What defines a successful organization? It’s not just how few mistakes they make but rather how effectively they address and resolve mistakes.
Since payroll is a massive undertaking for any organization—it’s how the workforce gets paid, after all—errors are bound to arise if handled manually.
Addressing mistakes in payroll with reflexive solutions ensures that this crucial component of any organization possesses the fail-safes that keep it compliant. Retroactive pay is the most reliable process at an organization’s disposal for payroll errors.
Be ready for payroll mistakes in the future. Explore what retroactive pay is and how to handle it.
What is retroactive pay?
Retroactive pay, also known as retro pay, is paid by an employer to correct payroll errors wherein employees are paid less than they should.
If an employer fails to pay an employee owed income for any reason, they are required to ensure those funds are accounted for either in the next pay period or as a direct, one-off payment.
Retro pay is a necessary tool for an organization’s payroll; it’s how they retroactively correct payroll errors.
While failure to pay employees their entitled earnings invites trouble; failure to fix those mistakes immediately invites legal and compliance risks. With effective retro pay, organizations demonstrate their accountable compensation practices and capability to fix payroll mistakes when they arise, promoting a stronger culture.
When is retroactive pay necessary?
As its name suggests, retroactive pay is provided in hindsight. As such, organizations already familiar with common retro pay scenarios are better equipped to resolve them promptly.
Familiarity with these circumstances is essential. Preparedness for retro pay doesn’t just create faster responses; it sometimes helps prevent errors in the first place.
Here are a few instances where payroll errors tend to occur and where retro pay is a necessity.
Raises
When employees get a pay raise, payroll needs to be informed promptly. Payroll doesn’t always receive word about a given employee’s new rate after a pay bump as quickly as necessary. If the new pay rate is out of cycle with payroll, retro pay makes up the difference and updates employee pay according to their new hourly rate or salary.
Payroll errors
Mistakes happen; sometimes, the payroll system slips up, resulting in failure to pay the workforce what they are owed. In the event of payroll errors, retro pay remedies these mistakes, providing an organization with a straightforward fix for payroll slip-ups.
Overtime miscalculations
Payroll errors often occur when alternate or irregular pay rates kick in. For instance, overtime pay mistakes are sometimes curveballs for payroll; it’s easy to forget to pay overtime hours, especially when it’s a rarity in your organization.
Shift differential miscalculation
Depending on the shift, an employee might be paid different rates throughout one day or week at work. Employers add incentives for unpopular shifts, like the third shift. If payroll forgets the shift differential rate for a given shift, they have to correct the difference with retro pay.
Commissions
Many workers earn commissions, especially staffers in sales positions. Factoring in commission bonuses into an employee’s rate sometimes slips by payroll; commission pay depends on information that payroll does not know about.
Retroactive pay: Is it requested by law?
Retro pay is a fix to account for underpayment errors in payroll. But retro pay has more applications than payroll errors; if an organization is deemed negligent or even unlawful in their compensation practices, they are sometimes court-ordered to distribute retroactive pay to those affected by said practices.
Here are a few instances where an organization is legally required to issue retro pay.
Discrimination
Regrettably, discrimination still occurs in today’s workplace. Payroll is one of the more subtle ways discriminatory practices appear within an organization. All too often, employees are underpaid compared to their coworkers in the same position.
If an employee is underpaid based on their sex, race, religion, gender identity, or sexual orientation, they are entitled to retro pay as per Fair Labor and Standards Act.
Retaliation
Employees need to be free to speak their minds. There are some instances where workers are threatened with retaliation for whistleblowing about an organization’s wrongdoing or unlawful activity. Retaliatory practices like these are unlawful. Employees are entitled to retro pay if their payment is demonstrably shown to result from corporate retaliation.
Breach of contract
An employee’s contract spells out exactly what they ought to be paid. If an employer underpays an employee based on what their contract says, the employer is sometimes court-ordered to distribute restitution to the employee.
Overtime violations
As per the Fair Labor and Standards Act, employees who work more than forty hours a week are entitled to overtime pay: a time-and-a-half rate for every hour worked past forty hours. Failure to distribute overtime pay is illegal, and organizations are forced to distribute retro pay to their overtime employees.
Less than minimum wage
The Federal minimum wage is the baseline wage organizations are legally required to pay their employees, with a few irregular exceptions. If a non-exempt position pays an employee less than the Federal minimum wage, that employee is entitled to retro pay to make up the difference.
Under-the-table pay
Paying an employee under the table means that the employer does not report that income; taxes are not withheld. While under-the-table pay sometimes appears financially dubious, it is still held to the same legal FLSA standards. If an under-the-table employee is paid less than minimum wage, they are still entitled to the difference through retro pay.
Retroactive pay laws and payroll
From an organization’s standpoint, it is essential to understand the legal parameters that determine retro pay. Organizations must be familiar with the legal foundations that undergird retro pay to understand their responsibilities fully.
The chief legal basis for retro pay is the Fair Labor and Standards Act. Passed in 1938 with many addendums since, the FLSA forms the core legal foundations for overtime, the workweek, and retro pay, amongst other employee rights.
