Earlier this month, a federal judge issued a decision that could have significant financial implications for employers. The case involved the calculation of the overtime rate under the Fair Labor Standards Act (FLSA) and whether merit bonuses and other forms of compensation must be included in the calculation of the rate of pay for FLSA overtime.

In Gilbertson v. City of Sheboygan, Case 2015-cv-139 (E.D. Wis. 2/5/16), the federal court for the Eastern District of Wisconsin ruled that lump-sum bonuses must be included in the calculation of the FLSA overtime rate. Surprisingly, the court also held that payments made through certain types of Health Reimbursement Accounts (HRA) must also be included in the FLSA overtime rate. In addition, the parties agreed that cash-in-lieu of health insurance payments and education bonuses must also be included in the FLSA overtime rate. This decision serves as a reminder of the need to carefully monitor your compensation plans and payroll practices, and serves as an example of the type of FLSA litigation that is sweeping the country.

Background

In 2011, the City of Sheboygan implemented a new compensation plan which included a pay for performance system for its non-represented employees. Employees were evaluated based upon factors such as quality and quantity of work, job knowledge, safety, dependability and attendance. The compensation system provided discretion to department heads to delay or deny merit adjustments if employees were not performing at an acceptable level. However, all employees who were rated as either “successfully achieved” or “exceeds” expectations on their performance review were eligible for a wage increase. Beginning in 2013, the City determined that, based on their performance rating, employees could receive either a wage increase or a lump sum bonus payment if the employees were at the top of the pay range. The City did not factor the lump sum bonus into the “regular rate” used to calculate the FLSA overtime rate.

In the benefits area, the City offered a cash-in-lieu of health insurance option, which paid employees for not enrolling in the group health insurance plan. The City also offered a Health Reimbursement Account (HRA) to reimburse employees for some of their medical expenses. The City used a third party administrator (TPA) to process and pay eligible claims in accordance with the IRS regulations. Typically, the TPA would pay the portion of the claim covered by the HRA and then would bill the City for the amount that it paid, but on occasion, the TPA would issue a check directly to the employee as reimbursement for qualifying medical expenses. The City did not create a trust account to administer the HRA plan; instead the TPA would pay claims from an account drawn from the City’s general fund.

The Federal Court Decision

In December, 2014, three City employees filed a federal lawsuit against their employer alleging that the City failed to include lump sum bonus payments, education incentives, cash-in-lieu of health insurance payments and HRA payments in the calculation of their FLSA overtime rate. During the litigation, the City stipulated that the education incentives and cash-in-lieu of health insurance payments should have been included in the calculation of FLSA overtime. The City disputed that lump sum bonuses and HRA payments should be factored into the FLSA overtime rate, but the federal court ordered the City to include these payments in the calculation of overtime.

Lump Sum Payments. The City argued that the lump sum bonus payments should be excluded from the calculation of FLSA overtime because they are discretionary, uncertain and not tied to hours worked. U.S. Department of Labor (DOL) regulations state that lump sum payments can be excluded from overtime calculations if the fact of the payment and the amount of the payment are solely at the discretion of the employer, and not offered under a contract, agreement, or promise resulting in the employee expecting such payment. The court agreed that the City did retain discretion over whether to grant a bonus; however, the court held that the bonuses were “promised” to employees who reached a certain rating in their performance evaluations. Applying the DOL regulations, the court concluded that bonuses which serve to induce employees to work more rapidly, steadily or efficiently must be included in the FLSA overtime rate and that is the type of bonus program at issue in this case. The court also noted that the same performance evaluation system was used by the City to award wage increases and those increases were factored into the FLSA overtime rate.

HRA Reimbursements. Perhaps the biggest surprise is the court’s determination that HRA reimbursements must be included in the employees’ overtime rate. The court considered two possible exceptions under the DOL regulations which could have excluded HRA reimbursements from the calculation of FLSA overtime. The first exception requires that irrevocable contributions be made to a trustee or third party administrator. The court held that this exception did not apply to the City’s plan because the contributions were not made “irrevocably” to a third party; instead, the TPA paid the medical claims and then received reimbursement directly from the City. The second exception applies to payments made for travel and other expenses incurred by the employee to further the employer’s interests. The court held that the HRA reimbursements were for the benefit of the employee and did not further the employer’s interests. Therefore, the HRA payments must be included in the regular rate used to calculate FLSA overtime.

Conclusion

This decision serves as an important reminder to employers to review and monitor their compensation and benefit programs and payroll practices. All employers who offer lump sum bonuses, cash-in-lieu of health insurance payments, and HRA reimbursement plans should review their policies and plans to ensure that they comply with the FLSA. Any bonus payments to nonexempt employees should be evaluated to determine if the payments should be included in the calculation of the FLSA overtime rate. The court decision on HRA payments appears to be a case of first impression and may be overturned if an appeal is filed. In the meantime, employers should review their HRA plan documents to ensure that they are properly structured to avoid an FLSA issue.

If you have any questions or concerns, or would like to discuss this decision in more detail, please contact Attorney Matt Flanary at (262) 364-0253 or mflanary@buelowvetter.com, or your Buelow Vetter attorney.