by Robert W. Ditmer, CPP*
In an effort to cut payroll administrative costs many employers
will pay some or all of their non-exempt employees a salary,
especially if the employee has a fixed workweek. The employee’s
salary is usually stated in terms of a specific frequency of
payment (such as an annual salary) or according to the employer’s
payroll period (such as a biweekly salary). Salaries are an
acceptable alternative under the FLSA, but employers must remember
one basic fact: The employee is still subject to the FLSA.
That means the employer must be able to calculate the employee’s
regular rate of pay, and the employee is entitled to additional
compensation if he works more than 40 hours in a workweek.
Therefore, if a non-exempt employee is paid a salary, the employer and the employee
must come to an understanding that the salary covers a fixed number of hours
in each workweek. [29 CFR 778.113(a)] So the employee’s regular rate of
pay can be calculated by dividing the number of hours expected each week into
the weekly salary. For instance, suppose a secretary is hired to work from 9:00
am to 5:00 pm each, and she has an hour off for lunch. She would be working a
35-hour workweek. If she is paid $350 per week, then her regular rate of pay
is $10 per hour ($350 / 35 hr).
What if a salaried, non-exempt employee works more than 40 hours per week?
The CFR states that the employee should be paid for the first 40 hours of work
at his regular rate of pay, and he is then entitled to overtime at one and
a half times his regular rate of pay. If the above secretary works 45 hours
in one workweek, the overtime can actually be calculated using the overtime
premium method as follows:
- Calculate the regular rate of pay. ($350 / 35 hr = $10/hr)
- Calculate the employee’s total remuneration. (45 hr x $10/hr = $450)
- Calculate the overtime premium. (5 hr x .5 x $10/hr = $25)
- Calculate total pay. ($450 + $25 = $475)
So the employee is paid $125 in addition to her salary of $350/week. We can test
the validity of the above method by following the CFR’s
description exactly.
- Calculate the additional straight-time pay for the hours between 35 and
40. (5 hr x $10/hr = $50)
- Calculate the overtime pay at time and a half. (5 hr x 1.5 x $10/hr = $75)
- Calculate pay in addition to salary. ($50 + $75 = $125)
There are some additional issues that still need to be addressed. What if the
agreed upon salary is not stated in weekly terms? Then the CFR
provides the basic calculations for reducing the employee’s
salary to weekly terms. [29 CFR 778.113(b)]
- Annual – Divide by 52.
- Monthly – Multiply by 12 and divide by 52.
- Semi-Monthly – Multiply by 24 and divide by 52.
- Biweekly – Divide by 2.
What if the agreed upon workweek is less than 40 hours, and the employee
works more than the expected number of hours, but less
than 40 hours? The Tax Court has ruled that if a non-exempt,
salaried employee works more than the normal week, but less than
40 hours, the employer is not required to pay for the additional
hours worked. [U.S. v. Klinghoffer Brothers Realty,
285 F.2d 487 (2nd Cir. 1960)] For instance, if the above
secretary works 38 hours during the workweek, she does not have to be paid
for the additional 3 hours. The agreement between the employer
and the employee is that the salary covers all hours worked
with the exception of workweeks in which the employee works
more than 40 hours.
Employers have the option of paying for all extra hours over what the
salary is meant to cover, but if the employer is going to pay the employee for all
extra hours, then the employer might as well just pay the employee on an hourly basis. And if the employee consistently works
overtime, then there are no savings administratively because of the constant need to calculate overtime.
There are other alternatives in that case, and these will be discussed later.
What if the employee works less than the expected number
of hours during the workweek? In some cases there could
be problems because in some states if an
employee is paid a salary, his salary cannot be reduced if he works
less than the expected number of hours. He is treated
the same as an exempt employee.
In those states the only way an employer can avoid paying the employee
who works less than the expected number of hours is
to make the employee an hourly
employee. So employers must be aware of what state law permits.
So when is paying a non-exempt employee a salary an
effective strategy? The best situation in which to
use this method is when an employee has a workweek
with a fixed number of hours. Preferably this would be when the employee
actually works less than 40 hours per week. If the
employee is scheduled for 35 hours
or 37.5 hours per week, then minor fluctuations in the workday that
result from the employee arriving a little early, leaving
a little late, or working part of his lunch break can be ignored (although the time must still
be tracked).
Salaries can also be used when employees are paid less
frequently than once a week. But employers need to
be aware of problems that can be inherent in doing this. In some states non-exempt employees cannot be paid less
frequently, so employers must conform to state law in these cases. And payroll periods
that do not correspond to workweeks (such as semi-monthly and monthly
payrolls) have their own special problems. In fact, in the next section I will address
one of these – semi-monthly payrolls.
Semi-Monthly Payrolls
Semi-monthly payrolls have an obvious cost savings
because they eliminate at least two payroll runs each
year for companies that would normally pay biweekly.
