Retroactive pay is when an employer has to add compensation to an employee’s normal paycheck to make up for a deficit in an earlier pay period. It’s different from back pay, which happens when a person receives no pay for the work they did during a pay period.
Take military workers during a government shutdown, for example—they still have to work, but they don’t receive their pay until the shutdown ends.
The most important thing for you to know is this: if you find out that you owe retroactive pay, make the necessary corrections as soon as possible. The last thing you want to do is find yourself shelling out big bucks when an angry employee goes to court.
Retroactive pay usually happens because of simple payroll mistakes, like miscalculating overtime pay. But other reasons for retroactive pay are more nefarious.
Let’s take a closer look at some of the most common examples.
1. Off-Cycle Raises
Forgetting to include a raise in a paycheck is one of the most common—and innocent—reasons for retroactive pay.
Most companies have a procedure in place to manage the promotion cycle. Usually, this happens after the holidays or when a new budget cycle begins for the business. Many companies start a new fiscal year in January. Others start one in June.
Since everyone expects promotions and raises during promotion season, the payroll team has no problem remembering to include the raises in the next round of paychecks.
Not so with off-cycle raises. If someone randomly gets a promotion in May, for example, your payroll team might not be in the promotion-season mindset. They could forget to calculate that raise in your employee’s paycheck. Or maybe the manager forgot to sign off on the raise so that payroll would be ready for it.
It doesn’t really matter why it happened. What matters is that your company would owe that employee retroactive pay during the June pay period to make up for the lost income in May.
If this happens in your company, make sure you correct it ASAP. Calculating retro pay isn’t terribly hard to do. If a person making $4,000 a month gets bumped up to $5,000 a month and their raise goes into effect three months late, for example, you’ll owe them $3,000.
Just make sure you fix the problem quickly. Nothing deflates an employee’s excitement over a raise like failing to receive that first, bigger paycheck after a promotion.
2. Overtime Miscalculation
This common payroll mistake happens when an employee who’s eligible for overtime doesn’t get it. As a result, they earn normal wages when they should have been earning time and a half.
Overtime miscalculations happen because overtime can vary so much from employee to employee or season to season. It’s typically a simple human error, but it must be corrected. Employees are legally required to receive overtime wages after they work 40 hours in one week.
Calculating the retroactive pay is pretty simple. Say an employee works 60 hours per week but only gets their regular pay of $20 an hour for all 60 of those hours. Time and a half is $30 an hour for this employee, so your company failed to pay them $10 for every hour of overtime they worked.
Since they put in 20 total overtime hours, you’d owe them 20 x $10, or $200 in retro pay.
3. Delayed Commissions
If you pay your employees a regular hourly wage or salary plus commissions, you might find yourself needing to use retro pay quite a bit. Especially if customers aren’t required to pay for the sale right away.
You can’t pay your employees their cut of a commission until the customer pays, and that might be after the next regular payday.
Make it a habit to retroactively pay your employees their cut of the commission the next pay period after the customer pays. Calculate the backpay the moment you get the payment and add it to the employee’s paycheck.
The good news here is that calculating retroactive pay because of a delayed commission is super simple. All you need to do is calculate the commission.
For example, we’ll say that one of your employees earns a 10% commission from the sale of a product or service that costs $1,000. The buyer pays half the price upfront and has 30 days to pay the other half.
You pay your employee 10% of the first $500, or $50, on the next biweekly pay period. The customer pays the other half of the price, but not until the 30 days are about to be over. So you’d include this 10% of the second $500—another $50—as retro pay in the next month’s first paycheck.
4. Shift Differentials
If you pay employees more than their base wage during certain, less favorable shifts—like a graveyard or weekend shift—you pay a shift differential.
Maybe you run a nursing home or a factory or an emergency veterinary clinic. The type of place that must run 24/7/365.
How do you get employees to work the second, third, weekend, and holiday shifts? You offer them a shift differential for those hours of work.
A factory worker might get an extra 15% per hour for the third shift, for instance. If the worker receives hourly pay of $20, they’d get an additional $3 an hour for each unpopular hour worked. A nurse might rake in a 15% shift differential on a base wage of $65, sending their hourly salary for that shift up to a nice $74.75 an hour.
