Michael Lodge, NCPM, CRTP - When I owned a healthcare staffing firm in Los Angeles a few years back the term "differential pay" was brought up a lot when contracting with hospitals and other types of healthcare providers. Nurses especially wanted to know the answer depending on the facility they were going to be placed at. Some medical facilities pay it and some don't, so you have to make sure that you have a policy that states the use of differential pay and know what facilities get it. But below is a good exercise for us to understand how differential pay is used and paid. Happy reading.
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Shift differential is non-mandatory premium pay offered by a company to eligible employees. Neither the Fair Labor Standards Act (FLSA) nor any state laws require shift differential. However, some businesses offer this premium pay to employees in various situations as an added benefit for working under certain conditions such as overnight or holiday shifts. We offer tips on creating your own shift differential policy below, along with a free template you can use.
If your business is considering a shift differential policy for your employees, you may benefit from time tracking software like Homebase to help keep employee hours straight. To adhere to accurate pay calculations around shift differential consider using payroll software.
How Shift Differential Works
Because shift differential isn’t required by law, employers have flexibility within their policies. You may choose to offer employees a flat dollar amount per hour or, more commonly seen with salaried employees, a percentage. For example, if you need an employee who makes $15 per hour to work security overnight at an apartment complex, you may offer them an additional $3 per hour in shift differential pay for hours worked between 8 p.m. and 8 a.m.
No matter what, though, if you offer shift differential pay, you should have a policy in place to clarify which employees and shifts are eligible to avoid any confusion.
Calculating Shift Differential
In most cases, only hourly employees are eligible for shift differential. However, some companies want to offer this benefit to salaried employees as well. Because there is no law mandating this type of premium pay, companies are free to offer shift differentials to all or just certain classes of employees.
Be aware of employee classification as it relates to shift differentials. Your business may have two different classes of employees: exempt and non-exempt. Under the FLSA, exempt employees are not subject to overtime laws and, therefore, not eligible for overtime pay. Non-exempt employees are, however. Understanding the difference between these two classifications will help keep your business compliant.
Salaried Employees
If you expect your salaried employees to regularly work odd or undesirable hours, you can add shift differentials to every paycheck. This will make payroll easier for you by providing these employees with a flat supplement on every paycheck.
You may also choose to offer premium pay based on the hours the salaried employee works. This is more complicated and requires detailed time keeping records, something salaried employees aren’t always ready to do. Instead, you may decide to pay shift differential pay as an annual or quarterly bonus.
Hourly Employees
Calculating shift differentials for hourly employees is not as difficult as it may seem. Because hourly employees already record their hours in your time keeping system, you will know exactly how much shift differential pay they’re entitled to.
Where it can become confusing is in calculating overtime. The FLSA has strict rules regarding overtime pay. Some states even go beyond the FLSA, mandating additional overtime pay in certain situations. Under the FLSA, overtime pay is calculated at one and a half times the employee’s regular hourly rate. So, if an employee is paid $10 per hour, they must receive an additional $5 per overtime hour worked.
To calculate overtime pay for an employee entitled to shift differential pay, you need to determine their new base rate.
An employee worked 50 hours last week. They make a regular rate of $10 per hour and five of their 50 hours were eligible for shift differential at $2 per hour.
You owe the employee for 40 hours of regular pay (40 x $10 = $400). Five more hours are regular overtime (5 x $15 = $75). The final five hours are subject to shift differential pay, making the employee’s base rate for those five hours $12 per hour.
Now we need to calculate the overtime rate for those final five hours (1.5 x $12 = $18) and then determine the total rate for those five hours (5 x $18 = $90).
Putting it all together ($400 + $75 + $90 = $565). For these 50 hours worked, you would owe the employee $565. Because the employee worked overtime during a period where they were entitled to shift differential pay, they are getting time and a half for the shift differential period. This creates even more incentive for the employee to help you cover those less desirable hours.
You may be interested in learning how to calculate overtime for hourly and salaried employees. Also, check out our related guide to the exemptions from minimum wage and overtime rules.
