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Overtime pay: What is it and how do you calculate it?

What is overtime pay? 

Nonexempt employees must receive overtime pay for working over 40 hours in a workweek. The standard rate is time and a half their regular pay rate.

Overtime pay is a must-know topic for small business owners. You have to pay overtime to ensure a fair work environment, but also because of federal overtime laws. Overtime pay is additional compensation employees get when they work more than the standard 40 hours per week. 

Failing to compensate employees for their overtime work can lead to legal repercussions, including expensive lawsuits and penalties. Let’s look at how overtime compensation works, who’s exempt from it, and the importance of an overtime policy. 

How does overtime pay work? 

Certain eligibility considerations determine whether an employee gets overtime pay. These considerations include the type of job and the salary or wage amount.

Some employees, such as executives, professionals, or certain administrative positions, are exempt from overtime pay requirements. However, nonexempt employees get overtime pay for any hours worked beyond 40 hours per week. 

Which employees get overtime pay? 

Exempt employees are not eligible for overtime pay as they are exempt from the Fair Labor Standards Act (FLSA) regulations.

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To be exempt from overtime, employees must meet three criteria:

  1. Salary basis test: Exempt employees must receive a set salary
  2. Salary level test: Their salary must meet the minimum threshold set by the FLSA, which is $684 per week or $35,568 per year. 
  3. Job duties test: Exempt employees must primarily perform executive, administrative, professional, or outside sales duties. 

Nonexempt employees typically receive an hourly wage rather than a fixed salary and get overtime. Although exempt employers don't have to pay exempt employees overtime, they can offer extra pay through a compensation benefits package. 

Overtime pay regulations and rules 

Overtime pay rules are in place to ensure employees who work beyond their regular working hours get fair compensation. Employers need to adhere to both federal and state requirements. Certain states have more stringent regulations when it comes to overtime pay. 

On the federal level, the Department of Labor (DOL) and its Fair Labor Standards Act (FLSA) set overtime pay rules. If your business makes over $500,000 in annual sales or conducts interstate commerce, you must comply with the FSLA. 

Note that interstate commerce means you conduct business between multiple states. This can be many things, such as sending or receiving mail from another state, making or receiving calls from another state, or using goods from another state.

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Employers who fail to pay for overtime work may owe employees back wages and even the employee’s legal fees. Additionally, the DOL can issue penalties for repeated or willful violations.

Typically, these fines are $1,000 per violation, where it’s a lot more expensive not to pay and get caught than it is to pay the overtime. 

🗞️FYI: Employee classification is a complex subject. Misclassifying employees is a major FLSA violation and can result in a detrimental wage lawsuit.

How to calculate overtime 

You calculate overtime pay by multiplying the number of overtime hours your employee works by 1.5 times the employee's regular hourly rate.

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To calculate overtime pay: 

  1. Determine the regular working hours: Before calculating overtime, it is important to establish regular working hours. This typically refers to the hours an employee works during a standard workweek. 
  2. Identify the overtime threshold: Labor and payroll laws often dictate the threshold for overtime begins. This threshold is typically either 40 hours worked within a single workweek or a fixed number of hours in a day. 
  3. Calculate overtime hours: Once you set the regular working hours and the overtime threshold, you can calculate the number of overtime hours. Subtract the regular working hours from the total hours during the relevant period to determine the overtime hours.
  4. Determine the overtime rate: The overtime pay rate is higher than regular hourly pay. This rate is typically set at one and a half times the regular hourly wage. Some employers may have different rates for certain occasions or holidays. 
  5. Calculate overtime pay: To calculate your overtime pay, multiply the overtime hours by the overtime rate. This will give you the additional compensation you should receive for the extra hours worked.

For example, if an employee works 45 hours ‌during the week and their regular hourly rate is $30, the overtime pay would be 5 hours x $30 x 1.5 = $225.

Types of overtime  

You can offer various types of overtime, from voluntary to compulsory.

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Here are the types of overtime pay small business owners typically offer: 

  • Time off in lieu (TOIL) is the practice of granting employees time off instead of paying them for the extra hours they work. Employees can choose to take time off later in exchange for the overtime they work. 
  • Voluntary overtime is when employees willingly choose to work additional hours beyond their regular working hours. Employees generally work these hours at their own discretion.
  • Compulsory overtime is when employees must work additional hours as per the employer's requirements. This can often occur during peak season or when there is a high demand for the company's products or services.
  • Non-guaranteed overtime refers to the situation where employees are not guaranteed overtime but may still have to work extra hours when needed. Unlike compulsory overtime, employees have the right to refuse non-guaranteed overtime, although there may be consequences.

Each type has implications and considerations for both the employer and the employee. Creating and implementing an overtime policy can avoid confusion and curb overtime costs. 

Note that no policy prohibiting unauthorized overtime can relieve employers of their legal obligation to pay employees the correct wages for all hours worked.

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What to include in your overtime pay policy

An overtime pay policy should state when you allow overtime, the authorization requirements for overtime pay, and what happens when workers ignore the policy. Also, include clear instructions and consequences for employees, managers, and supervisors.

Your overtime policy should include: 

  • Amount of overtime employees can work
  • How employees can get overtime authorized
  • What will happen if employees ignore the policy

Remember, overtime policies are only effective when you apply them consistently. Many business owners make the mistake of discussing overtime policies and employee expectations during onboarding—and never again. Employees get much new information during this time and can forget specifics. Also, have your overtime policy in your policies and procedures manual. 

The most important thing is to make sure you tie your policies to legitimate business needs. Failing to do so could result in discrimination allegations. To avoid this, make sure your policies are task-oriented and uniform. Avoid anything that could be discriminatory. 

For example, if two employees are doing the same job, you cannot allow one to work overtime and not the other. It’s fine to have different wages, but it’s not fine if one employee gets preferential treatment.

An overtime policy can protect you against wage and hour disputes, but the policy must be compliant with FLSA regulations and implemented consistently.

Tips for managing overtime costs

Payroll expenses are often the biggest cost for a small business, where overtime pay adds up quickly. Knowing this, many business owners discourage or prohibit employees from working overtime hours. But what happens when employees work overtime anyway? If overtime work wasn’t authorized, do business owners still have to pay? 

To ensure compliance with overtime laws, keep a close eye on your employee’s work hours and pay rates—and consider reclassifying nonexempt employees. 

Ask yourself four important questions when managing your overtime pay costs: 

  1. Are my employees close to the overtime threshold?
  2. Could a small salary increase turn those employees into exempt employees?
  3. Would an annual bonus push them over the threshold?
  4. Have I misclassified them in the first place? 

There are rare instances where employers don’t have to pay unauthorized overtime. If the employer knows or has reason to know of the overtime, then the employer must pay for the overtime. 

You’ll want to train managers and supervisors on budgeting and managing overtime. Direct them to monitor the time worked to ensure employees are aware of potential issues.

Next step for streamlining your payroll process 

After you have an understanding of the federal and state overtime pay laws, it’s time to implement a system for accurately tracking your employees' weekly working hours and calculating overtime pay using your overtime pay rates. 

A time tracking tool like QuickBooks Time with seamless integrations for efficient payroll and invoicing ensures accurate and fair compensation for your employees but also saves time and reduces administrative burdens.

Overtime pay FAQ

Here are small business owners’ top questions about overtime pay: