How Wages Work


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Very few of us work for free. But not everyone gets paid in the same way. You might be paid hourly, on a salary, by commission or work mostly for tips. Many different federal and state laws govern how much people can be paid and when. These laws also dictate how much we have to pay for taxes and whether certain jobs, like ones that require overtime or dangerous work, should pay more.

In this article, we’ll explore all aspects of wages -- from the legal side, to the types of wages, to taxes, to how much money you’ll finally take home. Because there are so many different state laws concerning wages, we’ll focus mainly on federal law. It’s always a good idea to check with a labor lawyer or your state’s Department of Labor to learn more about laws that may apply to your state.

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The Fair Labor Standards Act (FLSA) is the most important law covering wages. Originally passed in 1938 but amended many times since, the FLSA sets standards for minimum wage and overtime pay, affecting most private and public employees. A nice feature of this law is that wherever it may overlap with state law, the law dictating higher standards is obeyed. This feature has become especially important with minimum wage, allowing individual states, cities and counties to pass their own minimum wages laws that are higher than the federal minimum wage.

The Act applies to all employees involved in interstate commerce, a definition that is generally very broad -- a business that receives telephone calls or mail from other states may be deemed to be engaging in interstate commerce. Firms that do more than $500,000 in business annually are usually covered under ­the act, and the following businesses are covered no matter their volume of business:

  • Government agencies
  • Hospitals
  • Institutions that take care of the sick, elderly or disabled
  • Schools

Domestic service workers are covered if they earn at least $1,400 in wages from an employer in a year or if they work more than eight hours a week. To figure out if you’re exempt from the FLSA, contact your local Wage and Hour Division Office or check out the Department of Labor’s Employment Law Guide.

Next, we'll look at minimum wage and other provisions of the Fair Labor Standards Act.

 

 

 

Child Labor and Hazardous Work

The FLSA sets standards for wages that help to determine how much many workers will be taking home come payday.
The FLSA sets standards for wages that help to determine how much many workers will be taking home come payday.
Photo courtesy Stephen Coburn/StockXpert

The Act requires employers to pay at least the federal minimum wage and 1.5 times the regular rate of pay for overtime. It also contains provisions regarding which jobs minors can do and the hours they can work. Children under 16 years of age are allowed to do nonagricultural work, but children under 18 years of age are prohibited from doing work that’s considered “too dangerous” - meaning the work could potentially present a health or safety hazard. According to the U.S. Department of Labor, some examples of hazardous work are:

  • working with or around explosives
  • working with heavy equipment, such as power-driven saws, metal working machinery and manufacturing equipment
  • logging and sawmill work
  • working with radioactive materials
  • demolition work
  • roofing or other intense height-related work
  • operating motor vehicles

The FLSA allows children under age 16 to do agricultural work, but only during non-school hours.

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The FLSA includes a prohibition against the shipment of goods produced in violation of minimum wage or overtime regulations or involving child labor. It also prohibits gender-based discrimination.

Contrary to what one might think, federal law does not require employers to give you paid vacation or sick days, overtime for working on holidays, raises, benefits of any type or a reason for termination if you’re fired. However, most employees have come to expect these perks (among others), and companies generally offer them to maintain morale among employees and to remain competitive when searching for talent.

It is a violation of the FLSA to fire or discriminate against an employee for filing a complaint or pursuing legal action under the Act. A toll-free helpline is available at 1-866-4USWAGE that provides information on how to file a formal complaint against an employer. You may also file a suit for two to three years of back pay (depending on if it was an intentional violation of the FLSA) and for damages, attorney’s fees and court fees. And in case you were wondering if anyone ever does receive back pay, more than $166 million in back wages were recovered by the Employment Standard Administration’s Wage and Hours Division in fiscal year 2005 [ref].

In the next section we'll look at the different types of pay.

Types of Pay

The value of the federal minimum wage has shown an overall decline since its 1968 peak of $7.71 (in 2006 dollars).
The value of the federal minimum wage has shown an overall decline since its 1968 peak of $7.71 (in 2006 dollars).

Sometimes getting paid isn’t as simple as drawing a salary or getting paid by the hour. Let’s look at some of the different types of pay.

Minimum Wage

Minimum wage is a frequent topic of debate. As of May 2007, the federal minimum wage stood at $5.15 an hour. For the average fulltime worker, that’s only $10,700 a year, which can make supporting oneself -- much less a family -- very difficult, especially in big cities where property values and rents are high. The inflation adjusted value of this minimum wage is the lowest amount in 50 years [ref]. Twenty-eight states do have a minimum wage greater than $5.15 an hour.

