When business processes involve large numbers of calculations, mistakes can happen. If payroll errors lead to paychecks being smaller than they should be, you must make up the gap with retro pay.
We’ll explain retro pay, the laws surrounding it and how to calculate it correctly.
Retro pay describes extra wages added to employee paychecks when a previous paycheck was less than the amount they should have received. Issuing retro pay as quickly as possible is essential to complying with wage and labor laws.
Retro pay isn’t quite the same as back pay, which we’ll explain later.
Retro pay typically stems from modest errors found after processing payroll that can be corrected easily. These errors include the following:
In the above cases, your company shouldn’t face legal trouble if you address the situation immediately. Acknowledge the issue with the employee, calculate the retro pay owed, add it to their next paycheck and verify that they’ve received it. You should be all set.
However, in other cases, specific laws apply.
Federal overtime rules, as outlined by the Fair Labor and Standards Act (FLSA), state that employees may pursue retro pay for unpaid minimum wages, overtime and wage increases. It doesn’t provide much of a framework beyond that. However, it does cap the time after an issue arises during which an employee can pursue retro pay. This statute of limitations is two years. If you intentionally violated FLSA provisions, this period increases to three years.
Beyond retro pay, the FLSA requires that employees be paid no later than 12 days after a pay period ends. This provision comes into play if including retro pay in a regular paycheck would mean you’re issuing it after this 12-day period. If so, you may need to issue retro pay through a separate paycheck instead of with the employee’s next regular paycheck.
As retro pay goes, state laws mostly concern wage payments upon employee termination. In many states, you must immediately pay employees the wages earned between the previous pay period and their moment of termination. Other states give you a bit more time.
Additionally, in some states, if you overpay rather than underpay an employee, you can’t ask for that money back or withhold it from future paychecks. Consult an expert in your area to learn more.
Calculating retro pay looks slightly different based on whether you do so for an hourly or salaried employee. Either way, your choice of when and how to pay depends on the factors above. If you pay retro wages in the employee’s next regular paycheck, you generally indicate the amount as miscellaneous income.
To calculate an hourly employee’s retro pay, subtract the incorrect rate you paid from the correct rate you should have paid. Multiply this difference by the number of improperly paid hours. The result is the employee’s retroactive gross wages. Be sure to withhold federal and state income taxes and other deductions from this pay.
(Incorrect rate – Correct rate) X Number of improperly paid hours = Gross retro pay
To calculate a salaried employee’s retro pay, divide the annual salary by the number of pay periods per year. For example, an employee who makes $60,000 with biweekly pay is paid 26 times per year. Their gross wage per paycheck is calculated as:
$60,000 ÷ 26 = $2,307.69
Compare that to how much the employee was paid.
For example, say an employee’s $60,000 salary reflects a recent raise. However, in the last pay period, you used the employee’s old $58,000 salary to calculate two weeks of pay, resulting in gross wages of $2,230.76 ($58,000 divided by 26). You owe gross retro pay of $76.93 ($2,307.69 minus $2,230.76).
(Annual salary at correct rate ÷ number of pay periods per year) – Actual gross salary paid) = Gross retro pay owed
The terms “retro pay” and “back pay” are often used interchangeably. However, the latter term has a harsher connotation and is often used in situations requiring legal action. Here’s how to tell the difference.
Regular pay is exactly what it sounds like. Anytime an employee receives a paycheck on their typical payday, that’s regular pay. Any money missing from this paycheck is what you’ll later issue as retro pay.
Retro pay, as explained earlier, is payments made after a pay period ends for wages accidentally not paid during that pay period. It can result from mistakenly using the wrong pay rate or number of hours worked.
Back pay is a type of retro pay in which an employee is owed all their wages for a pay period after that period’s payday. It’s what employees demand when they aren’t paid at all for a pay period.
While retro pay often stems from accounting errors, back pay may have more serious implications. The term “back pay” is often used to describe a court-ordered payment of wages owed to an employee. Courts may also require employers who owe back pay to double the amount to be paid. This fact should make it pretty clear why it’s critical to issue any money owed well before your employee threatens legal action.
Whether you’re issuing back or retro pay, the stress is similar: How can I assure the employee that I intend to pay them? How can I ensure this won’t happen again? How can I correctly calculate retro pay and tax withholding to nip this issue in the bud?
That’s where payroll software comes in.
The best payroll services and software will handle and automate all your wage calculation, payment and tax needs while helping you keep accurate paycheck records. You just need to ensure your payroll software has the correct numbers to work from. Then, you can sit back and let it calculate and issue all your paychecks.
Correct retro pay calculations must include employee and employer payroll taxes. Taxes like Social Security and Medicare are calculated as they would have been originally. Federal and state income tax withholding depends on how you issue retro pay. If paid as “supplemental pay,” you withhold federal income tax at a flat rate of 22 percent.
Consider the following payroll solutions to take the stress out of retro pay and payroll processing in general:
With today’s payroll software, paycheck mistakes should be rare. However, software calculations are only as accurate as the information added to the system, so occasional errors can happen. Whether an employee points out an underpayment or you discover it yourself, you may need to issue retro pay. Fortunately, your payroll software can do the calculations for you and solve the problem to the satisfaction of you, your employee and the taxing authorities.
Sally Herigstad contributed to this article.