Regardless of the arguments you could make against the DOL’s logic, it’s the current standard, which was recently applied in a ruling by the U.S. 5th Circuit Court of Appeals (the court with jurisdiction over federal cases in Mississippi).

The 5th Circuit decided a performance bonus must be included in the regular pay rate because the amount was predetermined, even though the employer retained the discretion on whether to pay it at all. The opinion was later withdrawn for entirely unrelated reasons, but it serves as good indication of how the court would rule in future cases.

One caveat: While it probably goes without saying, you should remember the label given to a bonus has no bearing on whether it’s truly discretionary or nondiscretionary. A bonus labeled as discretionary but that doesn’t satisfy all of the statutory requirements is actually a nondiscretionary bonus, and you must account for it in the regular pay rate during overtime weeks.

Takeaway

The issue of bonuses and their potential FLSA implications is just one compliance issue you face and should take a look at sooner rather than later. Hopefully, taking the time to check compliance early in the year will lead to better times later.

Martin J. Regimbal, a shareholder of The Kullman Firm, can be reached at mjr@kullmanlaw.com. Also contributing to the article was Stephen L Scott, an attorney at the firm, who can be reached at sls@kullmanlaw.com.