Retroactive pay: What is it and how do you issue it?

One of an employer’s primary responsibilities is to ensure that their team has been compensated accurately and on time at the end of each pay period. But as a human, you know that mistakes can happen. Retroactive pay is how employers can rectify payroll errors, righting wrongs with their team and their financial records.

In this post, we’re taking a closer look at retroactive pay, how it works, its legal considerations, and more. Read on for an extensive overview of retroactive pay, or click on a link below to navigate to the subtopic that best answers your query.

• What is retroactive pay?
• Calculating retroactive pay
• Retroactive pay taxes
• Legal considerations
• Ways to issue retro pay
• Final thoughts

Retroactive pay is when a business issues its employee(s) money to correct underpayment during a given pay period. The need for retroactive pay doesn’t usually come up very often. It can happen when raises are issued in the middle of a pay cycle, a contract is being negotiated, or an accounting mistake is made. Retroactive payment can also be court-ordered—we’ll discuss that in more detail a little later on in this post.

Bottom line: Retroactive pay is used to pay employees back when they’re not initially compensated for the amount agreed upon.

• A pay increase was authorized but was not reflected on the employee’s paycheck.
• A payroll or accounting error occurred when processing payroll.
• An employee worked overtime hours but overtime pay wasn’t calculated accurately.
• A bonus, commission, or another special type of pay wasn’t accounted for or was underpaid.

Retroactive pay and back pay are oftentimes used interchangeably. While both are payments issued after the original pay period, they have some key differences for employers to be aware of. Let’s take a look.

• Retroactive pay: The remaining balance an employer owes to a worker, compared to what was originally issued during the pay period.

• Back pay:  Payment to catch up on compensation that was never issued for work that was carried out. Usually, back pay is brought on by a lawsuit in which an employer failed to pay salaries due. The judge generally issues particular orders on back pay, fines, and restitution.

Put simply, retroactive pay occurs when your employee is paid less than they should’ve been paid, whereas back pay is used when a worker isn’t paid at all.

If you discover a payroll error or are alerted to one by an employee, you’ll want to resolve it ASAP. How you calculate retro pay depends on how you classify the employee affected—retro pay is computed differently for salaried employees and hourly employees.

Calculating retroactive payments for hourly employees is relatively straightforward. To begin, you’ll need to determine what you did pay the employee for the hours they worked. For example, if an employee worked 40 hours but you only paid them for 35, you owe them 5 hours’ worth of their regular pay.

Once you’ve determined the difference in hours paid and owed, you’ll need to identify the hourly rate you’ve agreed on—let’s use $15/hour for this example. When you multiply (5) hours x ($15) hourly wage, you’ll find that you owe them $75 in retro pay.

Typically, retroactive payments are added onto the employee’s next paycheck. So don’t forget to add the amount owed in retro pay to the number of hours worked during the current pay period. We’ll discuss other ways of issuing retro pay a little later on in this post.

Salaried employees are usually issued the same amount on each paycheck earned, so figuring out their retro pay is also quite simple. If your salaried employee is supposed to be paid $2,100 per paycheck but they only received $1,650, you owe them $450 in retro pay.

Keep in mind that retro pay may be used in a variety of circumstances, including retroactive pay increases. A retroactive pay increase occurs when an employee receives a pay raise but the new pay rate is not reflected on the appropriate paycheck.

For example, let’s say an employee currently earns $60,000 per year and they recently got a raise. The employee discovers that their most recent paycheck shows their old rate of pay even though the new rate was supposed to go into effect. Their new annual salary should be $65,000 in gross pay. You’ll need to determine how much they should be paid on each paycheck with their new rate, then subtract the old rate to find the difference. Once you’ve determined the difference, you can issue retroactive pay accordingly.

Just like regular pay, retroactive pay is subject to taxes, including:

• Federal income tax
• State income tax
• Local income tax
• Social Security
• Medicare

When you make retroactive payments to employees, you’ll still need to withhold the appropriate amount based on the sum of the retro pay.

In addition to the examples of retroactive pay discussed above, there are certain cases where retro pay may be court ordered. Here are some circumstances when a judge may order retro pay by law:

If a judge determines an employer issued pay increases to a segmented group based on characteristics like race or gender, they may award retro pay to affected employees. In 2019 alone, approximately $20.7 million was awarded to victims of discriminatory pay protected by the Equal Pay Act of 1963.

A judge may order retro pay if a business withholds pay or pay increases because it’s retaliating against an employee for whistleblowing. An estimated 43% of workers who report wage theft also experience some form of retaliation that may also constitute retroactive payment.

When an organization knowingly violates an employment contract and pays less than the agreed-upon rate, retroactive payments may be demanded by a court of law.

Retro pay may be ordered if an employer fails to compensate employees appropriately according to their overtime rate. (Overtime is time and a half, according to Fair Labor Standards Act [FLSA] standards). According to the Department of Labor, there were 8,495 violations of overtime pay in FLSA cases filed in 2020.

If an employer is caught paying employees under the table for less than minimum wage, a judge may require the employer to issue retro pay.

If an employer pays workers less than the FLSA minimum wage, they may be subject to retro pay. Per the Economic Policy Institute, roughly 2.4 million workers covered by state or federal minimum wage laws were paid less than their state’s minimum wage each year.

Now that you’re familiar with how retro pay works and when it might be necessary, let’s discuss your options for issuing retro pay.

1. Issue a lump sum payment on a separate check
2. Include retro pay in the employee’s next paycheck and label the amount as “RETRO”
3. Add retro pay to their regular pay on their next paycheck—no need to label

Mistakes happen—from missing the memo on a salary increase to omitting overtime, payroll errors shouldn’t be something to panic about. With QuickBooks, you can streamline your payroll system and accounting to avoid errors from the start and, if needed, resolve them with ease.

Whether you’re managing payroll in-house or choose to outsource your payroll, QuickBooks can help you stay organized and ensure accuracy. Plus, access features like free cash flow reporting to set the stage for financial growth, and enjoy a user-friendly experience that saves on accounting time.