Retroactive pay, more commonly known as retro pay, is the additional income added to an employee’s paycheck to compensate for mistakes made by the employer in a previous pay period.
What Are Common Reasons For Needing To Issue Retroactive Pay?
There are certain situations that cause compensation errors and require an employer to issue retroactive pay, including:
- Delayed wage increases: When an employee’s pay increase is approved (usually because of a promotion or length of service), it is not reflected in their paycheck.
- Payroll errors: When payroll mistakes, such as miscalculations, missed hours, or incorrect pay rates, are made.
- Incorrect employee classification: Misclassifying an employee may result in incorrect wages. For example, if you treat a non-exempt employee as exempt and don’t pay them for the overtime worked.
- Underpaid overtime: If you forget to multiply overtime hours by 1.5 times their usual hourly wage.
- Missed commissions: A late-paying client may delay funds for paying out commissions, meaning you owe the employee their commission as retroactive pay.
For example, if a newly promoted employee was supposed to receive a raise from a specific date but the payroll system hadn’t updated in time, the employer would need to issue retroactive pay to cover the wage difference for the affected period.
How To Calculate Retroactive Pay
To calculate retroactive pay, subtract the amount of wages an employee received from the amount they should’ve received. The difference becomes retroactive pay, which is added to the employee’s next paycheck instead of issuing a corrected or second paycheck to cover the amount.
If multiple pay periods have been affected, multiply that difference by the number of pay periods affected.
How Does Retroactive Pay Affect Payroll and Tax?
Retroactive pay is treated the same way as regular earnings for the most part.
Retroactive pay raises an employee’s taxable income in the period it’s paid, not when it was earned. This can temporarily increase federal, state, and local tax withholdings for that employee.
Employers must also factor in employee payroll taxes, such as Social Security and Medicare, when calculating retroactive pay adjustments.
Can Retroactive Pay Be Court-Ordered?
Calculating and issuing retroactive pay as quickly as possible is crucial to maintaining employee satisfaction and ensuring the company remains compliant with local labor laws.
In some cases, an employee can take their employer to court in pursuit of retroactive pay. These cases include:
- Discrimination: A group of employees receives more compensation than another due to their race, gender, or age.
- Breach of contract: An employer fails to pay the employee the negotiated rate.
- Overtime violations: An employer fails to factor in overtime hours and pay rates.
- Minimum wage violations: An employer pays an employee less than the minimum wage outlined in the Department of Labor’s (DOL) Fair Labor Standards Act (FLSA).
Retroactive Pay vs Back Pay
Retroactive pay differs from back pay.
Back pay is compensation that makes up for a pay period where an employee receives no wages at all. Whilst retroactive pay is compensation provided to an employee to correct an error in a previous pay period.
For example, if an employee worked overtime but the employer forgot to pay them at the rate of at least 1.5 times their usual wage, you owe them retroactive pay to correct the mistake. Meanwhile, if an employee works overtime but is not paid for any of the additional hours, you owe them back pay.