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How to Calculate Overtime Pay, for Small Businesses

A young woman wearing a white T-shirt and a baseball cap is standing in the middle of the photo. She's looking down at a clipboard she's holding in her left hand and seems to be copying with her right hand info from the clipboard to a sticker on a cardboard box. The box is on a table, on which a large computer screen also sits. To the back of her is a shelf full of boxes. She seems to be working in a warehouse or mail room and is exactly the type of worker who is paid by the hour and for which you'll need to calculate overtime pay if she works over 40 hours a week.

Most workers in the US know that if you work overtime, you get paid 1.5 times your normal wage. And most workers don’t mind making a little extra money from time to time. But businesses like to have steady, predictable expenditures. Having to pay overtime wages tend to make payroll unpredictable. So, many businesses avoid paying overtime by hiring a new employee. This is why business owners like yourself should understand how to calculate overtime pay, so you can control your payroll. And that’s what we’ll go over in this article.

As a reminder, this article is on US overtime pay rules. If you’re reading this from another country, be sure to check out your country’s overtime rules, so you can follow those instead.

You Don’t Have to Calculate Overtime Pay for Exempt Workers

Not every worker is entitled to overtime pay. Most people understand this, but they don’t always know where to draw the line between those who are eligible for overtime pay and those who are not. Some think that, as long as you’re a manager or you’re on salary, you’re not eligible for overtime pay.

This is wrong.

Under the Fair Labor Standards Act (FLSA), Some Categories of Workers are Exempt from Overtime Pay

In the US, the Fair Labor Standards Act (FLSA) is the main law that governs calculating overtime pay. Some states have more stringent laws that put additional requirements on top of the FLSA. Other states follow the FLSA exactly.

The FLSA carves out several categories of workers and exempt them from overtime pay. Not surprisingly, these workers are often called exempt employees. To qualify as an exempt employee, the worker has to:

  1. Make more than $684/week AND
  2. Be in one of several categories of jobs specifically named in the FLSA

There are three exceptions to the above rule:

  • Employees working on outside sales don’t have to hit the $684/week rule.
  • Employees in some computer-related jobs can either make $684/week or $27.63/hour.
  • Highly compensated employees—those who make $107,432/year (as of 2023) and still make at least $684/week on a fee or salary basis can be exempt if they work in one of the exempt categories.

Categories of Exempt Workers

Under the FLSA, the following types of workers are exempt employees:

  • Executive. Executives or department managers with hiring, firing, and promotion powers. Must manage at least 2 employees.
  • Administrative. Must do office or non-manual work directly related to management or general business operations of their employer or customers of employer (e.g. employer runs a consulting business). Job requires exercise of discretion or independent judgement.
  • Professional. Must do work in a field of science or learning (e.g. law, medicine, architecture) and use discretion or judgement when doing job. The knowledge they need to do their jobs must be learned through schooling (i.e. no apprenticeships). Category also includes creative professionals who do artistic or creative work that requires invention, imagination, originality, or talent (e.g. actors, musicians).
  • Computer. Must be software programmer, network architect, computer systems analyst, and similar doing work designing, developing, testing, documenting, or consulting on computer software or hardware.
  • Outside sales. Must work regularly outside of the employer’s office and be engaged in making sales or taking orders.

The above are the major categories. But deciding who is exempt and who is non-exempt can get very tricky. The Department of Labor gives more examples and categorizes more types of jobs in its Fact Sheets #17A-U. Some of the specific exemptions/non-exemptions include:

If you’re not sure how to categorize an employee, we recommend you check the fact sheets for the correct analysis.

You Must Calculate Overtime Pay When an Employee Works Over 40 Hours in a Week

When you’re thinking of hiring someone, one of the first things you have to decide is if you need the person full time or part time. Full time or part time might be an important distinction when deciding on who is eligible for various employee benefits like paid vacation. But it’s not important for FLSA and calculating overtime pay.

How to Calculate Overtime Pay: The Basic Rule

Under the FLSA, the only thing you need to worry about when you calculate overtime pay is whether the worker works over or under 40 hours a week. If they work over 40 hours, they get overtime.

A week is 7 consecutive days. It doesn’t matter if you start the week on Sunday, Monday, or even Wednesday. If a worker works over 40 hours in a 7-day period, then they’re entitled overtime pay for the hours worked over 40.