Most companies that have a lot of hourly wageworkers don’t use them because
state law prohibits them or administering them can actually be more expensive.
This appears to be reflected in the American Payroll Association’s
2001 Benchmarking Study. The number of companies using semi-monthly
payrolls dropped
from 24.3% in 2000 to only 9.7% in 2001. [PAYTECH 11(4), April
2002, pp. 26ff.]
Since the semi-monthly payroll period doesn’t match
any workweeks, how can employers deal with the adjustments
that are necessary to pay overtime?
To administer these payrolls an employer needs to establish certain
timeframes and set certain policies regarding adjustments
to payroll. These might include:
- Pay Dates – The employer has to determine
which two calendar dates each month will be used for paying
payroll. This would include the issue of when to pay the
payroll if the calendar date falls on a weekend.
- Cut-off Dates – The payroll department needs
a certain number of days of lead-time to process the payroll.
For instance, the cut-off date may be set at 5 business
days before the payroll date. Anything that would require
an adjustment to payroll (such as overtime) would have
to occur prior to the cut-off date to be included in the
next payroll.
- Payroll Period – The employer has to make a
choice between alternatives here. The payroll period could
include all of the workdays that occur from the first day
following the previous payroll’s cut-off date through
the cut-off date of the current payroll. Or the employer
could decide that payroll will be paid current, so the
payroll period would begin on the day following the previous
payroll and would end on the date of payroll.
- Workweek – Since
the workweek is the basic unit of the FLSA, the employer must
set a workweek for determining if employees have worked overtime.
Any overtime that occurs in a workweek that ends prior to the
cut-off date would be paid on the next pay date. If the workweek
ends after the cut-off date, then the overtime would not be
paid until the following pay date.
Probably the
biggest problem that administrators of semi-monthly payrolls
face is how to pay employees for the initial payroll or the final
payroll. This issue is not addressed by the CFR, although some
state governments have developed formulas for calculating initial
or termination payrolls. Be sure to check state law to see if
the issue is addressed.
If the payroll period is current, then the employer will have to calculate
the initial payroll based on the expected number of days or hours the employee
is scheduled to work in the payroll period. If the payroll period is based
on the cut-off dates, the employee’s actual hours worked can be used.
The employee’s daily rate would be calculated by dividing the annual
salary by 52 and then by the number of days normally worked each week. The
regular hourly rate of pay could be calculated by dividing the weekly salary
by the number of expected hours.
The following equation could then be used:
- Gross wages = Number of hours worked x Regular rate of pay
Suppose a secretary
is hired to work a 35-hour week, and she will be paid a semi-monthly
salary of $834.17. She starts work in a payroll period that has
11 available workdays, and she works 4 days of that period.
- First calculate the employee’s regular rate of pay. ($834.17 x 24 = $20,020.08/yr;
$20,020.08 / 52 = $385.00/week; $385.00 / 35 hr = $11.00/hr)
- Calculate the number of hours worked (or expected to work) in the payroll
period. (4 days x 7 hr = 28 hr)
- Calculate the initial paycheck. (28 hr x $11.00/hr = $308.00)
There is also another method that can be used in the semi-monthly payroll period
situation for an initial or terminating paycheck. If the employer
and employee agree beforehand,, the employee's regular rate of
pay can be determined by dividing the monthly salary by the number
of working days in the month and then by the number of hours
in the employee's normal workday. That rate is then multiplied
by the number of hours worked in the semi-monthly period to determine
the employee's gross wages.
- Calculate the employee’s regular rate of pay. ($834.17 x 2 = $1,668.34/month;
$1,668.34 / 22 working days = $75.83/day; $75.83 / 7 working hours = $10.83/hr)
- Calculate the number of hours worked (or expected to work) in the payroll
period. (4 days x 7 hr = 28 hr)
- Calculate the initial paycheck. (28 hr x $10.83/hr = $303.24)
This section and the previous one have focused on paying non-exempt employees
a salary if the employee regularly works 40 hours or less. Overtime
must be paid for any hours worked over 40, but if this does not
occur on a regular basis, then the employer can realize savings
in administrative costs. On the other hand, what if the employee
regularly works more than 40 hours per workweek? Or what if the
employee sometimes works less than 40 hours a week and then works
more than 40 hours a week? There are alternative strategies for
paying such employees a salary. These are explored in the following two sections.
*Originally
published as "Calculating Salaries for Non-Exempt Employees," PAYTECH,
March 2003, pp. 38-40.
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**Robert W. Ditmer, CPP, is Controller of Parker, Cade & Large, Inc., a commercial real estate development and construction company located in Columbia, Maryland. Mr. Ditmer has worked in five different states and has experience dealing with multi-state taxation involving states with reciprocal agreements and those that do not. He can be reached at robertwditmer@yahoo.com.
