Compensation- Module 3 of 5

Compensation- Module 3 of 5


Compensation is the amount of money an employer pays to its workers for hours worked in a pay period, plus all non-cash benefits employees are entitled to.  Workers can be compensated for services performed through the exchange of anything that has current or future economic value.  In addition to wages, employees may be entitled to performance bonuses, paid time off, travel accommodations, stock options, profit sharing, access to corporate expense accounts, health insurance, and any number of other valuable benefits offered by their employers.  Compensation and benefits are regulated by a number of laws and regulations with the federal Fair Labor Standards Act of 1938 serving as the cornerstone for nearly all other compensation requirements.


Compensation Required by Law


            Since the 1930’s, federal, state, and local laws have regulated when, how, and in what amount workers must be compensated.  The following discussion highlights some of the rules that employers must follow when developing compensation packages for their employees.


Minimum Wage

The Fair Labor Standards Act (“FLSA”) created the first national minimum wage in the United States.[1]  When the law was passed in 1938, employers at that time were required to compensate covered workers at a rate of at least $0.25 per hour.  Since then, the federal minimum wage has been increased 22 times, and, following the most recent increase in July 2009, the federal minimum wage is $7.25 per hour.  Minimum wage requirements apply to at-will as well as contracted employees as long as they are working for a covered employer or are otherwise eligible for FLSA protection.[2]

Supporters of a national minimum wage point out that it protects workers from exploitation.  Opponents argue that a mandatory minimum pay rate reduces overall employment by forcing business to pay some employees more than they otherwise would.  Not all developed nations have minimum wage laws; countries such as Austria, Denmark, Italy, Switzerland, Sweden, and Norway have no national minimum wage and require salaries to be negotiated directly by employees or labor unions and employers.[3]


The Fair Labor Standards Act (“FLSA”)

The Fair Labor Standards Act creates national laws regarding compensation and overtime pay for about 130 million American workers, or about 84% of the total labor force.  While the Equal Employment Opportunity Commission enforces the FLSA’s anti-discrimination requirements (asdiscussed more extensively in Module 8), the Department of Labor administers and enforces the law’s compensation and wage rules.

The foundational rules for the payment of wages under the FLSA only apply to “covered” workers and their employers.  Public employers, including hospitals, schools, colleges, and government workers, are all covered by the FLSA.  However, coverage is not as extensive in the private sector.  Only private companies who produce goods for “interstate commerce” or that have more than $500,000 in revenue are subject to the requirements of the FLSA.[4]  Interstate commerce is a broad term that applies to any commercial activity that crosses state lines.[5]  If any goods or services used or produced by a company are bought or sold across state lines, the company is engaging in “interstate commerce” and thus subject to the FLSA.  Additionally, even if a private company operates entirely within state lines, it may nonetheless be involved in interstate commerce if it serves “as a link in a chain” of commerce that crosses state lines.  For example, a private company that has been hired to do construction on an interstate highway may be engaging in interstate commerce even if the company works and employs people in only one state.  Because the stretch of highway the company is working on is part of a larger system that crosses state lines, the FLSA likely applies to the construction company and its employees.[6]  


State and Local Minimum Wage

States and local jurisdictions are free to pass their own minimum wage laws, and all but five states – Mississippi, Alabama, Tennessee, Louisiana, and South Carolina – have established their own minimum wages.   A few states have minimum wages set at a rate below the federal minimum wage.  In these jurisdictions, the U.S. federal minimum wage of $7.25 per hour applies.  About half of the U.S. states have established local minimum wages equal to $7.25, but several states and municipalities require employers to compensate workers at higher hourly rates.[7]  For example, California and Massachusetts both require employers to pay workers at least $10 per hour.  Additionally, cities with relatively high costs of living such as Los Angeles and Seattle have enacted laws requiring a $15 per hour minimum wage – more than twice what is required by federal law.[8]  In cases where the federal minimum wage differs from the local minimum wage, non-exempt workers are entitled to the higher of the two wages.[9]  

Subminimum wage

Believe it or not, the federal minimum wage is not the lowest wage mandated by law in all circumstances.  Several classes of employees covered by the Fair Labor Standards Act qualify for what are known as “subminimum wages,” including full-time students employed in retail or service jobs, individuals whose productivity is impaired by a disability, and young people.  The purpose of the subminimum wage is to increase employment opportunities for individuals who may be less desirable hires due to inexperience or low productivity.[10]

