Employers May Have to Include Pay-in-Lieu of Benefits In Regular Rate for Overtime

Various states, including California, also follow the FLSA regular rate definitions. For non-exempt employees paid only on an hourly rate, determining the regular rate is easy: It is the hourly rate. However, matters can be tricky when an employer also pays non-exempt employees additional compensation, such as bonuses or commissions. In many cases, additional amounts paid must be included in determining the regular rate. These issues have become more important, as legal claims have increased in alleging the failure to include all amounts required in the regular rate. The failure to determine the regular rate correctly results in an underpayment of overtime, with possible penalties.

The US Ninth Circuit Court of Appeals’ new decision in Flores v. City of San Gabriel raised a new twist, not addressed by any previous case. In Flores, the court considered whether an employer that paid cash in lieu of unused benefits should have added those payments into the regular rate for overtime pay. The court concluded the answer is “yes,” under some circumstances.

The FLSA defines the “regular rate” as “all remuneration for employment paid to, or on behalf of, an employee.” In general, all compensation paid for hours worked or performing a duty must be included in the regular rate. The FLSA, however, expressly excludes several items from the regular rate. For example, they include sums paid as gifts, payments for occasional periods when an employee performs no work, business expenses, and certain income from stock options and employee stock programs. The US Department of Labor’s regulations further address determining an employee’s “regular rate.”

In Flores, the employer provided a flexible benefits plan. Employees had to use a portion of the funds for dental and vision benefits. If an employee declined to use the remainder to purchase medical coverage, and could show proof of alternative coverage, the employee could receive the unused portion in a cash payment added to his or her wage payments. Over several years, these payments ranged between $1,036.75 and $1,304.95 per year. The employer designated the cash-in-lieu of payments as “benefits,” not including them in the regular rate or in overtime calculations.

The court held that the payments should have been included in the regular rate. First, the employer argued that the amounts should not be included in the regular rate because they “were not compensation for hours worked.” It conceded that the payments were “compensation,” but contended the amounts should be excluded because they were payment for unused benefits, but not tied to hours worked or the amount of services provided. The court disagreed. It held that the key issue is whether “the character of the payment was compensation for work.” A payment cannot be excluded from the regular rate “if it is generally understood as compensation for work, even though not directly tied to specific hours worked by the employee.” For example, the court noted that amounts for bonuses generally, as well as for room and board, are not excluded. They are compensation, although they may not vary based on hours worked.

Second, the court rejected the employer’s argument to apply the FLSA’s limited exclusion of certain benefits from the regular rate. The FLSA does not exclude “benefits” from the regular rate generally. Rather, it only excludes “contributions irrevocably made by an employer to a trustee or third person pursuant to a bona fide plan for providing old-age, retirement, life, accident, or health insurance or similar benefits for employees.” Because the employer paid the amounts directly to the employees, the court held that this exception could not apply. In addition, the court concluded that the plan at issue was not a “bona fide plan,” because the cash payments to employees rather than in benefits were at least 40 percent or more of the employer’s total contributions. That level, the court concluded, was beyond any “incidental” payment amount that federal regulations allow.

Because litigation over regular rate issues has increased, employers should take care that they properly calculate the regular rate and include all necessary items. In addition to liability for unpaid overtime stemming from miscalculating the regular rate, employers may face various additional liability. Under the FLSA, they may face liquidated (double) damages and a longer, three-year limitations period for a “willful” violation. The Flores court found both of these provisions applied in that case. Employers also can face additional liability under state law. Under California law, for example, an employee may face waiting time penalties of up to 30 days’ wages, as well as civil penalties.

The Flores decision warrants employers’ attention. It cautions that employers cannot simply treat anything that may be considered a “benefit,” or not tied to particular hours worked, as excluded from the regular rate. Under the Patient Protection and Affordable Care Act, employers may face additional challenges or limits in providing cash-in-lieu of benefits for benefits that law covers. Even so, as Flores demonstrates, employers must consider whether payments in lieu of “benefits” (as well as other types of payments) must be included in the regular rate for calculating overtime.