Nonexempt Employees Paid on a Commission Basis – Common Overtime Mistakes

Overtime compensation is required irrespective of the method used to calculate
wages.  That is “common knowledge.”  Yet, mistakes are made.  I have seen numerous occurrences of
incorrectly computed overtime pay for commissioned employees.  It is also not rare for an employer to
initially compute the overtime wages correctly, and then obliterate the good
intentions by adding one final step.

Piece rates and job rates are as likely to involve the same mistakes, but I am focusing on
commissions because that arrangement is more common.  If you are utilizing any type of incentive
pay plan, my observations and suggestions should be useful.  In fact, some of the shortcomings that I will
describe often affect hourly-paid employees.

Before discussing common errors, let’s look at the correct way to compute overtime
compensation when employees are paid on a commission basis.  It is important to “keep it simple.”  When unnecessary nuances enter into the
equations, mistakes happen.  The Code of
Federal Regulations, Title 29 Part 778, at §§ 778.117 and 778.118, sets forth
some very straightforward rules regarding the computation of overtime wages
when commissions constitute all or part of the regular wages.  Part 778 (the overtime compensation CFR) may
be accessed at http://ecfr.gpoaccess.gov/cgi/t/text/text-idx?c=ecfr&sid=48d6ee3b99d3b3a97b1bf189e1757786&rgn=div5&view=text&node=29:3.1.1.2.39&idno=29.

When an employee’s regular wages result from a commission plan, those wages are
typically compensation for all hours worked (not just the first forty) in the
workweek.  Therefore, the required overtime pay is the half-time premium.  As
overtime pay must be a multiple (at least time and one-half) of the regular
rate, it is necessary that the regular rate be determined each workweek.  A DOL opinion letter – www.dol.gov/whd/opinion/FLSANA/2008/2008_09_22_12NA_FLSA.htm – is an excellent example of the simplicity of properly computing overtime pay for a commissioned employee.

The FLSA record keeping rules (Part 516) correlate with the above explanations by
requiring, in part, that the records reflect, for each workweek and for each
employee,

 

  • basis of pay (e.g.,
    “commission,” “piece rate,” “hourly,” etc.),
  • the regular rate,
  • total regular wages (for all
    hours worked), and
  • overtime premium wages
    (half-time pay for overtime hours).
  • It is helpful, in developing an understanding of the overtime compensation
    principles, to be knowledgeable of Part 778 in general, but particularly §§
    778.100 through 778.308.  Especially
    useful are the §§ 778.107 through §§ 778.109 explanations of “the regular
    rate.”

These are examples of practices that lead to overtime back wage liabilities.

  • Many employers believe that
    employees paid on a commission basis are not subject to overtime
    compensation provisions.  The owner
    of a courier business (under DOL investigation) recently informed me that
    he had classified his owner/drivers as employees (not “independent
    contractors”) to avoid problems with the IRS, but that he assumed the commissions constituted
    total wages (no need to pay overtime compensation).
  • It goes without saying that the
    record keeping rules (Part 516) require an accurate record of hours
    worked.  Employers must be
    especially diligent, when employees are paid on commission, in order to
    ensure that all hours worked are recorded.
    Failure to consider all hours worked when computing overtime wages
    obviously results in FLSA violations.
  • The perception that regular wages are always just for forty hours
    and that overtime pay is time and one-half added to the perceived
    regular wages
    complicates the computation of overtime compensation for
    commissioned employees.  I have seen
    various types of errors occasioned by the misconceptions; the most
    detrimental are those that result in failure to pay any overtime
    compensation, even though the records reflect that overtime was paid.  One client had been creating an
    artificial “regular rate” to make the records appear that overtime pay had
    been added to commission earnings, but in reality the half-time premium
    was imbedded in the commissions (not legal, of course).
  • A similar (but more formal)
    method is to boost the overtime hours by 1.5, divide total commissions by
    the new “total” of hours worked to obtain a (flawed) regular rate, and
    then show in the records that this rate was paid for the first forty hours
    and time and one-half this rate was paid for overtime hours.  Obviously, the result is false records
    and failure to pay any true overtime compensation.
  • “Tinkering” with the results
    after overtime wages have been properly computed often obliterates the
    intended overtime pay.  This happens
    when an employer, intentionally or inadvertently, modifies the calculations
    of compensation.  One example is the
    use of a guaranty plan.  There are
    numerous variations of such an arrangement (always resulting in FLSA
    violations).  Here is an
    illustration: The employer had been paying 25% commission with no overtime
    pay.  After being investigated by
    DOL, and paying back wages, the employer came into compliance  by agreeing to pay half-time premium
    wages for all hours over forty.  The
    employer modified the commission plan, reducing the percentage to
    22%.  However, this employer made a
    serious mistake by advising the employees that he will see to it that they
    do not average less than the previously paid 25%.  Each workweek, after all commissions
    have been determined @ 22%, the employer follows the Part 778 rules in
    arriving at the regular rate and adding the half-time premium pay to the
    commission earnings.  Then the
    employer re-computes commissions at the old (now guaranteed) 25%
    rate.  If this yields less than the
    computed total wages, no change is made.
    If the 25% computation yields more than the wages computed @
    22% plus overtime pay, a pseudo bonus is added to increase the total pay
    to the desired level.  The half-time
    premium compensation that had been computed and added to the 22%
    commissions now becomes meaningless because the pseudo bonus ensures
    payment of the guaranteed commission rate.
    However, even in workweeks when there is no need for adjustment,
    overtime compensation has not truly been paid (because of the guaranty
    arrangement).  The “overtime pay” is
    now simply a part of the regular wages, increasing the regular rate.
  • A subtle variation of the
    above-described guaranty plan is to base the guaranty on a period longer
    than a workweek.  For example, the
    employer might guarantee that the total pay for the year will yield a 25%
    average commission.  If necessary, a
    supplement will be added (at the end of the year) to achieve the desired
    percentage rate.  Again, the records
    do not reflect the facts, the methodology is wrong, and no actual overtime
    compensation has been paid.

All of the described practices result in a back wage liability.  In the first two examples, if the employer
has not been previously investigated by the Wage and Hour Division and there is
no evidence of willfulness, civil money penalty assessment is not likely.  Litigation (if it occurs) will probably
involve the basic two-year statute of limitations.  With regard to the other examples, DOL will
view the records as having been falsified, indicating willful violations.  Civil money penalties are likely.  If there is litigation by DOL or employee
plaintiffs, a three-year statute of limitations will be invoked.

Early on I suggested that, when computing overtime pay for commissioned employees, it is
best to “keep it simple.”  Doing so avoids the deviations and problems that I just described.

In summary, if your overtime computation methods for commissioned employees are less than
straightforward, you should make changes right away.

This article is focused on arrangements involving commission as the only method of
pay.  The same principles generally apply
if commissions are supplements (see Part 778, §§ 778.115 and 778.118).  If the commissions are paid other than
weekly, see §§ 778.119 and 778.120.  Piece rates and job rates are discussed in
Part 778 at §§ 778.111 and 778.112; however, the more detailed information (in
Part 778) regarding commissions will be helpful when analyzing compliance
procedures regarding piece rates or job rates.

The Wage & Hour Self-Audit Guide, in the Self Auditing section of www.BizKeys.com,
contains an overtime compensation section that covers the overtime basics, with
elaboration regarding various guaranty plans that result in violations.