DISCRETIONARY AND NON-DISCRETIONARY BONUSES

Steven Cesare, Ph.D.

A business owner from California contacted me the other day while he was developing his company compensation plan, and had a couple of questions about various bonus programs that he wanted to offer to his employees as motivation to improve their job performance. Of the many topics we discussed, the owner was most surprised by the legal distinction between discretionary bonuses and non-discretionary bonuses.

Discretionary Bonus

In this case, the employer has complete discretion regarding if, when, and how much a bonus can be given to an employee, who for the most part does not expect it. A discretionary bonus is completely based on the owner’s preference to distribute a bonus to an employee for a non-performance based reason. There is no promise or agreement between the owner and the employee regarding the terms of the bonus. Examples of discretionary bonuses include: “Today is Tuesday, here is $100.” “I see that you just bought a new car, here is $50 for gasoline.” “Here is a $500 Christmas bonus for you and your family.”

Non-discretionary Bonus

In this case, the employer uses a specific set of criteria to determine bonus payments. There is no discretion in this type of bonus; instead, there is an objective standard. If the employee meets the goal, the employer must pay the bonus to the employee. Examples of non-discretionary bonuses include: meeting 50% gross margin production goals for the quarter, coming to work for a full month with no absences, maintaining 95% client retention rates for the entire fiscal year, or achieving desired staffing levels of 95% for 90 days.

Upon clarifying that distinction, I then informed the owner that all non-discretionary (i.e., performance-based) bonuses must be added into non-exempt employees’ regular rate of pay to accurately calculate overtime wages.

For example, if a non-exempt employee earns $400 a week for a 40-hour workweek, the employee has a regular rate of pay equal to $10 per hour (i.e., $400 divided by 40 work hours). As such, all overtime pay for that workweek must be paid at a time and a half rate of $15 per hour.

However, if the employee earns a $40 non-discretionary bonus for completing the equipment inventory project during that week, the employee will then have earned $440 for a 40-hour workweek. Thus, in that week, the non-exempt employee’s regular rate of pay becomes $11 per hour (i.e., $440 divided by 40 work hours). As such, all overtime pay for that workweek must be paid at a time and a half rate of $16.50 per hour.

I told the owner that if he did not include non-discretionary bonuses in appropriate overtime payments, state or federal officials could levy financial penalties against him. Moreover, the Fair Labor Standards Act allows employees to file their own private lawsuits against their employers, which can result in judgments for back pay and liquidated damages as well as court costs and attorney fees.

If you have any questions or comments about this topic or anything else related to human resources, simply call me at (760) 685-3800.