As we’ve established, mistakes happen. The FLSA acknowledges the necessity for retro pay and sets clear guidelines on issuing retroactive payments without incurring additional legal consequences. Here are a few standards organizations must follow to stay above board when issuing retro pay:
- Employers must issue retro pay for overtime miscalculations, shift differential miscalculations, missed wage increases, failure to pay minimum wage, etc.
- Employees have a statute of limitations of up to two years for retro pay entitlements; three years if employers knowingly underpaid their employees.
- Employers must make payments within 12 days; retro pay from a previous period that cannot accommodate that time frame must be issued as a one-off payment.
The FLSA sets the Federal standard that every state must follow. That said, some states have legal parameters to their retro pay specific to them. Organizations should always look to State retro pay laws in addition to Federal FLSA mandates.
What is the difference between back pay and retroactive pay?
While back pay and retroactive pay appears to be synonyms, they are not. The concepts are similar, but the details of why they are issued reveal their core difference. To wit: Back pay refers to restitutive payments made when an employer hasn’t paid an employee.
For instance, back pay triggers when an employer fails to pay an employee for a given period, i.e., they miss a payment on for biweekly check. Back pay restitutes several types of income depending on the situation: salaried pay, hourly wages, commissions, or bonuses. Simply put, if an employer misses a payment to an employee, that employee is entitled to back pay.
Whereas back pay addresses missed payments, retroactive pay addresses underpayments. As we’ve already established: If an employee didn’t get paid the full, entitled amount for a given pay period, the difference is accounted for through retro pay.
Essentially, back pay is money that hasn’t been paid yet to an employee, while retroactive pay is money that the employer owes from a previous pay period.
How does retroactive pay affect taxes?
Retroactive pay is an unfulfilled payment. Therefore, employers must factor in tax payments on those earnings when they are fulfilled. Retroactive pay taxes are subject to the same payroll taxes an employer accounts for according to the employee’s contract.
An employer who covers federal income tax, state income tax, local income tax, Social Security payments, and Medicare/Medicaid through their payroll must make the same adjustments to the retro pay.
How employers decide to make tax adjustments on retro pay depends on how they issue retro pay, as an addition to the employee’s next paycheck or as a one-off payment. When it comes to making tax adjustments to the retro pay, employers have two primary options:
- Tax the payment within an aggregate of the employee’s salaried payments or regular wages.
- Tax a percentage—typically 22 percent—of the stand-alone retro payment.
How to calculate retroactive pay
W-2 employees or 1099 contractors?Let’s examine the two most commonplace instances employers should know when issuing retro pay: Retroactive pay for their salaried and hourly employees.
1. Retroactive pay for salaried employees
Suppose a salaried employee didn’t receive sufficient payment after a salary increase. To rectify using retro pay, payroll must identify their old and new annual salaries and the number of pay periods within the year.
For a specific example: An employee earning 50,000 dollars was given a 5,000 dollar raise, paid bi-weekly, i.e., 24 pay periods over the year.
Divide their 50,000 dollar salary by 24 to determine their gross pay for the previous pay period: 2083.33.
Then, find the new gross pay per period, dividing 55,000 by 24: 2291.67.
The difference between the two—208.34—is the retroactive pay increase payment the employee is entitled to for each pay period the new salary went unaccounted for.
2. Retroactive pay for hourly employees
With hourly employees, employers have a more granular method to restitute underpaid wages — just identify the underpaid hours.
For a specific instance: Suppose an hourly employee received a one-dollar pay bump—17 to 18 dollars an hour.
Payroll needs to find the number of hours underpaid and adjust accordingly. Suppose an employee, after the pay bump, was paid their old rate for half the week, 20 hours.
Payroll simply needs to find the amount they paid the employee (17 times 20: 340), then find the amount they were owed (18 times 20: 360).
The difference between them — twenty dollars — is the retroactive pay owed to the hourly employee.
Issuing a retroactive pay
With the retroactive pay determined, business owners must find an appropriate way to add it to the employee’s pay. As per the FLSA, employers must issue payment within 12 days, presenting them with parameters for how retro pay is dispensed.
Nevertheless, there are several ways employers issue retro pay to their employees:
- Issuing a separate, stand-alone check for the fulfilled amount
- Including the fulfilled amount on the employee’s next paycheck labeled as “RETRO”
- Adding retro pay to an employee’s gross wages in one lump sum without distinguishing it from the wages of that pay period
Retroactive pay trends and future
Retroactive pay builds trust between employees and employers. A clear retro pay program distinguishes the accountability of an organization; retro pay allows employees to hold their employers accountable for fair and equitable pay.
Any organization must implement a coherent plan for calculating and issuing retro pay. Again, the more prepared an organization is for retro pay, the better equipped they are to prevent payroll errors from spiraling into bigger problems.
Every employee wants a safe, stable work environment where they trust their hard work is properly rewarded. As organizations compete for top talent in a competitive labor market, keeping a watertight payroll program with retro pay promotes stability and confidence in the workforce.
The issue of retroactive pay will continue to be discussed in the future. Therefore, employers and policymakers should continue their efforts to ensure fair employee pay and promote a healthy and productive workforce.
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