Incentive compensation plan and non-exempt employees
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Incentive compensation plan and non-exempt employees

An Incentive compensation plan can run into major problems with overtime laws and hourly employees.

I generally advise clients to make non-exempt or hourly employees not a part of the incentive compensation plan. The reason for that is really twofold.

An Incentive compensation plan doesn’t make you competitive with hourly employees
First and foremost, if you look at market data, if you look at what other organizations do, if you look at the competitive labor markets and say, “What do we have to offer in order to attract and retain quality employees?” Most organizations do not offer bonuses or if they do, they’re very, very small bonuses for non-exempt or hourly employees.

The second issue and just as important, I would argue, is that an incentive compensation plan can become a record-keeping nightmare with very little benefit. The reason I say that is that most organizations are not aware of this. But if you pay a bonus to your non-exempt employees, you are required by federal law to pay them retroactive overtime based on the amount of that incentive, based on the amount of that bonus.

What I mean by that is if you pay an hourly employee a bonus – let’s just say for simplicity’s sake that it’s an annual bonus, you essentially need to go back and calculate the total number of hours worked through the course of the year and calculate what was that bonus on an hourly rate.

And it may be $0.05 an hour if that’s what it works out to, $0.10 an hour. But then, you need to go back and look at all their overtime hours and you owe them half time of that bonus hourly rate for any overtime hours that they worked.

Incentive compensation plan becomes a payroll nightmare

Essentially, the overtime regulations are written to protect the non-exempt or protect the hourly employees from these big, evil employers. And so, the way the law is written is they want to avoid an employer from being able to approach a prospective employee and saying, “We want to offer you a job. We’re going to pay you minimum wage. We’re going to pay you overtime based on minimum wage but we’re going to pay you a $30,000 bonus.”

What the law said is, “Well, that’s fine, that $30,000 bonus. You owe them overtime. You can’t just pay them overtime based on that hourly rate, based on that minimum wage. You have to pay them overtime based on their total compensation which would include that $30,000 bonus.” Now, that’s an extreme example but I use it for illustrative purposes. If you pay a $500 bonus, the exact, same calculations apply.

My recommendation is that non-exempt or hourly employees not be included as part of the incentive compensation plan one, because it’s market competitive, most organizations don’t do it; secondly, because of the overtime requirements associated with it.

Edited remarks from the Rapid Learning Institute webinar: “Incentive Pay Plan Blunders That Can Cost You a Fortune” byEd Rataj

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