DOL Endorses “Bonus Pool” Approach to Calculating Percentage Bonuses

Employers that award “percentage of total earnings” bonuses to nonexempt employees are not required to calculate supplemental overtime amounts owed due to the bonus because the bonus is deemed to already include overtime. While convenient, this approach can lead to budgetary uncertainty as the employer will not know the total amount of bonus payments until after the performance period is complete. In Opinion Letter FLSA2026-6, the U.S. Department of Labor (DOL) endorsed an alternative approach to the “percentage of total earnings” bonus, allowing employers to determine the total bonus pool amount after the incentive period is complete and then “reverse engineer” the percentage amount after the fact.

Background

The FLSA requires that employers pay nonexempt employees overtime compensation at a rate not less than one and one-half times the regular rate at which the employee is employed for all hours worked over 40 hours in a workweek. Subject to limited exceptions, an employee’s “regular rate” includes all remuneration paid to the employee. When an employee earns a nondiscretionary bonus that must be included in the regular rate, the employer must calculate the impact of that bonus on the regular rate across the entire period in which it was earned. This can impose significant burdens on employers, especially when the bonus is earned over a long period such as a calendar year.

Traditional Percentage Bonus Approach

The DOL has long recognized that recomputation of an employee’s regular rate – and the resulting additional overtime pay – are not required for a “percentage of total earnings” bonus. That is, when an employer pays a bonus expressed as a percentage of the employee’s total straight-time earnings and total overtime earnings across the incentive period, the bonus provides for the simultaneous payment of overtime compensation due on the bonus. In other words, the overtime due on the bonus is already being paid as part of the bonus itself. 

DOL regulations describe one type of percentage bonus, occurring when an employer applies a percentage to an employee’s straight-time and overtime earnings without regard to how the employee’s earnings compare to those of other employees. For example, an employer could announce an annual bonus program in which all employees who meet a certain performance metric during the year will receive a 10% annual bonus.

In the percentage bonus example provided in the regulations, the bonus percentage was announced prior to the performance of services. In that scenario, the employer will not know the total amount of bonus payments until after the performance period is complete. If the employees worked more overtime than expected during the year, the employer may find that the total bonus payments are higher than anticipated.

Total Bonus Pool Approach

In the opinion letter, the DOL describes a different type of percentage bonus that may provide employers with significantly more control over their incentive budgets. In this scenario, the employer determines the total bonus pool amount after the bonus period is completed. Then, the employer distributes those funds to the eligible employees based on their individual earnings expressed as a percentage of the group’s earnings. For example, let us assume that total earnings (straight-time and overtime) of all eligible employees during the incentive period was $1 million. After the bonus period is complete, the employer decided to establish a bonus pool of $100,000. If Employee A had total earnings of $50,000 during the incentive period (5% of $1 million), then Employee A would receive a $5,000 bonus (5% of the $100,000 bonus pool). If Employee B had total earnings of $75,000 during that same period (7.5% of $1 million), then Employee B would receive a $7,500 bonus (7.5% of the bonus pool). While each employee in the bonus pool receives a different percentage of the pool, they will each be paid the same percentage of their individual total earnings (in this example, 10%) – specifically, the bonus pool amount expressed as a percentage of the total earnings of all employees participating in the pool.

The most significant difference between the approach described in the opinion letter and the approach described in the DOL regulations is that in the approach described in the opinion letter, the employer can determine the total bonus pool amount after the incentive period is complete and then “reverse engineer” the percentage that will be applied. This approach provides the employer with significantly more control over their incentive budget than the approach described in the regulations, where unexpected overtime work during the incentive period could lead to higher-than-expected bonuses.

The DOL provided important caveats to its endorsement of this “bonus pool” percentage approach. 

• First, an employer may not use the percentage of total earnings approach to evade the overtime requirements of the FLSA. For example, an employer cannot award a predetermined bonus amount to eligible employees and then pretend that the award is a percentage of total earnings. In the example above, the employer could not decide to award all employees a $1,000 bonus and then announce that Employee A is receiving a 2% bonus (since $1,000 is 2% of $50,000) and Employee B is receiving a 1.3333% bonus (since $1,000 is 1.3333% of $75,000).
• Second, an employer that uses a “total bonus pool” approach and then “reverse engineers” the percentage amount based on the total earnings of all eligible employees cannot include particular items within the employees’ total earnings that were previously excluded from the regular rate of pay, such as gifts, discretionary bonuses, expense reimbursements, or employer contributions to employee benefit plans. According to the DOL, including such amounts in the calculation of total earnings could dilute the portion of the total bonus pool allocated to overtime.
• Third, the employer may include in total earnings any premium payments that are considered equivalent to FLSA overtime premiums, such as premium pay for work in excess of a daily standard or for work on a holiday or weekend.

Conclusion

The DOL’s endorsement of a total bonus pool approach will come as welcome news to employers that want to award percentage bonuses while also retaining discretion to set the total bonus amount after the incentive period is complete. The requirements for establishing a compliant percentage bonus plan are complex, however, and it is recommended that employers work with experienced counsel when establishing percentage bonus programs for nonexempt employees.