The FLSA allows employers to pay a lower minimum wage -- $4.25 per hour rather than $7.25 per hour – to employees under the age of 20 for their first 90 days of employment.  After the young person has been employed for 90 calendar days, he or she is entitled to the regular federal minimum wage. Employers covered by the FLSA may pay new employees under age 20 a subminimum wage without the need for special approval or certification by the U.S. Department of Labor. However, employers are prohibited from reducing hours, wages, or benefits or from terminating employees in order to hire a young person at the lower subminimal wage.  The displacement of existing employees to hire someone at the youth subminimal wage is a violation of the FLSA’s anti-discrimination provisions. [11]

Upon receiving special authorization from the U.S. Department of Labor, employers may pay less than the federal minimum wage to workers with certain disabilities.  In cases where a disability actually impairs a worker’s ability to perform a job, employers may pay a wage based on the worker’s actual productivity. There is no floor to the subminimum wage paid to workers with disabilities, but the wage must be “commensurate” to the wages of workers without disabilities performing the same type of work in the same geographic area.  All subminimum wages must be reevaluated every 6 months and adjusted as appropriate.  The payment of a subminimum wage does not impact a worker’s rights regarding overtime or other benefits. [12]

In addition to young workers and employees with certain disabilities, some agricultural workers receive a subminimum wage.  Farms who employ agricultural workers for only a limited number of days per year also may be exempt from the FLSA’s minimum wage requirements that protect workers in other industries.  Furthermore, agricultural employees are not entitled to overtime pay.[13]  Some question the fairness of exempting many agricultural workers from the FLSA’s minimum wage and overtime protections, but these exemptions apply in order to provide employers with more flexibility in designing proper compensation packages for their workers.  For example, agricultural workers are often compensated based on their productivity, such as by bushel or pound of produce harvested or based on the number of crops the worker planted.  This encourages productivity in a manner that direct hourly wage does not.  Similarly, workers performing jobs classified by the federal government as “industrial homework” are also commonly paid by per-unit production rather than hourly wage.  As discussed in other sections of this course, industrial homeworkers may also receive subminimum wages if their employer is properly certified to do so by the U.S. Department of Labor. [14]



Incentive-paid or “tipped” workers receive some portion of their earnings based upon sales revenue or productivity, such as in the form of tips or commission.  Approximately 5% of the American workforce is incentive-paid.[15]   The FLSA requires the payment of at least the federal minimum wage to nonexempt employees, but tips can be included in this wage calculation. 

Employees working in industries where tipping is customary are entitled to a lower cash wage than traditional workers.  However, tipped employees also have rights to the wages they earn through tips.  An employer in an industry where tipping is standard must pay at least $2.13 per hour in direct wages.  In each pay period, the employee’s tips are added to this direct wage, and the average hourly pay must equal at least $7.25 per hour.  If the worker’s tips do not make up the difference between $2.13 and the federal minimum wage, the employer is required to make up the difference.

Employees’ tips are their property, and workers earning more than $30 per month in tips may not be required to forfeit their tips for any reason other than as a “tip credit” or to fund a valid “tip pool.”  The limited exception to this rule arises when tips are charged to a customer’s credit card.  In this case, employers may subtract the credit card company’s fee from the tips paid to the employee.  However, the employer may not pass these fees onto the tipped employee if deducting credit card fees would cause the employee’s average wage to fall below the minimum hourly wage.

The FLSA allows employers to take a portion of employees’ tips as a “tip credit” to make up the difference between the required cash wage for tipped employees and the federal minimum wage.  Currently, the minimum cash wage for tipped employees is $2.13 per hour, and the federal minimum wage is $7.25.  Thus, an employer may take up to $5.12 per hour – the difference between these two wages – as a “tip credit” from its employee.  Before claiming a tip credit, the employer must provide certain information to an employee, including:  the employee’s cash wage (which must be at least $2.13 per hour), the amount of the tip credit (which may not exceed $5.12 per hour), notice that the employer is prohibited from collecting a tip credit in excess of the tips actually received by the employee, notice that the employee is entitled to all of his or her tips except for those collected for a valid tip pooling arrangement, and that the tip credit will not apply unless the proper notices and disclosures are made.  The tip credit is not intended to be a tax on tipped employees, and it does not apply to low-wage workers.  If an employee does not receive enough in tips to make what averages out to be the minimum wage, the employer must pay the difference.  Tipped workers are usually covered by the FLSA, so their total compensation must reach at least the federal minimum wage of $7.25 per hour, or any higher amount that may be required by the jurisdiction.  State and local minimum wages can vary substantially, so tipped employees should be aware of the minimum compensation that workers in their area are entitled to.

