What Retroactive Pay Is and How to Calculate It

Make things right again when you accidentally underpay your employees.

A woman sits at a desk in front of a laptop holding an pay record in one hand and a check in the other, as she calculates retroactive pay.

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Retroactive pay is issued when a business owes its workers more than they were paid and need to correct the issue. 

Occasionally, businesses will run into the need to issue retroactive pay. This can happen when a raise takes effect in the middle of a pay period and workers are shorted as a result, when a contract is still in negotiation after the signing date passes, or when an accounting mistake is made and an employee is paid less than the amount agreed upon.

Retroactive Pay and the Law

Retroactive pay may also be court ordered, when a judge determines a business is guilty of:

  • Discrimination: When an employer discriminates against some group of people by giving wage hikes to only another group, for example, to all the men and no women, or to all white people and no minorities.
  • Breach of Contract: When a business deliberately breaches an employment contract and pays less than the negotiated rate.
  • Retaliation: Employers are not legally allowed to retaliate against an employee for whistle blowing by withholding raises or pay.
  • Overtime Violations: Failure to pay overtime is the most common violation.
  • Under-the-table pay: When an employer pays lower than minimum wage off the books.
  • Less than minimum wage: When an employer pays less than the law allows.

It’s important to note that state laws are complex and differ for retroactive pay, and most states have a statute of limitations with specific awards defined. Massachusetts state laws, for example, allow employees to pursue legal actions against employers for three years. If they win the case, employees are entitled to three times the amount owed.

New Mexico does not allow retroactive pay for state employees, even if a mistake is made, and some occupations and industries, including commissioned salespeople, high school students, and seasonal farm workers, are exempt from New Mexico's overtime laws.  Make sure you understand what the law requires in your state.

Regular Pay, Retroactive Pay, and Back Pay: What’s the Difference?

While these terms all apply to employee pay, the laws governing these types of pay are different.

Regular pay: This is everyday employee wages, either paid as an annual salary divided equally into regular pay periods, or an hourly rate with the amount based on actual hours worked. 

Retroactive pay: This is the difference between what you paid your employee and what you should have paid your employee. The payment amount is equal to the difference between the amount paid and the amount owed, and backdated to when the discrepancy took place.

Back pay: This is payment to catch up on payments that were never made for work performed in the past. Back pay is usually the end result of a lawsuit where an employer refused to pay wages owed. Typically, a judge gives specific orders about back pay, fees, and restitution.

How to Calculate Retroactive Pay

To figure how much an employee is owed, you need to gather some specific information:

  • Start and end dates for the pay period during which the employee was shorted
  • Number of hours worked during that pay period
  • The pay they received during that pay period
  • The pay they should have received during that pay period

In addition, you’ll need to determine how the employee is paid. Is this an hourly employee with overtime to consider or a salaried employee?

Retroactive Pay: The Math for Hourly Employees

Kelly is a cashier working at $10 an hour. She gets paid every two weeks. On May 1st, a Wednesday, a new minimum $11 minimum wage takes effect. Kelly’s pay period began on Sunday, April 28 and ends on Saturday, May 11. Kelly is an hourly employee entitled to overtime pay who worked 40 hours each week during the pay period plus four hours of overtime

Her check was issued by your accounting system at the old rate of $10 an hour and $15 for overtime hours.

$10 x 80 hours = $800
+ $15 x 4 overtime hours = $60
Subtotal = $860 (this is the actual amount she was paid)

With a little research, you determine that Kelly worked 8 hours for two days and 9 hours for one day under the old pay rate: 

$10.00 x 24 hours = $240
+ $15.00 x 1 overtime hour = $15.00
Subtotal = $255.00

Then her pay went up for the remaining period:

$11.00 x 56 hours = $616.00
$16.50 x 3 overtime hours = $49.50
Subtotal = $665.50

To calculate how much Kelly should have been paid, add the subtotals:

$255.00 + $655.50 = $920.50

And subtract the actual amount paid:

$920.50 - $860.00 = $60.50 

You owe Kelly $60.50 in retroactive gross pay.

Retroactive Pay: The Math for Salaried Employees

Calculating retroactive pay for salaried employees is a bit different. While there is rarely overtime to consider, you’re dealing with an annual amount. This might be necessary when a raise is given effective immediately, and the pay period has already started.

To calculate salaried retroactive pay, you need to know the employee’s previous annual salary, the new annual salary, and the number of days the employee is expected to work in the course of a year (payroll days). Bear in mind that some salaried employees are entitled to overtime pay.  

For example, Chris is an account executive with an annual salary of $75,000 per year. After a noticeable bump in sales generated by her division, she is given a $5,000 annual raise. As before, the first falls on a Wednesday in a two-week cycle. The pay period began on Sunday, April 28 and ended on Saturday, May 11. Her paycheck was calculated at the old rate. 

Chris’ annual pay is based on a standard calendar: 365 days minus 104 weekend days and 10 government holidays. That means she has 251 working days. To figure what you owe in retroactive pay, divide the amount of the raise ($5,000) by the number of days (251) for a per day total of $19.92. Multiply that amount by the number of working days she was paid at the wrong rate (8 days). 

$19.92 x 8 = $159.36

Your company owes Chris $159.36 in retroactive gross pay.

In most accounting software, retroactive pay has to be calculated outside the regular timekeeping system and manually entered as miscellaneous income into the payroll system. Retroactive pay is taxed at the same rate as regular pay, regardless of whether you cut a separate check to make up the difference or add it to the next paycheck.