Back Pay: What It Is and Why It's Scary for Small Businesses

Staying on top of your small business’s finances is one of the most important tasks to complete regularly. Not only does this include tracking any expenses you’ve accrued or profits you’ve made, but also ensuring your employees are being paid correctly and on time.

If overtime hours aren’t being accounted for or a member of your team feels like they’re owed money that’s rightfully theirs, you could be on the hook to provide back wages. With more than 24,000 wage compliance actions taken in 2021 alone, understanding what back pay is and under what circumstances you might be responsible for paying it is something that every business owner should know. 

Don’t panic yet. We’re here to answer all of your questions about unpaid wages and help you deal with claims for back pay from current or former employees.

First...What Is Back Pay?

Back pay is the amount of money or other benefits that an employee believes they’re owed but have never received. And it doesn’t only apply to unpaid wages for hours actually worked. 

Back pay awards can also be given for pay increases or bonuses that were promised but never materialized, or if a worker was prevented from completing something at their job and their wages were withheld as a result. Former employees can even claim back wages if they’ve been fired or let go from their position and they feel their dismissal was unfair or illegal.

If an employee is successful in their claim, your business must repay them in full for anything that is owed, as well as potentially cover administrative fees for the lawsuit itself.

Why Might You Owe Back Pay to an Employee?

Back pay can be owed to current employees for a number of reasons, including:

• Unpaid overtime, bonuses, or commissions
• Theft of wages or tips
• Miscalculation of wages
• Misclassification of non-exempt workers as exempt
• Discrimination over salaries and promotions
• Underpayment accounting errors

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You may also owe back pay to former employees as a result of a wrongful termination lawsuit. This happens when employees sue their employers for wages they believe they're owed when they were wrongfully let go.

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In addition to back pay, you may owe federal or civil penalties and/or damages if you don’t properly manage back pay.

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The most common wage violation is misclassification of workers, so make sure you’re adequately classifying employees and paying your team, and any overtime owed to them.

For contractors working on federally-funded construction projects, unpaid wages and something called liquidated damages (that’s an amount that needs to be paid when there’s a breach in the contract) can also be claimed under the Davis-Bacon Act. 

Workers performing services on prime contracts over $2,500 must be paid the federal minimum wage, so violations relating to this can also be claimed under the Service Contract Act. If you’re not sure if this applies to your business, it’s best to check the FAQs on the dol.gov site.

Although lawsuits can take several years to process, there is a set period of time that workers must file their initial claim in order to keep their eligibility for receiving back pay. 

Under current wage laws, there is a two-year statute of limitations for unintentional wage violations, and three years for willful violations.

An Example of Back Pay

Let's say that your business pays your service technicians an hourly rate. However, they're also eligible to receive a 20 percent commission for any jobs where they successfully complete an upsell.

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It's a great incentive for your technicians to promote your business' other products and services. However, due to a system error between March and June of 2021, none of those commissions were appropriately recorded and paid out.

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Your service technicians brought the issue to your attention and you immediately remedied the problem by adding those back wages from commissions to their next paychecks.

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Had you not been willing to do so, though, your technicians would've submitted their claims to the U.S. Department of Labor and you would've had to move through the legal and administrative process to determine how much back pay you owed, as well as if you were going to face any fines or penalties.

Has Coronavirus Impacted Claims for Back Wages?

As a result of the coronavirus pandemic, some businesses needed to close or significantly reduce their staffing levels. In many cases, workers were told not to report to the business location or were required to quarantine in order to prevent the spread of COVID-19. 

Under these circumstances, the usual back pay requirements may not apply. Wrongful termination cases may still be brought forward if workers were permanently removed from their positions, but most would find it difficult to prove unfair dismissal in such unique circumstances. 

Instead, employees may have been eligible for unemployment benefits under the Families First Coronavirus Response Act (FFCRA), which provided funds to terminated workers who would not usually be eligible for Social Security or unemployment benefits.

It’s best to check with your human resources team and legal counsel if an employee claims unpaid wages for time off during the COVID-19 pandemic. While you still may end up in the courtroom, a settlement may be agreed upon before it reaches that stage.

How Is Back Pay Collected?

Under the Fair Labor Standards Act (FLSA), employees are able to file claims through the U.S. Department of Labor (DOL) to get the money that they think they’re owed. Just this year, the DOL required more than $230 million be paid in back wages by businesses all over the country.

The Wage and Hour Division typically handles these cases and the Secretary of Labor may bring a lawsuit for back wages and liquidated damages against your business, on behalf of the employee. Employees can also file private suits for back pay, in addition to attorney’s fees and court costs.

An investigation will be conducted to determine whether unpaid wages are owed. The process usually looks like this:

1. You’ll be asked to provide pay stubs and additional information to determine if the claimant is an exempt employee. Under FLSA rules, exempt employees are not eligible for overtime pay, so claims for this reason would be automatically rejected.
2. If there’s suspicion that your business is recording a non-exempt employee as exempt in order to avoid paying them for overtime, this is an immediate red flag for investigators.
3. Interviews will be conducted with both the employee and employer.
4. A final decision will be made by the Department of Labor as to whether you owe back pay and if additional fines are necessary. Violating wage laws can result in civil penalties up to $1,000, while willful violations can see fines of up to $10,000 and possibly criminal prosecution.

If back wages are being sought as a result of wrongful termination, the back pay is calculated from the date of termination until the date that a judgement is reached. You may also be required to rehire that employee into their former position.

Protecting Your Small Business against Claims

While this all sounds quite alarming for small business owners, there are steps that you can take to protect your company. 

Working with an accountant and using payroll software can help you manage your finances efficiently and correctly, so that you’re always accounting for any overtime that your employees may work. Your human resources team should also be working closely with your accounting team to manage raises and promotions, along with how employees are classified in your payroll and tax systems.

If you’re concerned about the potential for wrongful termination lawsuits, it’s worth considering private employment practices liability insurance. This protects your business against claims by both current and former employees for unfair dismissal, discrimination, sexual harassment, and other employment-related problems. 

Small businesses can also add this type of insurance as an endorsement to existing business owner policies, or BOPs. This can help support you financially should the DOL rule that back wages are owed to an employee, without you having to foot the bill directly from your business.

Stay Organized and Avoid Legal Headaches

Even with the best intentions, mistakes can and do happen. If an employee comes to you asking for unpaid wages, take the time to sit with them and investigate the situation yourself. Most disagreements can be handled internally and settled quickly, without ever needing to involve the government.

The best way to avoid problems is to ensure that your records are accurate and that all of your employees are treated fairly and respectfully while in the workplace. With organized accounting and supportive leadership, back pay is hopefully something that you’ll never even have to worry about.