Other than as a tip credit, employers are allowed to take their workers tips to fund a “tip pool.”  A tip pool is an arrangement under which tipped employees contribute some or all of their tips into a common fund, which is then distributed equally or proportionally to the entire staff.  Employees can be required to contribute into a tip pool if notified in advance, but like all other employment policies, tip pooling programs must be designed to avoid discriminatory impact.  Tip pooling arrangements that discriminate based on gender, race, disability, or age may expose employers to liability under federal or state anti-discrimination laws.[16] 



Many employees in retail, sales, or service establishments receive commission.  Commission is typically a fixed percentage of the revenue a worker brings to the company, such as the fees commonly taken by real estate agents or financial brokers when they close a deal.

Workers in retail service establishments are entitled to different overtime protections than other non-exempt workers under the FLSA.   Businesses who receive at least 75% of their annual revenue from the direct sale of goods or services qualify as “retail service establishments” under the FLSA.  Wholesalers and other businesses who sell goods or services for resale do not qualify as retail service establishments, only businesses who deal directly with end-use customers.

Under the FLSA’s overtime exemption for commissioned employees in retail service establishments, businesses may add an employee’s commission wages to his or her direct wages in determining the employee’s overtime pay.  If his commission makes up more than half of an employee’s earnings during a pay period, the worker is entitled to at least one and one-half of the applicable minimum wage for every overtime hour worked.  If a worker employed in a retail service industry does not make at least half of their wages in commission, regular overtime rules apply.[17]


Back Pay

Employees who receive paychecks that do not meet the minimum compensation requirements under the FLSA may be entitled to back pay.  The FLSA provides for a number of remedies for workers seeking back pay, including legal action against the offending employer by the Department of Labor or by the employee himself.  Employees entitled to back pay are subject to a two-year statute of limitations, which is extended to three years in the event the employer intentionally and willfully violated the law.  As a result, workers who believe that they are entitled to back pay should take steps to recover what they are due from their employers as quickly as possible. [18]



Overtime pay is the most prevalent type of supplemental pay required by law, with 55% of the U.S. workforce being employed in jobs where they regularly receive overtime pay.  Overtime compensation made up 2.6% of all compensation in 2007, averaging about $0.72 per worker per hour.[19] 

 Overtime pay is guaranteed for covered workers by the Fair Labor Standard Act. Employees covered by the FLSA are entitled to overtime pay if they work more than 40 hours in one workweek.  For every hour worked over 40 in a working week, employees must be paid at least one and one-half of their regular pay rate.  For workers on commission, salary, or some basis other than hourly pay, the overtime rate should be set at the average hourly rate from their total earnings. Because overtime pay is an employment right created by federal law, employees cannot be coerced to waive or give up the overtime premium.  Companies that prohibit overtime work or enforce policies stating that overtime work will not be paid unless pre-approved can place the business at risk of violating the FLSA’s overtime rules.[20]   Overtime can be compensated in the form of paid time off rather than direct wages, but the overtime premium remains the same.[21]


Some workers are entitled to hourly compensation at “prevailing wage” rates.  The prevailing wage is the hourly wage, including typical benefits and overtime, that is paid in the largest city in the worker’s area.  Employees performing what is known as “public work” are typically compensated at the prevailing wage, which is set by state labor commissions on an industry-specific basis.  The Davis-Bacon Act of 1931, passed several years before the Fair Labor Standards Act, requires federal contractors to pay prevailing wages and provide benefits to their employees. [22]   Otherwise, prevailing wage laws vary from state to state, but in general prevailing wage is paid to privately contracted employees working in a job funded by public money.  For example, mechanics working on government-owned vehicles, construction workers performing highway maintenance, and drivers employed by municipal bus systems may all be entitled to the prevailing wage.

Workers should be aware of the prevailing wage requirements in their state, as prevailing wages may be much higher than the minimum wage in the area.  For example, starting pay for a laborer entitled to the prevailing wage in the state of Washington ranges from around $25 to $30 per hour depending upon the county in which the laborer is working.  This wage is clearly much higher than the state’s already-generous minimum wage of $10 per hour, so workers entitled to prevailing wages should make sure that their employer is compensating them appropriately. [23]


Garnishment of Wages

In some jurisdictions, courts may order an employer to withhold a portion of a person’s wages to pay off a debt, such as unpaid child support or tax debts.  Wage garnishments are, by definition, involuntary, and the same legal requirements do not apply to workers who have voluntarily specified that their employers should turn over a portion of their earnings to creditors. 

