If you’re an HR manager, you’re probably well aware of the need to keep a well-organized payroll to help your organization maintain balanced finances and to keep your employees feeling well-compensated. Understanding what back pay is and how it works is critical to helping ensure the financial stability of your organization as well as the fair compensation of your workers.
Two common reasons employers owe employees back pay are promotions and retroactive pay increases. Workers also claim back payment in response to paycheck-processing errors, either due to human computation errors or glitches in payroll software resulting in underpayment. Motives for back pay aside, Payscale is here to help you understand how it all works.
What is back pay?
Back pay is unpaid salary and benefits that an employer owes their employee. Another way of explaining back pay is the discrepancy between how much compensation an employee receives and how much they earn.
Companies are often required to use back pay when they wrongfully terminate an employee (although back pay is different than severance pay), neglect to compensate an employee for work they’ve already done or for paid off time, fail to adequately provide overtime pay (as specified by the federal overtime provisions in the FSLA), fail to honor a pay raise or bonus or prevent an employee from doing their contracted work.
Both ignorant and willful violations of wage laws, whether committed by small businesses or massive corporations, theoretically empower workers to recover back pay.
How is back pay calculated?
Calculating back pay is simple. The amount of back pay your organization owes depends on whether the employee you pay is paid hourly or on a salary. To calculate back pay for hourly employees, start by counting the number of hours that the employee worked. Then, multiply the total number of hours by the hourly pay rate. Finally, adjust the hours depending on whether the employee is entitled to overtime, interest, penalties, or attorney fees.
To calculate back pay for a salaried employee, you must first determine the number of pay periods your organization has in one year. Then, divide the employee’s wage by the number of annual pay periods. Finally, multiply the result of that division—the amount the employee makes each pay period—by the number of pay periods the employee earned back pay for.
Retro pay vs. back pay
Retroactive pay and back pay are similar but not the same. Both retro pay and back pay are sums that an employer owes an employee for work completed in the past. However, while back pay is for unpaid work, retro pay is for work that’s been underpaid. In other words, retro pay is for a job that an employer already paid an employee in part but not in full. For example, an employee paid a substandard wage for hours they previously worked earns retro pay. An employee who was paid nothing at all for hours they worked earns back pay.
How does back pay work?
Legally, an employee is entitled to back pay if their employer withholds their pay. When employees are entitled to back pay, employers are required to pay it. How much an employer owes a worker in back pay depends on the worker’s wages and hours logged and whether the worker filed a lawsuit for lack of compensation.
If your employee deserves back pay and decides not to file a lawsuit, then compensate the employee for their unpaid wages. In the case of a lawsuit, however, the amount that you owe the employee increases. Once an employee files a lawsuit, the employer is also responsible for paying the employee liquidated damages, attorney fees, court costs, and unpaid wages unless the employee elects to have the U.S. Department of Labor (DOL) file the lawsuit.
Depending on how your organization’s human resources department (HR) processes payroll, the components of back pay differ from organization to organization. If you owe an employee back pay for a salary increase, fill out relevant paperwork to ensure that the employee gets paid from the proper budget, receives applicable benefits and wages, and is paid for the correct period.
Back pay is applied under several specific circumstances. A worker can claim back pay if they are wrongfully terminated, entitled to a retroactive pay increase, or paid incorrectly due to a worker misclassification, payroll calculation error, or failure to meet minimum wage or overtime wages.
The Fair Labor Standards Act (FLSA) is essential regarding back pay because the law protects employees from unfair labor practices and sets the statute of limitations on back pay recovery, which dictates how long employees have legal rights to claim back pay. (The current statute of limitations on back pay recovery is two years unless an employer intentionally withholds pay from an employee, in which case it is three years.) The FLSA also permits the U.S. Department of Labor to file a lawsuit for workers entitled to back pay.
Three examples of back pay you should know
Here are three common scenarios in which back pay applies.
1. Salaries
Employees who receive a retroactive salary increase are entitled to back pay.
2. Hourly wages (regular or overtime)
If an employee receives no pay for regular or overtime hours, that results in back pay.
3. Bonuses
If your organization commits an error when calculating organization earnings, thus preventing you from paying employees a bonus, you might owe back pay.
