What is Differential Pay & Why Does It Matter for HR Departments?

Conor Quinn
March 15, 2023

You’ve probably heard the phrase “differential pay” in the news, especially in discussions around wage equity. It sounds simple — people have different pay scales because they have different duties, right?

In reality, no. Differential pay is an incredibly important factor for ensuring an equitable workplace. If that’s a major goal for your workplace (and it should be), differential pay is an essential part of your payroll process. Otherwise, you may actively deprive your employees of what they truly deserve in terms of compensation.

HR is the business of ensuring employees are taken care of. Differential pay measures are an easy way to do that so that your employees notice the effects on a regular basis. Without it, you’re underutilizing one of the greatest tools in the human resources toolbox, one that can level the playing field between employees and demonstrate your commitment to pay equality as an organization.

As discussions about equal pay and protections continue on an international level, you’ll likely hear about differential pay more and more. In light of this, our team at Criterion has developed this guide to differential pay and how you can effectively use this tool within your organization.

What Is Differential Pay?

Differential pay, in a nutshell, is money bestowed in acknowledgement of an employee taking on extra money or atypical working conditions. It is an amount bestowed in addition to a regular paycheck, and is explicitly given to acknowledge that the employee is completing work that is outside of their job description or outside typical parameters of their position’s requirements.

This is not to be confused with “shift differential pay,” which is paying hourly workers more to work on shifts that are outside of normal hours (i.e. graveyard shifts). The two concepts are highly similar. But shift differential pay is much more specific. “Differential pay” is a much more expansive term that can apply to salaried workers.

Differential pay falls under different categories. It is a frequent point of discussion in union negotiations, because unions work to ensure that additional risks to employees are acknowledged by the organization. Differential pay accomplishes this and conveys a respect for the employees’ decision to take on the work. It can also be a key point of contention in collective bargaining — after all, it’s important to establish what is considered going above and beyond.

It should also be noted that differential pay is not intended to be a long-term arrangement. In other words, it isn’t a permanent part of the employee’s base pay, but a type of “extra” pay that can be bestowed on an employee for several reasons.

How To Calculate Differential Pay

Of course, it’s important to research the exact types of differentials that may affect your employees. Depending on the type, differential pay may come in the form of a percentage or flat amount. There may also be predetermined timelines for how long it will be dispersed and/or conditions for stopping it prematurely. Check to see if there are historical examples of differential pay within your organization and how it was handled or dispersed over time.

For example, say you have an employee who has taken it upon themselves to start a carpool as part of the company’s new green initiatives. If your company is based in California, you potentially award them a $100 pay differential that was created as a van incentive. You’ll recognize their extra effort and (hopefully) ease the cost of working toward a company goal.

As well, pay differentials can also be a way to recognize additional skills that allow them to be helpful to their department and the company at large. Employees of Washoe County, Nevada can enjoy a five percent pay differential for performing bilingual services during working hours. They’re eligible for this specifically if it is not required in their job description to speak Spanish — this differential is specifically to reward people with additional skills Washoe County in particular offers many unique pay differentials to its employees, including an incentive for undergoing hazard training, becoming a designated educator on a topic, and even for working in the ghost town of Vya.

That said, these are just two examples of how differential pay can be applied, but it can take several other forms depending on the situation. In general, there are a few principles that frequently apply when calculating out differential pay:

Be Explicit About Rates and Purposes

It should not be a surprise when an employee receives differential pay, and the amount they receive should not be a mystery. The surrounding policies around receiving differential pay need to be published in the employee handbook and readily accessible regardless of seniority. Differential pay is not a favor, and should theoretically be made available to all qualifying employees. It should never be seen as a privilege or a secret perk only available to those in the know.

Calculate Differential Pay Separately From Base Pay

This is especially applicable for calculating differential pay for hourly workers. It’s an easy mistake to add the rate of differential pay to the employee’s overall rate and then calculate the total. But this leads to overpay and doesn’t match the principle of differential pay being an extra addition to a worker’s base salary. Do your research and run trial calculations before officially instituting any new differential pay policy.

Apply Differential Pay Separately From Overtime

Overtime is sometimes classified as a type of differential pay, but they are fundamentally not the same. Overtime pay is awarded as a direct proportion or ratio of the employee’s base salary, and it is mandatory for companies to bestow it to eligible employees. Not all forms of differential pay are dictated by law. But the federal standard for overtime pay is time and a half, and your organization may choose to pay higher than this depending on the reasoning and cause for overtime.

