Retroactive pay, or retro pay, is a financial correction made by employers when an employee has been underpaid in previous pay periods. It involves calculating and paying the difference between what the employee was paid and what they should have been paid. 

How is Retro Pay Calculated?

Calculating retro pay involves several steps:

For Hourly Employees:

• Determine Gross Wages Paid: Calculate the total wages paid for the hours worked.
• Calculate Correct Wages: Compute the correct amount including any overtime pay at the proper rate.
• Calculate Retro Pay: Subtract the amount initially paid from the correct amount to find the retro pay due.

For Salaried Employees:

• Determine Pay Periods Affected: Identify the number of pay periods affected by the salary change.
• Calculate Correct Salary: Find the correct salary amount for each affected pay period.
• Calculate Retro Pay: Deduct what was paid in those periods from what should have been paid.

Retro Pay is Taxable

Retro pay is subject to all standard payroll taxes, including FICA, federal, and state/local income taxes. Employers must withhold these taxes from the retroactive payment.

Examples of Retroactive Pay

Situations where retro pay is common include:

• Adjustment for Cost of Living Increases: If an employer announces a cost of living adjustment retroactively, employees are owed the difference for the period between the effective date of the increase and when the increase is actually applied.
• Retroactive Pay Due to Promotion: If an employee is promoted and the salary increase associated with the promotion is delayed, retro pay would cover the difference between the old and new salaries for the period of the delay.
• Delayed Annual Raises: If an employer has a policy of annual raises (e.g., based on performance reviews) but the implementation of these raises is delayed, employees are owed retro pay for the period between the review and the raise implementation.
• Incorrect Pay Grade Assignment: If an employee is initially placed in a lower pay grade and is later reclassified to a higher grade, they may be owed retroactive pay to compensate for the period they were underpaid.
• Error in Salary Negotiation Fulfillment: If an employee negotiates a certain salary but is initially paid less due to administrative errors, the difference would be made up with retro pay.
• Incorrect Payroll Calculations: If payroll calculations (due to system error or human mistake) result in an employee receiving less than their due salary, the shortfall would be corrected through retro pay.
• Bonus Payments: If an employer promises a bonus by a certain date but delays the payment, the owed amount could be given as retro pay.

How to Issue Retro Pay?

• Communication: Inform the employee about the error and the planned correction.
• Prompt Correction: Quickly calculate and issue the retroactive payment.
• Payroll System Adjustment: Use the payroll system to adjust the employee’s next paycheck.
• Compliance Check: Ensure compliance with labor laws in issuing the retroactive payment.
• Pay Stub Reflection: Ensure the retro pay is reflected clearly on the employee's pay stub.

Key Differences Between Retro Pay and Back Pay

• Retro Pay: Addresses underpayments due to payroll errors in recent pay periods, like miscalculated raises or overtime.
• Back Pay: Involves compensation for longer periods of missed payments, often related to legal disputes or settlements.

When Might Retro Pay be Court-Ordered?

Retro pay can sometimes be mandated by court orders, especially in cases involving:

• Discrimination: Underpayments due to discriminatory practices.
• Retaliation: Compensation related to unfair treatment or retaliation.
• Breach of Contract: When an employer fails to honor contractual wage agreements.
• Minimum Wage Violations: Situations where an employer has not complied with minimum wage laws.

Importance of Accurate Payroll Practices

Maintaining accurate payroll records and promptly addressing any discrepancies is vital to avoid the need for retroactive payments. Regular audits and careful tracking of wage changes, overtime, and commissions can significantly reduce the likelihood of errors that lead to retro pay situations.

Employer Responsibilities for Retro Pay

Employers are responsible for ensuring all employees receive the wages they are entitled to. This includes monitoring pay rates, overtime calculations, and staying updated with any changes in employee contracts or salary structures. When errors are identified, employers must act swiftly to correct them and issue any owed retro pay.