One of the most often misunderstood Fair Labor Standards Act (“FLSA”) provisions is 29 U.S.C. § 207(e)(3), which excludes bonuses from non-exempt employees’ regular rate of pay if the employer retains discretion over (a) whether such bonus should be paid in the first place, and (b) the amount of the bonus. Only if both criteria are met is a bonus “discretionary,” such that it does not have to be included in the regular rate when calculating overtime. See also 29 C.F.R § 778.211 (setting forth criteria for discretionary bonuses). Over the years, significant litigation has occurred over whether bonuses that employers may refer to as “discretionary” in fact meet both prongs of this test, such they may be excluded from overtime.
(A) Discretion over whether a bonus should be paid
To be discretionary, the bonus must be paid “without prior promise or agreement.” 29 C.F.R § 778.211(b). If the employee has a contractual right to a bonus or the employer has promised the bonus in advance, the bonus will be included in the regular rate. Id. This principle applies even to bonuses that the employers calls “discretionary.” Particular areas of concern include:
- Hiring bonuses: Bonuses promised as part of the hiring process are likely nondiscretionary and included in the regular rate.
- Bonuses tied to a benchmark: Bonuses paid for reaching certain benchmarks (such as attendance bonuses, longevity bonuses, or productivity bonuses), are likely nondiscretionary and included in the regular rate.
- Contractual or written promises: Bonuses referenced in a contract or in a written document, such as an email, could be interpreted to be a promise and therefore included in the regular rate. If a bonus is not announced in advance, there is a better argument that it is discretionary .
- Recurring bonuses: A bonus that otherwise would be discretionary could be considered nondiscretionary if it is consistently paid at the same time such that employees come to expect to receive the bonus.
- Holiday bonuses: While the FLSA permits employers to give gifts to employees without including the value of those gifts in the regular rate, see 29 U.S.C. § 207(e)(1), if the employer states or hints in advance that a holiday bonus will be paid, it could be interpreted as a nondiscretionary bonus. If an employer does not make statements in advance about a holiday bonus and states that it has not yet been determined whether a holiday bonus will be paid, there is a better argument that it is discretionary.
(B) Discretion over the amount of the bonus
To be discretionary, the employer must likewise retain discretion over the amount of the bonus. Thus if the employer establishes criteria for the amount of a bonus to be paid, it is likely nondiscretionary. This can arise if the employer specifies that a bonus will be equivalent to “1 cent for each item sold,” 29 C.F.R. § 778.211(b), or if the employer establishes a set rate for the completion of each stage of a frack job, for example.
Putting it all together: a recent non-precedential example
Several clients have contacted us to inquire about a recent Fifth Circuit decision, Edwards v. 4JLJ, L.L.C., No. 19-40553, 2020 WL 5229686 (5th Cir. Sept. 2, 2020), which raises these issues and also held, as a matter of first impression, that it is the employee who bears the burden of proving that a bonus is nondiscretionary. That decision has subsequently been withdrawn on jurisdictional grounds, leaving open the question of which party bears the burden. See Edwards v. 4JLJ, L.L.C., No. 19-40553, 2020 WL 5628689 (5th Cir. Sept. 21, 2020). Nevertheless, the withdrawn opinion gives insight into how courts might interpret the discretionary-bonus criteria in the context of performance bonuses.
One specific bonus at issue was a performance bonus identified in the employees’ employment contracts. The contracts contained a list of criteria, both positive and negative, that could impact the awarding of the bonus, and also contained a statement that “THIS BONUS IS NOT TO BE EXPECTED, IT IS TO BE EARNED.” The bonus was calculated using a pay scale setting the bonus amount at a particular amount per hour. Edwards v. 4JLJ, L.L.C., No. 19-40553, 2020 WL 5229686, at *1 (5th Cir. Sept. 2, 2020).
The appellate panel’s original, since-withdrawn opinion would have deemed the bonus to be nondiscretionary and thus to be included in the regular rate. With respect to the first prong of the inquiry—i.e., discretion over whether the bonus would be paid—the court’s withdrawn opinion found that the inclusion in the employment contract of the language that the bonus is “NOT TO BE EXPECTED,” combined with testimony that the company exercised discretion over whether to give the bonuses generally, indicated that the company retained discretion over whether to make the payment. Id. at *9. Thus the first prong of the discretionary test was satisfied.
However, the court would have found that the second prong—discretion over the amount of the bonus—was not met, because the inclusion of a specific pay scale combined with the lack of evidence indicating that the company ever deviated from the pay scale led the panel to conclude that the employer did not retain discretion over the amount of the bonus. Id. at 10.
THE BOTTOM LINE: Employers must retain discretion over both whether to make a bonus payment and the amount. Employers who wish to preserve an argument that a bonus is discretionary should carefully consider their actions with respect to bonus payments in light of the principles included in this article, and generally should be cautious when making any statements to employees about potential bonus payments. Statements that describe how a bonus amount is calculated can cause the bonus to be nondiscretionary, even if the employer has otherwise stated that the decision to pay the bonus in the first place is discretionary.