How to Calculate FLSA Section 7(i) Overtime
If you’ve been running payroll or working in human resources for any amount of time, you’ve heard of the Fair Labor Standards Act (FLSA). Developed in 1938, this set of laws ensures fair practices between employers and employees regarding leave, wages, working conditions, hours, and more. Complying with these standards isn’t just a suggestion for companies — it’s essential to operating ethically and legally.
While there are several important regulations to keep track of with FLSA, overtime comes up frequently with payroll departments. Traditionally, overtime pay is required to be 1.5 times the employee’s regular rate of pay and is used for any hours above 40 that are accrued in a given workweek. This may seem simple for standard hourly employees, but what about employees with different pay structures such as commissions?
FLSA section 7(i) addresses this very topic for retail establishments. While you might think you are calculating overtime pay correctly, doing so for commissioned employees can be more complex than you may realize.
If you’ve heard of the 7(i) exemption, but you’re not sure what it means or if it applies to you, you’re not alone. Here, we’ll explain the 7(i) exemption in detail and show how to calculate it to remain compliant with the law.
What Is the Section 7(i) Overtime Exemption?
To understand the section 7(i) overtime exemption, let’s first look at some basic payroll formulas and terminology:
- Regular Rate of Pay - This is whatever the employee makes (hourly) for the first 40 hours in a given workweek. This rate must be at least minimum wage for the job location. For instance, the employee’s regular rate of pay might be $17.00. For a standard 40-hour workweek, that employee’s gross pay would be $680. Written out, that’s $17.00 x 40 hours = $680. Additional pay and commissions may affect this rate as well. For instance, if an employee made 40 hours of regular wages plus $300 in commissions, that makes the hourly rate $24.50 ($980/40 hours).
- Minimum Wage - This is the lowest rate a company is allowed to pay an hourly employee for the first 40 hours of work in a given workweek. While the federal minimum wage is still $7.25, many state governments have raised the minimum wage to much higher ($8.75 to $15.74). Rates vary by location, and you will need to pay your employees at least the hourly minimum wage of their working location, even if your company is based elsewhere.
- Overtime Pay - This is the rate at which employees must be paid (1.5x) for any hours worked over 40 in a given work week. According to the Department of Labor, “Unless exempt, employees covered by the [Fair Labor Standards Act] must receive overtime pay for hours worked over 40 in a workweek at a rate not less than time and one-half their regular rates of pay.” For example, if a regular hourly employee making $17.00 per hour were to work 42 hours in a given workweek, their gross pay would be $731. Written out, that’s $680 in regular wages + ($17.00 x 1.5) x 2 hours = $731.
The key phrase with overtime is “unless exempt.” Some employees are plainly not exempt from overtime pay (standard hourly workers, most union workers, etc.). However, some may be exempt from overtime pay because of additional pay that compensates for that extra 1.5x rate. The 7(i) overtime exemption is a section of the FLSA (specifically concerned with retail or service employees) that determines whether or not someone needs to be paid overtime, or if their regular wages and commissions combined suffice for overtime pay.
This exemption ensures that commissioned employees always receive the higher of two possible pay rates. For instance, imagine that an employee works overtime sales hours, but doesn’t make as many commissions during those hours. In this case, the 7(i) rate kicks in to ensure they’re paid a fair wage (with adequate overtime) regardless of whether or not they made a sale. On the other hand, if the employee did make enough commissions during that pay period to make adequate overtime, there’s no reason to pay them more than they’re owed, unless you choose to.
Three Requirements for 7(i) Exemption
Employees that qualify for the exemption don’t need to be paid overtime in addition to their regular wages during a given pay period. So, how do you know if an employee is exempt from overtime pay with the 7(i) exemption? Consult the Department of Labor (DOL).
According to federal law, there are three requirements that must be met for an employee to qualify for the 7(i) overtime exemption.
1. Must Be Paid by a Retail Establishment
First, the qualifying employee must be paid by a retail establishment. That means your company must be a retail, service, or similar business to use this exemption. According to the DOL, a retail establishment is defined as any business, “75% of whose annual dollar volume of sales of goods or services (or of both) is not for resale and is recognized as retail sales or services in the particular industry.”
Most of the time, these are consumer-facing businesses such as jewelry stores, car dealerships, etc. These establishments typically employ salespeople who are paid on commission in addition to regular wages rather than only making an hourly rate. However, this may also include businesses such as pest control services, HVAC technicians, and independent contractors (roofers, window installation, etc.). While these service businesses often employ hourly-wage workers, those employees may also make commissions from sales made on the job (e.g. if they upsell clients to another service).