Unless a worker is exempt, you must pay overtime. There are no exceptions to this rule. You also can’t agree to a special pay rate for any working time over 40 hours without calculating overtime. This is true even if the special pay is more than 1.5 times the person’s regular pay rate.

An Example on Calculating Overtime Pay

Let’s say your employee is always scheduled to work 45 hours a week. You agree to pay them $450 for the 45 hours. If you paid them the minimum wage of $7.25/hour for 40 hours and then paid them 1.5 times the minimum wage for the next 5 hours, the worker would earn $344.38. In other words, by paying them $450 for 45 hours, the worker would get more than they’d get if they were paid minimum wage plus 5 hours of overtime.

But that’s not how you’re supposed to calculate overtime pay. To figure out the rate, you first find the average rate of the worker’s total hours they’re regularly scheduled to work. Here, it’s $10/hour. Then, you calculate 1.5 times the pay rate—here, $15/hour. Then, you pay the worker $10/hour for the first 40 hours worked and $15/hour for the 5 extra hours worked. So, you have to pay the worker $475 for the 45 hours worked.

The rule of thumb for calculating overtime pay is always: take the employee’s actual or effective hourly pay rate, multiply 1.5 times that rate by the number of hours over 40, and you get the overtime pay for the employee.

Some Breaks Count Towards the 40 Hours but Others Don’t

Given that calculating overtime pay depends on exactly 40 hours worked over 7 days, how do you count breaks or lunch time? Are they considered work time or non-work time?

Below are some guidance under the FLSA on what counts as work time and what doesn’t. But be aware that your state might define activities differently, so always check your state’s rules too.

Here are some typical activities and whether they usually count as work hours:

  • Breaks of less than 20 minutes typically count as work time
  • Lunch period of 30 minutes or more typically not counted as work time
  • Waiting time in between working activities counts as work time
  • Waiting time to start work does not count as work time
  • On call time while at work counts as work time
  • On call time while at home does not count as work time

Sleeping time, travel time, off-site training time may or may not count as work time. See Department of Labor Fact Sheet #22 for detailed information.

The Department of Labor has also compiled charts on minimum rest periods and meal periods for each state. Be sure to check the charts if you have questions on close cases.

You can avoid having to deal with close cases by always scheduling your workers to work less than 40 hours a week. This gives you some flexibility. Workers usually have some freedom to choose to work over their scheduled work hours—for example, to spend an extra 15 minutes to finish a project. So, if you always only schedule them to work 35 hours a week, then this gives you some cushion before you have to pay overtime.

Some Youth Workers are Never Eligible for Overtime Pay

Both the FLSA and state laws have rules on the minimum age kids can start working.

In general, kids under 14 aren’t allowed to work.

From 14 to 15, kids are allowed to work typically at restaurants and similar jobs. But they’re only allowed to work on some days and for just a few hours per day. These hours vary during school days and non-school days. Even for non-school days and weeks, they’re never allowed to work more than 40 hours a week. So, kids between 14 and 16 are never going to get overtime pay.

Kids between 16 and 17 are typically allowed to do most types of work for as long as they wish—so they might get overtime pay if they work over 40 hours a week.

For a detailed chart on the FLSA rules on hiring younger workers, see here. But always remember—your state law might be more restrictive than the FLSA. So, if you’re thinking about hiring kids 14 to 17, always check your state laws too.

Make Sure You Understand Overtime Pay Before Scheduling Work

We’ve worked for employers who were very strict about overtime pay, and we’ve worked for employers who didn’t seem to care much. It’s up to you, the business owner, whether you care. But whatever you decide, we recommend you do so mindfully. This way, you understand your payroll expenditures.

And, if you don’t want to manually calculate overtime pay every week, you can use a payroll software to help you manage everything. To save you time, we profiled some for you: Great Small Business Payroll Software.

Interested in starting and running a small business? Here’s the beginning of our step-by-step guide: What to do right after getting that great business idea.

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DISCLAIMER: This article does not constitute legal or accounting advice. Instead, it contains general information. The information gives you the background you’ll need to hit the ground running when you do go get advice from a lawyer or accountant. Only lawyers and accountants properly licensed in your state/country are qualified to give you legal or accounting advice.

Questions? Comments?