It should be noted that pay differentials are not exempt from overtime. After all, atypical conditions don’t change just because someone chooses to work longer hours within them. This is why it’s important to calculate factors in the right order when determining an employee’s take-home pay.

What Can Determine Differential Pay?

Multiple factors can determine how differential pay is calculated, and often varies by the conditions around receiving the pay. Circumstances can be different between employees and may necessitate different amounts being awarded. But ideally, these differences are easily attributable and are documented to prevent unchecked favoritism.

The exact amount of a differential pay bestowment can be determined by:

Of course, this is an overview of the most common differential pay determinants. There are many others you can employ to create a more egalitarian workplace, including those around remote work and recruitment to certain positions. Explore your options within local regulations, and peruse materials from states with extensive differential pay options to get ideas on how you can better serve your employees.

Why Institute Differential Pay?

Differential pay incentivizes employees to take on difficult tasks or less glamorous work. Very few people may want to transfer from Tulsa to New York City (or any other area with a much higher cost of living). However, offering extra pay to cover the move and/or ensure that their take-home pay isn’t drastically affected may make someone reconsider the offer. It may even make the difference in remote employees feeling like equal members of the team, no matter where they work.

Differential pay is also an essential tool in creating a more equitable workplace, at least in the area of pay. Awarding extra pay can convey an attitude that everyone’s separate conditions are equally respected. For example, people who have to commute over an hour to work may feel more respected (and possibly more engaged) if given differential pay to cover the extra gasoline.

Remote workers will probably appreciate differential pay to cover the cost of broadband (or anything their in-person work colleagues don’t need to pay for) to ensure they have everything they need. If a certain team within your organization needs to “crunch” for a quarter to ensure a product is put out on time, differential pay recognizing their irregular hours may communicate that their efforts are seen and appreciated.

The final reason is purely practical: if you’re not happy with what you see in your equal pay report, implementing differential pay is a much faster way to resolve inequity than formal raises. It’s not always necessary to evaluate the base salary of an entire position over temporary conditions, and the process may take too long to positively impact employees. Differential pay can also be a less fraught method for employee relations — even if employees agree that their underpaid coworkers deserve more, it may cause tension if the solution is awarding a raise or anything other employees work to earn as part of regular work life. In this case, differential pay isn’t “earned” per se, and is designed with the intent to bring everyone to the same level.

How To Implement Differential Pay

Before differential pay can even be discussed, you need to have an idea of the “baseline” pay for the position of each recipient. If this isn’t established, you can make it official using data about those currently holding the position, job descriptions, and even unions for those in that field. Record this number, as it may be helpful for future negotiations or for comparing the impact of differential pay over time.

The exact specifics of implementing differential pay will come down to the technical needs of your HR department. But it is important to outline each type of differential pay as it applies to the individual employee. List each on a separate line of the employee’s paycheck, so all parties are aware of the impact of each type of differential pay on the total. Set explicit terms and timelines for its enactment and duration, and be clear about these to the employee.

This may all seem very complicated, and that’s because it is. Maintaining and distributing differential pay requires diligence and attention to detail. But it’s worth it to create a work environment where employees feel respected and equity is practiced at every level.

That said, many companies who run payroll using spreadsheets or other homegrown systems need to create ad-hoc solutions for every instance of differential pay. Not only is this annoying and difficult to execute, but it can also quickly get out of control. It doesn’t make for the cleanest accounting record, either. With the right software, you can codify different types of differential pay and process pay according to specific rules or pay rates automatically. Time, attention, and the right tools can help you achieve equity at your company in a lasting and immediately impactful way.

Final Thoughts

Differential pay is designed to help close the gaps between employees. It can be used to recognize differences of location, and the burden of meeting certain shifts. It will be hugely important going forward as pay equity (rightfully so) becomes a bigger topic of discussion in corporate culture. A willingness to institute differential pay measures (especially when inequity is a major concern) may become the go-to sign that your company cares about instituting equity and doesn’t just make empty promises.

However, there are dozens of pay differentials to account for when running an organization. You don’t want to miss one and potentially deprive an employee of the pay or benefits to which they’re entitled.

Criterion can help you manage the potential benefits and pay differentials for which your employees are eligible. You won’t spend hours doing calculations or research. Instead, you’ll have the help of a tool designed by HR professionals, to help make your tasks easier on a daily basis and at a company level. With our streamlined payroll solution, you’ll keep cleaner records and maintain the agility to implement differential pay for every circumstance (without reinventing the wheel each time).

Schedule a demo of Criterion and learn how you can make your company a more equitable place to work.

Conor Quinn
Partner Success Manager
HCM Software Specialist focused on client and partner success.

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