2. Must Be Paid More Than 1.5x Minimum Wage
The employee’s calculated regular rate of pay (in a workweek that includes overtime hours) must be more than one and a half times the minimum wage rate for their work location in order to qualify for the 7(i) exemption.
Each pay period, you’ll need to add an employee’s regular wages and commissions, then divide that by the number of hours worked in that period. This will give you the employee’s “real” wage rate. According to section 7(i), this wage rate must be more than 1.5 times the minimum wage rate (for 7(i) overtime hours) to avoid paying overtime to the employee.
For instance, let’s say you are paying an employee working in Rhode Island, where the minimum wage (as of 2023) is $13.00/hr. When calculating their regular rate of pay and commissions, you find that the employee’s “real” wage rate for overtime that workweek is $20.00/hr. In this case, you won’t need to pay your employee overtime because they have already made more than the standard overtime rate that pay period, which is $19.50/hr.
However, if that same employee were to make a “real” wage rate of $19.00/hr, you would need to pay them overtime to compensate.
3. Commissions Must Be More Than Half of Total Earnings
More than half of the qualifying employee’s total earnings must be commissions, not just regular wages. If the employee’s regular hourly pay is $400 during a pay period, they must also receive at least $401 in commissions that same pay period ($801 total) to qualify. Of course, how much an employee earns in regular wages vs. commissions may vary over time. To remain compliant, you’ll need to reassess their 7(i) exemption each pay period.
NOTE: This assumes that 7(i) hours (hours during which an employee is specifically performing sales-related tasks) are paid only with commissions (and not a regular pay rate). There are several specific laws surrounding this, and it can get somewhat complicated to determine which examples qualify or not.
How to Calculate 7(i) Overtime Wages
Calculating 7(i) overtime wages can be a bit complicated. While there is no simple formula that works for every scenario, here are the general steps to follow for calculating payroll (for one employee/workweek) with this exemption in mind:
- Step 1: Determine Regular Pay, Hours Worked, Hour Type, and Commissions - Make sure you have all of the information you need to do the calculation. What is the employee’s regular rate of pay? What is the minimum wage for their work location? How many hours did they work during the workweek? How many of those hours were regular wages (not sales-related) and how many were 7(i) (sales/commission-related)? How much did they make in commissions?
- Step 2: Add Regular Pay and Commissions: Calculate standard payroll by determining the regular pay first. Multiply the hours worked (excluding 7(i) hours where the employee only made commissions) by the employee’s regular rate of pay. Then add the commissions earned from that workweek to get the total wages.
- Step 3: Determine “Real” Pay Rate: Divide the total wages for that workweek by the total number of hours worked (regular and 7(i) hours) to get the “real” rate of pay.
- Step 4: Compare “Real” Pay Rate to Overtime Minimum Wage Rate: Once you have the “real” rate of pay from step 3, determine whether or not it meets the standard for 1.5x the minimum wage rate for the employee's work location. The answer determines your next step.
- ~Step 4A: If the “real” pay rate is MORE than 1.5x the minimum wage rate for the employee’s work location, that employee qualifies for the 7(i) exemption during this workweek. You don’t need to calculate any additional overtime wages. Regular wages and commissions have covered that.
- ~Step 4B: If the “real” pay rate is LESS than 1.5x the minimum wage rate for the employee’s work location, you’ll need to make up the difference in extra 7(i) overtime pay. Take the “real” wage rate and divide that by 2 to get the 7(i) overtime pay rate. Multiply the number of hours worked in addition to 40 during that workweek by this 7(i) overtime pay rate. Add this amount to the employee’s paycheck (in addition to regular wages and commissions).
Example of 7(i) Overtime Pay
Here’s a hypothetical example of how this calculation looks with an employee in Rhode Island, where minimum wage (as of 2023) is $13.00/hr. Let’s say this employee makes $17.00 per hour in regular wages and made $700.00 in commissions this particular pay period.
Data - Here’s our initial information.
Regular Hourly Rate: $17.00
Minimum Wage for RI: $13.00
Minimum Wage OT Rate: $19.50
Regular Non-7(i) Hours: 10
7(i) Hours: 40
Total Hours Worked: 50 (10 Hours of Overtime)
7(i) Calculations - Here’s where we calculate the “real” hourly rate by adding commissions and regular wages, then dividing by the number of hours worked.
