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Bonus Effect On Overtime Wages

A recent decision from the First District Court of Appeal in San Francisco explains how bonus payments affect overtime wages. Marin v. Costco Wholesale Corp., Case No. A116847 (Cal. Ct. App. Dec. 23, 2008).

General Principles

Under the federal Fair Labor Standards Act and the California wage orders, employers must calculate overtime based on the “regular rate of pay.” Although that is easy to do if the employee only earns a set hourly wage, employee compensation often includes other components. Some nonexempt employees are paid a salary. A paycheck may also include commissions, gifts, profit-sharing, bonuses and other items.

The regular rate must be computed workweek by workweek. For each workweek, total all compensation paid, but omit overtime payments, premium pay for work during off-hours, such as nights and holidays, gifts, profit-sharing and other benefit plans, and discretionary bonuses. These concepts are described in the U.S. Department of Labor’s regulations at 29 C.F.R. sections 778.200 through 778.225. Divide the total by the number of hours actually worked (federal method) or the number of hours worked up to 40 (California method) to get the regular rate of pay.

Non-discretionary bonuses (those earned by by meeting performance standards, or based on formulas) are included in the regular rate calculation. (The distinction between discretionary and non-discretionary is described in 29 C.F.R. section 778.208.) But, such bonuses often cover more than one workweek. That requires an allocation of the bonus across the entire period, as explained in 20 C.F.R. section 778.209, and in section 49.2.4 of the California DLSE Enforcement Policies and Interpretations Manual.

The Marin Decision

Costco offered a formulaic bonus to its long-term hourly employees, which the Court of Appeal explained as follows: “To be eligible for the bonus, paid in April and October, these employees must: (1) have been paid a specified number of hours for continuous service—8,000 hours (approximately four years) for those hired before March 15, 2004, and 9,200 hours (approximately 4.6 years) for those hired after that date; (2) generally be at the top of their pay scale; and (3) have been employed by defendant on April 1 for the April bonus and October 1 for the October bonus. The maximum semi-annual base bonus amount is $2,000 for those with less than 10 years of service, $2,500 for those with 10 to 14 years of service, $3,000 for those with 15 to 19 years of service, and $3,500 for those with 20 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 are prorated for those paid for less than 1,000 hours; the formula for the base bonus is thus: hours paid up to 1,000 ÷ 1,000 × maximum bonus amount.”

Costco calculated the overtime attributable to 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), and then by multiplying the number of overtime hours worked during the bonus period by one-half of that regular bonus rate. Attorneys for a class of Costco employees contended that Costco should have divided the base bonus the employee earned by the number of straight time hours worked during the bonus period, and then multiplied the number of overtime hours by 1.5 times that regular bonus rate. For an employee who earned a $2,500 bonus, the two methods could yield a difference of $350. The trial court adopted the plaintiffs’ method with a modification, and entered judgment against Costco for $5.3 million.

The Court of Appeal reversed the judgment, and ruled that Costco had properly calculated the overtime due. The Court ruled that the DLSE manual did not have the force of law with respect to including bonuses in the regular rate of pay, because it had not been adopted as a regulation and did not cite any authority. Nonetheless, the Court also explained that Costco’s method of calculating the regular rate of pay satisfied the standards set out in the manual.