Anyone who is familiar with the laws governing the American workforce has at least a working knowledge of the requirements for paying overtime compensation. Generally speaking, employees will fall into one of two categories: exempt or nonexempt. Depending on that classification, which is determined based almost entirely on job duties, an employee will or won't be entitled to overtime compensation for all hours worked over 40 hours in a workweek. A nonexempt employee who works any hours in excess of 40 during a workweek will be compensated for those hours using a "time and a half" calculation (1.5 times his standard hourly rate). By contrast, exempt employees will receive no additional compensation.

Whether an employee is classified as exempt or nonexempt is governed by the provisions of the Fair Labor Standards Act (FLSA). Although many employers frequently confuse the concept of "salaried" and "hourly" employees with the exempt and nonexempt classification, proper classification has very little to do with how an employee is typically paid. As I alluded to in the previous paragraph, an employee will be an exempt employee, and not eligible for overtime compensation, only if her job duties fall within one of the several categories set forth in the FLSA for exempt classification.

Indeed, issues with "misclassification" of employees are one of the most common sources of posttermination litigation over unpaid overtime wages. Although employers should be cautious and seek legal advice when classifying employees, that is a topic for another day. This article focuses on one of the methods employers use to calculate overtime pay: the fluctuating workweek.

An alternate method: the fluctuating workweek

Many employers are familiar with the concepts governing overtime payment, but you may not be aware of a particular method of calculating overtime that can be useful in certain circumstances. The FLSA provides for a "fluctuating workweek" to address situations in which an employee's job duties don't neatly or consistently fall within the standard 40-hour workweek.

For a number of reasons, including seasonal highs and lows, the time needed to complete the work required for certain jobs will vary within a given week. Under the standard system, a nonexempt employee's paycheck is subject to corresponding variations and inconsistencies that make both the employer's and the employee's financial planning difficult. The FLSA's fluctuating workweek is designed to level out those variations.

The basic concept behind the fluctuating workweek is to compensate an otherwise nonexempt employee on a salary basis so that he will be paid the same weekly amount regardless of whether the job required him to work a full 40 hours in a particular week. During weeks when the workload requires more than 40 hours, the employee is paid an additional "half time" for his overtime hours, rather than the standard overtime rate of "time and a half."

The rationale for the difference is that because the employee is paid on a salary basis for all hours worked, the baseline salary has already compensated him for working every hour over 40 that was required in that week. In other words, the employee has already been paid for "time," and the only additional compensation that must be paid is "and a half."

An employer that pays employees under the fluctuating workweek method must satisfy several requirements. If the requirements aren't met and the employer pays only "half time" for overtime hours under the assumption that it's following the fluctuating workweek method, it can be found liable for the remaining compensation it would have owed a nonexempt hourly employee.

The fluctuating workweek requirements can be summarized as follows:

1. The employee must be compensated on a salary basis, meaning he is paid a "fixed amount" regardless of the number of hours he actually worked in a given workweek.
2. There is a "clear mutual understanding" between the employee and the employer that the fixed salary will be compensation for all hours worked in a workweek, regardless of the number of hours actually worked.
3. The fixed salary must be large enough to compensate the employee at a rate equal to or greater than the federal minimum wage, even during workweeks when the greatest number of hours are worked.
4. The employee's hours must actually fluctuate from week to week.

The requirements allow both employers and employees to see benefits under the fluctuating workweek arrangement.

Calculating overtime based on fluctuating workweek

Under the fluctuating workweek method, an employee's overtime rate changes correspondingly with the number of hours worked because the overtime rate is calculated using his base hourly rate. Because the agreed-upon salary amount is intended to compensate the employee for all hours worked in a given week, his base hourly rate of pay will depend on the number of hours for which a given paycheck is intended to compensate. In other words, the base hourly rate is figured by dividing the employee's weekly salary by the number of hours he worked in that week.

Thus, if an employee is compensated at $1,000 per week, his base hourly rate will be $25 in a 40-hour workweek but will go down to $20 in a 50-hour workweek. The more hours he works in a workweek, the lower an employee's hourly rate will be. By contrast, if the employee in our example is able to accomplish his necessary job duties in 30 hours, he will make $33.33 per hour.

Once an employee's base hourly rate is determined for a given workweek, the additional compensation for any hours worked over 40 will be calculated at a rate equal to half of his base hourly rate. In our example, the employee earning $1,000 per week will continue to make $33.33 per hour in a 30-hour workweek and $25 per hour in a 40-hour workweek. In the 50-hour workweek, however, he must receive additional compensation for the 10 hours of overtime work.

The employee would be compensated at his base rate of $20 per hour for all 50 hours (equaling the $1,000 weekly salary), and the additional compensation for the extra 10 hours would be figured using half of his base hourly rate for that week, or $10 per hour. Thus, the employee would be paid an additional $100 (10 hours x $10), for a total compensation of $1,100 that week. By comparison, the standard overtime calculation would have compensated him at $25 per hour for the first 40 hours and $37.50 per hour for the 10 hours of overtime (1.5 x $25), for a total of $1,375.

Avoid the pitfalls

As you can see from our example above, the fluctuating workweek can be an attractive arrangement for both employees and employers. Because it encourages efficiency, an employer is able to allow employees to work fewer hours for the same rate of pay. However, the employer won't be gouged by overtime compensation during the busy season.

Still, there are a number of pitfalls for employers that attempt to use the fluctuating workweek method, any one of which can invalidate an employer's pay practices and create liability for unpaid overtime despite its honest efforts to comply with the law. Most of the pitfalls arise out of a relaxed or uninformed application of the four requirements of the fluctuating workweek method.

Courts and the U.S. Department of Labor (DOL) have strictly applied the four requirements. For example, when employees are paid additional compensation to cover "night shifts," courts have held that arrangement doesn't satisfy the "fixed-salary" requirement. Similarly, if an employee's pay is reduced for absences from work, the fixed-salary requirement is lost. Indeed, even as you read this article, there are competing appeals in two different federal courts over whether payment of merit-based bonuses removes an employee from the fixed-salary requirement.

There are a number of other mistakes that can lead to misclassifying the payment structure, which can result in liability for additional compensation as well as penalties and attorneys' fees. The best practice is always to consult a knowledgeable attorney before making any decisions about changing compensation schemes. However, if your employees are eligible for the fluctuating workweek method of overtime pay, it certainly can be a win-win solution at all levels of your company.

Thomas J. Lloyd III is a partner at Greener Burke Shoemaker Oberrecht, P.A. He can be reached at tlloyd@greenerlaw.com.