How to give back pay
There are two ways employers distribute back pay to their employees. One way for your organization to allot back pay is by running a separate payroll for missed wages or benefits—just be sure to label the pay stub accordingly so you aren’t confused down the road. Another way to give employees back pay is by adding it to an upcoming pay stub. Again, make sure to identify the back pay to prevent confusion.
It’s essential for employers to pay the necessary taxes when workers incur back pay. To do so, withhold normal payroll taxes in addition to your portion. Remember that how you withhold income tax depends on how you provide back pay.
Consequences of not paying back pay
Because employees who earn back pay are legally entitled to it under FLSA, withholding an employee’s back pay comes with certain consequences. Employees who claim back pay and don’t receive it are entitled to file a complaint of FLSA violations with the Department of Labor’s Wage and Hour Division.
If an employee files a complaint with the Department of Labor, the DOL may require their employer make the backward payment, receive an injunction against future FLSA violations, be sued by the Secretary of Labor, or be sued by the employee.
Reasons to claim back pay
The most frequent reason employees claim back pay is wrongful termination. Some other common reasons are minimum wage violations, unpaid overtime, unpaid bonuses or commissions, wage/tip theft, worker misclassification, and salary discrimination.
Below, we’ve included a list of four potential reasons why your employees might request back pay.
Minimum wage violations
If you accidentally or intentionally paid your employee less than the minimum wage, you owe them back pay.
Unpaid overtime
If your employee works overtime and doesn’t receive an adjusted income for those hours, they might claim back pay.
Unpaid bonuses or commissions
When a worker is owed a bonus or commission and doesn’t receive it, that’s grounds for back pay.
Wage theft/tip theft
Employees are entitled to their agreed-upon wages and tips by law, so if they don’t receive that compensation, they will likely request back pay.
3 steps to give back pay
1. Confirm eligibility
Before giving a worker their back pay, ensure they’re eligible to receive back pay in the requested amount. First, double-check with their manager and colleagues that they earned retroactive benefits or worked more hours than paid for. It’s essential to ensure that your organization spends the right amount on back pay since that sum will appear on the payroll.
2. Balance budget
Before compensating a worker with back pay, ensure that your organization’s budget approves the back pay. Additional paperwork might come into the picture if you need to pay the employee’s back pay from a separate account.
3. Update records
HR representatives are not only responsible for issuing outstanding payments but also for recording when payment occurs. Keeping a copy of paychecks, including back pay for your organization’s records, is a good idea. Taking extra steps to be organized now will make it easier to manage your organization’s HR budget in the future successfully.
5 best practices to handle back pay correctly
Read on for tips to help you effectively handle back pay.
1. Use accurate data
One of the most basic yet essential ways to ensure the proper management of back pay and to help your organization keep a balanced budget is collecting and maintaining extensive, accurate data on employees’ paychecks and pay rates, including how and when payments occur.
2. Move quickly
Avoid procrastinating when handling back pay to keep your organization in line with FLSA regulations and your employees satisfied with timely payments. It is wise to take action as soon as you learn that your organization owes back pay by updating the employee’s next paycheck.
3. Double check calculations
As an HR representative, double-checking your calculations is critical. Confirm that your numbers are correct before distributing back pay to avoid additional back pay requests.
4. Report regularly
Be sure to keep managers, employees, and accountants in the loop when updating payroll and issuing a paycheck that includes back pay. Ensuring your team is on the same page will reassure team members and prevent confusion. There are also ways to proactively discuss back pay before distributing it begins. For instance, explain how back pay fits into your organization’s promotion policies when an employee receives a promotion. Also, take the time to be transparent with the employee at your organization who is receiving back pay to manage expectations.
5. Use teamwork
Involving your colleagues in HR and your organization’s accounting and legal departments in calculating back pay is a great way to help ensure you execute organization procedures correctly.
FAQs around back pay
Can back pay be taxed?
Yes, back pay is taxable income. Back pay is considered income by the Internal Revenue Service (IRS) because an employee earns it for hours worked, just like their normal wages.
Is back pay mandatory?
Yes. According to the FLSA, employers must compensate workers promptly and regularly, including back pay.
Why do I have back pay?
If you earn back pay, you were likely unpaid by a current or previous employer. Employers commonly owe back pay in response to unpaid overtime, minimum wage violations, accounting errors, and wrongful termination.
On which tax filing year do I report back wages?
The IRS dictates that companies report back pay on the tax filing year in which they paid it to an employee instead of when an employee earned back pay.
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