Wage garnishment is based on an employee’s disposable wage, which is the amount of earnings left after all deductions for taxes, Social Security, and other mandatory withholdings are made. Under the Consumer Credit Protection Act, employers may not discharge an employee because their wages are being garnished for any single debt.  This protection does not apply to workers with garnishments for multiple debts, although the law limits how much of the worker’s pay can be taken by garnishment. 

In general, the Consumer Credit Protection Act limits wage garnishment to either 25% of the affected employee’s disposable pay or the amount by which his or her weekly disposable pay exceeds $217.50, which is 30 times the federal minimum wage.  So, an employee receiving $217.50 per week or less cannot have his wages garnished.  If this same employee makes 40 times the federal minimum wage per week, currently totaling $290, his wages can be garnished no more than $72.50 per week – the difference between $217.50 and $290.  Any amount in excess of $290 per week can be garnished to a maximum of 25% of the worker’s total salary.  The Consumer Credit Protection Act increases the maximum wage garnishment for child support or alimony debts to 60% of a worker’s disposable earnings.  Maximum garnishments for child support or alimony are reduced to 50% for workers supporting another spouse or child.[24]


[2] Center for Poverty Research. (n.d.). What is the history of the minimum wage? Retrieved from UC Davis Center for Poverty Research:

[3] Lansford, T. (2017). Employment & Workers Rights. 46. New York, NY: Mason Crest.

[4] Rassas, L. (2014). Employment Law: A Guide to Hiring, Managing, and Firing for Employers and Employees. 258. Frederick, MD: Wolters Kluwer.

[7] Center for Poverty Research. (n.d.). What is the history of the minimum wage? Retrieved from UC Davis Center for Poverty Research:

[8] Kitroeff, N. (2017, July 1). Workers celebrate L.A.'s new $12 minimum wage, businesses brace for impact. Los Angeles Times. Retrieved from

[9]U.S. Department of Labor. (n.d.). Minimum Wage. Retrieved from  

[10] U.S. Department of Labor. (n.d.). Special Employment Overview. Retrieved from Wage and Hour Division:

[11] U.S. Department of Labor Wage and Hour Division. (2008). Fact Sheet #32: Youth Minimum Wage - Fair Labor Standards Act. U.S. Wage and Hour Divison. Retrieved from

[12] U.S. Department of Labor Wage and Hour Division. (2008). Fact Sheet #39: The Employment of Workers with Disabilities at Subminimum Wages. U.S. Wage and Hour Divison. Retrieved from

[13] U.S. Department of Labor Employment Standards Administration. (2007). Child Labor Requirements in Agricultural Occupations Under the Fair Labor Standards Act. Retrieved from

[14]U.S. Department of Labor. (n.d.). Industrial Homework. Retrieved from Wages:  

[15] Wiatrowski, W. (2009). The Effect of Incentive Pay on Rates of Change in Wages and Salaries. Retrieved from

[16] U.S. Department of Labor Wage and Hour Division. (2016). Fact Sheet #15: Tipped Employees Under the Fair Labor Standards Act (FLSA). U.S. Wage and Hour Divison. Retrieved from

[17] U.S. Department of Labor Wage and Hour Division. (2008). Fact Sheet #20: Employees Paid Commissions By Retail Establishments Who Are Exempt Under Section 7(i) From Overtime Under The FLSA. U.S. Wage and Hour Divison. Retrieved from

[18] U.S. Department of Labor. (n.d.). Backpay. Retrieved from Wages:

[19] Bishow, J. (2009). A Look at Supplemental Pay: Overtime Pay, Bonuses, and Shift Differentials. Bureau of Labor Statistics. Retrieved from

[20] U.S. Department of Labor Wage and Hour Division. (2008). Fact Sheet #23: Overtime Pay Requirements of the FLSA. U.S. Wage and Hour Divison. Retrieved from

[21] Rassas, L. (2014). Employment Law: A Guide to Hiring, Managing, and Firing for Employers and Employees. 260. Frederick, MD: Wolters Kluwer

[22] 23 U.S.C. § 113

[23] Washington State Department of Labor & Industries. (n.d.). Prevailing Wage: What You Need to Know. Retrieved from Trades & Licensing:

[24] U.S. Department of Labor Wage and Hour Division. (2016). Fact Sheet #30: The Federal Wage Garnishment Law, Consumer Credit Protection Act's Title III (CCPA). U.S. Wage and Hour Divison. Retrieved from