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Ask the Hotline | When is a Bonus Discretionary?

November 5, 2019
Question - I listened to your recent webinar on pending changes to the Fair Labor Standards Act (FLSA) for exempt employees. Part of the discussion touched on the topic of discretionary and nondiscretionary bonuses. Could you expand a little more on that topic to help me understand when it applies and when it does not? 
Answer - Employers sometimes struggle with trying to figure out which bonus rules apply in which situations.
In general, discretionary bonuses are the more common form of bonus given by an employer. 
Discretionary bonus - Paid at the discretion of the employer. An employee does not have advanced knowledge of what must be done to get the bonus and they are usually paid for services performed. It is also worth noting that discretionary bonuses are not subject to advance agreement or any sort of contractual obligation to be paid. A discretionary bonus does not need to be included as part of the regular rate of pay or overtime calculation. 
One way to show that a bonus is discretionary is for the employer to not say anything about it over the course of the year. A failure to follow this rule can lead to the following situation: If the employer announces in January that it will be paying a bonus in December, the bonus is no longer discretionary because the employer has promised it even if the employer retains control over the amount of the actual bonus.
The FLSA provides that special-occasion payments such as Christmas are discretionary if the amount of the bonus is not measured by, or dependent on, hours worked, production, or employee efficiency. The bonus is discretionary even though the bonus is paid every year and employees expect it.
The one caveat is that if the bonus is so substantial that the employees consider it a significant portion of their earnings, it will be viewed as a non-discretionary bonus.
Referral bonuses paid for recruitment of new employees are discretionary only if all of the following conditions are met: 
  • participation is strictly voluntary;
  • recruitment efforts do not involve significant time; and
  • the activity is limited to after-hours solicitation done only among friends, relatives, neighbors and acquaintances as part of the employees’ social affairs.
Non-discretionary bonus - Paid because of a contract or agreement that has been made between the employer and employee in advance. 
A typical nondiscretionary bonus covers something such as production, quality, attendance, remaining with the employer or other form of employee performance. A non-discretionary bonus is one that the employee expects to be paid and it is usually given on some form of schedule such as monthly, quarterly or annually.
The rules regarding their payment are clearly established, so they must be included in the regular rate of pay and the calculation of overtime, if applicable.
  1. A nondiscretionary bonus paid on a weekly basis must be added into the employee’s hourly earnings that week or two-week pay period. It must also be calculated into the overtime rate if applicable. For example, a business pays its employees on a bi-weekly basis. If its employees work their scheduled hours in a pay period, they are given a $100 bonus. If one or more employees works overtime, the bonus must be included in their regular rate of pay for calculating OT purposes. 
  2. If the bonus accrues over a longer period of time, the employer does not need to incorporate it into the hourly rate until the bonus can be ascertained (for example at the end of the month or quarter). Once the amount is known it must be apportioned back over the weeks of time it covered that employee and then included into the hourly rate and overtime rate for that employee. 
For example, in an effort to attract more personnel, an employer gives hourly paid employees a $2,000 bonus after being employed six months. The retention bonus must be included in the regular rate calculation in overtime weeks covered by the bonus period. The only difference in the situation is that the bonus needs to be calculated over a six month or 26-week period. 
Another example highlights how careful an employer needs to be in providing any sort of bonus for employees.
Early this century an employer had an unused sick-time buyback policy in which employees could sell their unused sick time back to the employer and receive a partial wage payment for doing so. The court ruled that the payments to the employees were an attendance incentive program subject to the nondiscretionary bonus rules, meaning the employer had to incorporate the buyback money employees received into their pay and overtime.
Even after more than 80 years the FLSA continues to present challenges to employers to ensure compliance.
If you have any questions about this or any other HR issues, please call the AIM Employer Hotline at 1-800-470-6277.
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