Regular Non-7(i) Pay: $170.00
Total Pay: $870.00
“Real” Hourly Rate: $17.40
FLSA 7(i) OT Rate: $8.70
Payroll Calculations - Here’s how these calculations would look when adding up the employee’s total paycheck for the workweek.
Regular Hours: 10 x $17.00 = $170.00
7(i) Overtime Hours: 10 x $ 8.70 = $87.00
Total Gross Pay: $957.00
Problems With Manual 7(i) Calculations
If you are still confused about how to calculate payroll and overtime pay in accordance with FLSA Section 7(i), that’s okay. This is just one of many ways in which calculating payroll manually can be very complicated. While it may be feasible to perform this calculation for one employee, doing so on a regular basis presents some serious challenges for payroll and HR departments, such as:
Inefficiency and Labor Costs
Remember, you’ll need to calculate overtime in full compliance with every section of the FLSA every single pay period. Gathering this data (likely into a spreadsheet) and doing these calculations manually will require several labor hours in your payroll cycle. For larger workforces, it may even take an entire working day. That’s wildly inefficient at best.
For a modern company competing with digitally advanced peers in the same space, doing this every pay period is a big waste of time. Every hour your team spends on payroll is more time (and labor hours) you could be spending on other key processes or improving your operations overall.
Lots of Exceptions
7(i) exemption calculations can be complicated because there are several exceptions you’ll need to account for in each pay period. Union employees and collective bargaining agreements can complicate things further. Some employees may qualify for these exemptions while others don’t. At the very least, you’ll need to develop a sorting process to calculate payroll for these employees separately.
However, you may have some weeks where an employee works 7(i) hours and some where they only work regular hours. Some weeks, employees work a combination of both, and depending on the ratio, you’ll need separate calculations to accommodate any lower wages. You need a way to efficiently determine whether or not they qualify each workweek, and how much you owe them if they aren’t exempt from overtime. Add in the fact that different employees make different wages, and you have a very complex process to run on a regular basis — just to comply with one section of the law.
Any time you are doing a manual payroll process with complex calculations, the risks of error increases. Run this process for several hundred employees over several pay periods, and you’re almost guaranteed to make a mistake.
These errors have real-world consequences. If someone (especially an hourly employee) doesn’t get paid correctly, their livelihood could be affected.. It can also cost your company a lot of money in payroll fines.
How Criterion Calculates 7(i) Overtime Pay
To prevent wasted labor hours and costly errors, look for a solution that calculates payroll automatically. Criterion has several key payroll calculations already built in (including 7(i) exemption and overtime). Here’s how it works:
- Criterion Handles All Employee Data - With Criterion as your HR system of record, all your employee data can be accessed in one location. From there, managers can easily add, manage, and edit specific custom fields such as union affiliation, job type, pay rate, and more. Employees can even update their own information, while you retain granular control over their permission levels.
- Time Entries Factor Directly Into Payroll - With self-service time tracking, employees can clock in, clock out, and specify what type of work they’re doing every time they come in for a shift. They can even do so remotely, with geofencing to keep them accountable for working at the job location. Once logged in Criterion's single unified database, the time entries instantaneously factor into payroll calculations. Uploaded commissions are factored in as well. There’s no sync process, no waiting period, and no discrepancy between payroll and HR — it’s all one database.
- Commissions and Payroll Are Calculated Automatically - Regular wage rate, hours, work type, and overtime rate (including 7(i) overtime) are all calculated automatically in Criterion. We also update our software on a regular basis to ensure compliance with the law including minimum wage rates, employee leave mandates, union rules, and more. You can then distribute payments to your entire workforce, pay taxes, and instantly make commissions and pay stubs available to employees. Once payroll calculations are complete, you can generate custom reports or send the data to your general ledger or accounting software (Acumatica, Unanet, etc.).
Calculate Payroll With Full Compliance
No matter what kind of business you do, payroll is complicated. But the FLSA standards and similar laws exist for a reason — to ensure fair pay and employment practices for everyone involved. To remain compliant and ensure your employees are paid accordingly, manual processes must be updated. You need a payroll solution you can count on to save time and ensure accuracy every single pay period.
With Criterion, you’re always in compliance. Our HCM ensures your payroll is fully compliant with FLSA section 7(i) and other key employment laws in the United States, Canada, and UK. That means you won’t need to double-check your math after each pay period. In fact, you won’t need to do the math at all. Your employees can track their time, and Criterion will calculate the rest.
See how Criterion can boost your payroll process efficiency in just one pay period. Book a demo today.