The regular rate exclusions: employee benefit and profit sharing plans

I know you woke up this morning wondering if you have to include payments under a savings or profit sharing plan into the regular rate when you pay overtime. No? I know I did.

The answer is probably not, if your plan is a bona fide profit sharing plan under the FLSA. The FLSA excludes employee benefit plans in two provisions. The first refers to “a bona fide profit-sharing plan or trust or bona fide thrift or savings plan” and leaves it up to the Department of Labor to specify requirements for those plans. 29 CFR § 778.200(a)(3). You probably get legal help of some kind in the employee benefits area – now is a good time to use it. The regulations governing employee benefits are fairly specific. So I will give you the shorthand version, and if you need help, call your trusty labor lawyer.

Under the regs, a “thrift or savings plan” is a program “for the purpose of encouraging voluntary thrift or savings by employees by providing an incentive to employees to accumulate regularly and retain cash savings for a reasonable period of time or to save through the regular purchase of public or private securities.” 29 CFR § 547.1(b). A profit sharing plan is a program “for the purpose of distributing to employees a share of profits as additional remuneration over and above the wages or salaries paid to employees which wages and salaries are not dependent upon or influenced by the existence of such profit-sharing plan or trust or the amount of payments made pursuant thereto.” 29 CFR § 549.1(b). In English, a profit-sharing plan is an extra benefit to employees, not part of their main compensation package.

The thrift or savings plan provisions and the profit sharing plans provisions share a few key themes. Number one, the plan needs to be a “definite program or arrangement.” 29 CFR §§ 547.1(b), 549.1(b). In other words, the plan needs to actually be a plan. Number two, there needs to be a provision for which employees participate, which is somewhat flexible, except that it may not be based on performance or efficiency. 29 CFR §§ 547.1(c), 549.1(d)(1)-(2). You can, however, exclude people based on work schedule – so for purposes of overtime, you need not include the high school kid who comes in to water the plants for an hour every two weeks in your profit sharing plan. 29 CFR §§ 547.1(c), 549.1(d)(1). Number three, there must be a formula for determining the amounts paid to employees, which can be based on straight-time pay, base rate of pay, or length of service. 29 CFR §§ 547.1(d), 549.1(e). So you have a fair amount of flexibility as far as who gets what, as long as that is not dependent on performance or efficiency. 29 CFR § 549.1(a).

Savings plans and profit sharing plans share some pitfalls, too. Payments under a plan cannot be excluded from the regular rate if the amount an individual gets is dependent on production, efficiency, or hours worked. 29 CFR §§ 547.2(c), 549.2(e). Participation in a savings plan must be voluntary. 29 CFR § 547.2(a), and employee wages cannot be offset or affected by the savings plan or profit sharing plan. 29 CFR §§ 547.2(b), 549.1. And that is key to excluding these types of plans. In short, what you can’t do is disguise “pay” as “profit sharing” and still exclude if from the regular rate calculation. Don’t try it, you will get caught.

Again, this is a quick version, so call your lawyer if you are trying to set up a program for the first time or if your program’s features have not been reviewed in a while.

Some companies also choose to compensate their employees with stock options. Back in the late nineties, while you were panic-buying Beanie Babies, the Department of Labor found that if an employer offered stock options as a form of compensation and the employees exercised the option and made a profit, that profit had to be included in the regular rate. This announcement caused an epidemic of heart palpitations in HR professionals around the country. After this determination by the DOL, Congress passed the Worker Economic Opportunity Act, amending the FLSA so that profits made on exercised stock options are not included in the regular rate if the stock option program complies with certain requirements.

These requirements are relatively simple, but specific. Number one, the employer must communicate the terms and conditions of the program to employees, either when the options are granted or when the employee begins participating. 29 CFR § 778.200(8)(i). Number two, the options must not be exercisable within the first six months after the grant, and the option’s exercise price must be at least 85% of the stock’s fair market value at the time of the grant. 29 CFR § 778.200(8)(ii). The statute makes exceptions for employees who die, become disabled, or retire before the 6 month period is over, and the limitation also does not apply if there is a change in corporate ownership. Number three, the employee’s exercise of the option must be voluntary – easy enough. 29 CFR § 778.200(8)(iii). Number four only applies if eligibility to participate in the program is tied to performance. If they are, the grants must be tied to the performance of a business unit of at least 10 employees, not individuals, or the entire plant. 29 CFR § 778.200(8)(iv)(A). However, the grants can be based on the duration of an individual’s service or a minimum schedule of hours or days worked. Employers can also base grants on past performance of individual employees, but only if the determination is discretionary and not pursuant to a contract. 29 CFR § 778.200. If you need a refresher on the true meaning of discretionary, see my post on discretionary bonuses.

There’s more to talk about in the employee benefits and incentives area, but we’ll leave it for next time.