Under the Fair Labor Standards Act, nonexempt employees are entitled to overtime at a rate of one and one-half times their regular hourly rate for hours worked in excess of 40 per week. However, it is possible for a nonexempt employee to be paid on a “salary” basis, in which case the employee may receive only one-half times the regular rate for hours worked in excess of 40 per week. This method is called the “fluctuating workweek” (or “flex-pay”) method of calculating overtime (though sometimes it is unfortunately referred to as “Chinese Overtime”). The premise of flex-pay is fairly straightforward: because a nonexempt employee received a salary as compensation for all hours worked, the employee has already been paid all wages at the regular rate for all hours worked, including hours worked over 40. Accordingly, only the additional half-time overtime rate is owed for hours worked over 40. Flex-pay gets its name(s) because, when an employee is paid on a salary basis, the regular rate will fluctuate based on the number of hours worked. Notably, the more hours an employee works, the lower the regular rate (and the overtime rate) will go. Consider the following examples:
(1) Nonexempt Employee #1 is paid $10/hour and works 50 hours in a week. Under traditional overtime, the employee will receive $400 for the first 40 hours ($10/hr * 40hrs), and $150 for the 10 hours above 40 ($10/hr * 10hrs * 1.5), for a total of $550 for the week.
(2) Nonexempt Employee #2 is paid $400 per week regardless of how many hours are worked, but also works 50 hours in a week. Under flex-pay, the employee will receive $400 plus ½ times the regular rate for the 10 hours of overtime. The regular rate, however, is calculated as $400 / 50hrs, or $8/hr. As a result, the overtime rate is $4/hr ($8/hr * .5), which yields total pay of only $440 for the entire week.
Initially, this may appear unfair to the employee, but such agreements may be attractive to employees whose hours vary widely both above and below 40 hours. That is, if the employee only works 30 hours in the week, the same salary of $400 is still paid.
Flex-pay has long been an approved method of calculating overtime, and is sanctioned by the Department of Labor in interpretive bulletin 29 C.F.R. § 778.114, but there are limits. Section 778.114 only endorses flex-pay “[w]here there is a clear and mutual understanding of the parties that the fixed salary is compensation (apart from overtime premiums) for the hours worked each workweek, whatever their number, rather than for working 40 hours or some other fixed weekly work period . . . .” The Supreme Court began to define the limits of such contractual arrangements in two cases from 1942: Overnight Motor Transportation Company v. Missel, 316 U.S. 572, and Walling v. A.H. Belo Corp., 316 U.S. 624. Both of those cases concerned contracts to set weekly wages for all hours worked. Though not the primary issue in those cases, the Court explained that any such agreement must meet the FLSA’s requirement that overtime be paid at one and one-half times the regular rate, whatever that may be (more on those cases in future installments).
While flex-pay may be a useful tool for employers seeking to reduce labor costs, it is exceedingly difficult to implement properly. Particularly when commissions or bonuses are also paid, overtime is routinely miscalculated. For help understanding the risks and benefits of flex-pay, it is critical to contact an employment attorney. In most cases, employers should use a payroll company to ensure accurate calculations. Without careful implementation, wage and hour violations are a near certainty.
Finally, flex-pay has become a hot topic in wage and hour law recently due to its increased use as a method of calculating damages in cases where a nonexempt employee has been misclassified as exempt. That topic will be explored in more detail in my upcoming post about flex-pay as a remedy in misclassification litigation.