Keeping track of shift differentials can get tricky, especially if you don’t use time tracking software that seamlessly integrates with your payroll software. Mistakes can happen. If you fail to pay a shift differential, fix it right away!
Let’s say a nurse worked the third shift (a.k.a. the graveyard shift) at your memory care facility six times over the course of a two-week pay period. His base wage is $50 an hour. Instead of receiving his shift differential of 15% for those six graveyard shifts, he gets his base wage of $50 an hour.
First, identify how much more the employee should have been paid for each hour of work during those shifts. For example:
0.15 (the shift differential percentage in decimal form) / 50 (the base wage) = 7.5
The shift differential is $7.50. Each of the nurse’s graveyard shifts was 8 hours long. To find out how much retroactive pay you owe, you’d multiply 7.5 by 8, which gives you $60.
Since the nurse worked 6 of these shifts, you’ll next multiply 60 by 6 to get $360.
That’s how much retroactive pay you owe your employee.
5. Missed Supplemental Income
Did you forget to include an employee’s bonus, PTO cashout, or other supplemental income on their most recent paycheck?
It happens. Maybe a manager waited until the last minute to sign off on a bonus. Or maybe you got so busy you forgot it was PTO cashout time until you were flooded with cashout requests. You accidentally overlooked one of the cashout requests in the melee and now that employee is annoyed (at best) or angry (at worst).
The first thing to do is apologize to the employee. The second thing is to calculate the amount of money you forgot to pay them and submit it to payroll to be included on the employee’s next paycheck.
Say that in your company, Employees A, B, C, D, E, F, G, H, and I all requested PTO cashouts for 50 hours of their unused PTO at the end of the year. You got everyone their cashout except Employee E. You don’t know how or why, but you overlooked them completely.
Now say that Employee E makes $30 an hour. If Employee E wants to cash out 50 hours of PTO, you multiply 30 by 50 to get $1,500. That’s how much retroactive pay you owe Employee E.
6. Union Collective Agreement
Retroactive pay is common for unionized industries. If your company negotiates contracts with a union, you might find yourself owing retro pay if a contract expires. The National Labor Relations Board states that in the event a contract expires, workers will work under the terms of the expired contract until the new one is finalized.
This can take weeks, months, or even years.
Once the new contract takes over, you’ll probably owe retroactive pay, assuming the negotiated wages increase.
For example, say an expired contract gives workers a salary of $65,000 a year, which equals $5,416.60 a month. The union and the company/alliance enter into negotiations to hash out a new contract. It takes them six months to agree on, among other things, a 5% raise paid retroactively from the date of the old contract’s expiration.
To calculate how much the company/alliance would owe, take 5% of $65,000. The total—$3,250 per year—brings the yearly salary up to $68,250. Divide that number by the 12 months and you get a monthly paycheck of $5,687.50.
During the six months of negotiations, you kept paying the old monthly payment of $5,416.60. Now, you owe the employees $5,687.50 per month. The difference between these two numbers is $270.90.
Multiply that number by 6 and you get $1,625.40.
That’s how much retro pay you’ll owe your employees for the six months they worked without a new contract to take the place of the old one.
7. Court-Ordered Retroactive Pay
Hopefully, you never find yourself needing to dole out retroactive pay because a court is mandating it.
Because if you do, it means your company’s in a very sticky situation.
There are only bad reasons why a court would order an employer to pay retroactive compensation:
- Minimum wage violations that go against the Fair Labor Standards Act (FLSA)
- Discrimination against an employee or group of employees
- Contract breaches by the employer against an employee or group of employees
- Retaliation by the employer against an employee or group of employees
The only good—if you can call it that—thing about court-ordered retaliation is that the court might let you know exactly how much retro pay you must provide. You might not have to calculate it yourself.
But that barely counts in my book.
Court cases cost money. So follow the minimum wage laws to a t. Treat all of your employees equally well. Know your contracts inside and out. And avoid making any employee feel like you are retaliating against them for things like taking medical leave or having a child.
If you treat your employees well, you can avoid costly court-ordered retro pay.