Creating Your Shift Differential Policy
Your next step is to create your shift differential policy that works for your business. You can download our free shift differential policy template as a guide to create your own. To make sure that your policy covers the important pieces and your employees clearly understand what work qualifies for premium pay, you need to develop a policy that includes several key elements listed here.
Eligible Work Hours
Your policy should specify the hours that are eligible for premium pay. As you can see in the University of Pennsylvania’s Shift Differential Policy, hours worked between 5 p.m. and 8 a.m. Monday through Sunday are specified as qualifying for additional compensation. I suggest listing all hours that your business is open and tagging them as either eligible or ineligible to avoid confusion.
Calculation of Shift Differential Pay
Describe how your payroll team will calculate shift differential pay. If you’re going to use more than one method, make sure you state clearly the different methods and when they apply.
Eligible Employees
Don’t list employees by name but rather by job title or classification. For example, you may wish to only offer shift differential pay to hourly, non-exempt employees. Or, if you operate a 24/7 diner, you may wish to offer this premium pay only to servers. The El Paso County Shift Differential Policy, for example, lists temporary and regular full-time and part-time non-exempt employees as eligible, with exempt employees specifically excluded.
Exceptions
You may have exceptions to your rules above, so list them. The best shift differential policies leave nothing to the imagination—describe everything in detail, as the University of Maryland Medical System does in its comprehensive shift differential FAQ.
Types of Shift Differential
There are several common types of differential pay to understand.
Common in manufacturing, shift differential and overnight pay offer premium pay to people working shifts other than the day shift. Typically during daylight hours, the day shift is considered the regular shift, or first shift, for workers. Second and third shifts, covering the late evenings and overnight, are less desirable times to work.
To reward employees who work second and third shifts, many companies will offer shift differential pay. This ends up adding additional pay to an employee’s hourly rate by working a less desirable shift, frequently overnight. It’s a win-win because the company gets to keep operating at full capacity 24/7 and the workers are able to make more money for the same work they would have done during the first shift.
Pros and Cons of Paying Shift Differential
Shift differential pay has historically been a significant benefit to offer that helps set your business apart from the competition. By providing premium pay, you can attract and retain top talent in your industry, reducing your hiring and retention costs.
You’re probably thinking that all of this is great but, ultimately, it’s going to cost your company more money. Initially, it will. Higher salaries mean more outgoing payroll and taxes, cutting into your margins. But don’t look at this increased cost in a vacuum. You can save money in other areas—such as staffing, turnover, employee engagement, just to name a few.
PROS/CONS
Gain a competitive advantage and attract better talentHigher payroll costs Improve morale and reduce turnover Resentment from ineligible employees Increase employee productivity Operational challenges complying with city and state overtime laws
Industries That Commonly Offer Shift Differentials
Shift differentials are not common in every industry. Businesses that operate during normal business hours rarely need to offer shift differential pay.
Any company may choose to offer shift differentials, but most commonly this type of premium pay is offered in four industries: restaurants and retail, manufacturing, customer service, and healthcare.
If your company operates in one of these industries, you would be wise to consider what your competitors offer. Even if none of your competitors offer shift differential pay, offering it to your employees might be a way to set yourself apart from your competitors and make yourself a best-in-class employer.
Many restaurants and retail establishments are open late, some 24 hours a day. To keep the shop running smoothly overnight or into the late evening hours, many businesses offer shift differential pay to employees working late and overnight hours.
Bottom Line
When your company operates beyond the traditional 9 to 5, you may look for ways to incentivize employees to work outside those hours. Shift differential pay is a great way for you to recognize your employees who work less desirable hours and attract high-quality employees. It’s also a great way to set yourself apart from your competition, especially if you’re the only business offering shift differential pay. With no laws requiring shift differential, you have a lot of flexibility. The key is creating a clear, comprehensive policy.
Even with a policy in place, however, calculating shift differentials can be a challenge. But you have a simple solution—payroll software. With a robust platform working for you, automating hourly, salary, overtime, flat-rate, and percentage shift differentials is easy. Gusto provides your business with everything you need to pay your employees correctly every time.
WRITTEN BY: Charlette Beasley, PUBLISHED JUNE 28, 2021