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Although the minimum wage has not been raised since 1997, the Democratic leadership has promised a raise to $7.25 an hour over the next two years. Opponents of raising the minimum wage claim that it would cause unemployment by forcing small businesses to lay-off workers. Some economists disagree, while others, such as Harry Holzer of the Georgetown Public Policy Institute, claim that any rise in unemployment would be offset by other positive effects [ref].

Minimum wage laws still apply to salary workers. A salary employee’s regular rate cannot be less than the minimum wage and is calculated by dividing the salary by the number of hours for which the salary compensates. Here’s an example:


Salary: $25,000/year

Hours worked: 40 hours a week * 52 weeks a year = 2080 hours


Regular rate: $25,000 / 2080 hours = $12.02/hour

For information on the minimum wage in your state, check out the Department of Labor.

Overtime

As long as an employee is at least 16 years old, there is no limit to how many hours an employer can require him or her to work, though overtime must be paid for all hours beyond 40 worked per week. Employees who earn a salary rather than an hourly wage and are either an executive, learned professional or a creative professional are exempt from overtime requirements. Outside sales employees, computer specialists earning at least $27.63 an hour, independent contractors, small farm employees and some others are also exempt. Overtime rules are also slightly different for police officers and fire fighters. Many states have passed legislation concerning overtime, so if you think you may be eligible for overtime pay, consult your state’s Department of Labor Web site.

Tipped Employees

The FLSA dictates that tipped employees can be paid a direct wage of $2.13 an hour on two conditions:

  • The employee earns at least $30 a month in tips.
  • The employee’s total income (tips plus wages) is no less than the federal minimum wage.

Some states have minimum wage laws specifically for tipped employees. Others don’t allow tipped employees to be paid less than the minimum wage, no matter how much an employee earn in tips.

In the next section we'll look at special types of pay. 

Special Types of Pay

Tipped employees can be paid a direct wage less than the minimum wage if their tips make up the difference.
Tipped employees can be paid a direct wage less than the minimum wage if their tips make up the difference.

Wage Garnishment

When a court orders a wage garnishment, an employer withholds money from an employee’s paycheck in order to pay off a debt. This money could be withheld to pay for child support or alimony. Title III of the Consumer Credit Protection Act states that up to 50 percent of a person’s disposable earnings (earnings remaining after tax, Social Security and other deductions) can be withheld to pay child support or alimony. Up to 60 percent can be withheld for other sorts of debts, and another 5 percent can be withheld if child support or alimony payments are more than 12 weeks overdue.

Commission

A commission is a sum of money given to an employee after completing a task, such as selling goods or services. A salesperson in a clothing store may earn commission based on a percentage of his sales. An insurance broker may earn a commission dependent upon how many policies she sells or for reaching a target number of policies sold.

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Commissions provide incentives for workers to be productive, but they can cause some problems. For one thing, a policy of compensation by commission can create an intensely competitive atmosphere among workers, which may actually undermine the business by creating a hostile work environment. Another concern is when employees are paid entirely by commission and don’t draw a regular wage. Not only can this method be burdensome for the employees, but it causes them to not know how much they are going to be earning from month-to-month.

Severance Pay

Severance pay is given to employees upon termination. If the termination process goes well, this can be something like a “farewell gift.” Frequently, we hear about these severance packages when large companies are forced to lay-off many employees after a major restructuring or a merger.

Severance pay is usually based on length of employment and terms set out in the employee’s initial contract. The FLSA doesn’t require employers to offer severance pay, but if you didn’t receive the severance package promised in your contract, the Employee Benefits Security Administration may be able to help.

Hazard Pay

Hazard pay is additional pay for performing dangerous or physically demanding work. It can involve work that is potentially life threatening, such as mining, or something that causes physical discomfort or stress such as working in extreme temperatures or frequent exposure to dust and other irritants. Members of the armed forces involved in combat operations are likely eligible for hazard pay. The amount or rate of hazard pay is usually based on the hardships involved and the amount of time workers spend exposed to those conditions.

Taxes

Taxes and other withholdings should be indicated on a pay stub like this one.
Taxes and other withholdings should be indicated on a pay stub like this one.

Say you just started a new job and got your first paycheck. You expected a certain amount, but this check is much smaller. What happened? Who is this FICA person, and why is he getting some of your money?

Employers are required by law to withhold some money from each paycheck in order to pay for certain taxes. These withholdings help pay for things like income tax, Social Security and Medicare.

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Payroll Tax

Employers must withhold federal and state income taxes for employees. The amount withheld is based on a W-4 form, filled out by the employee, that states his or her filing status (single or married) and number of personal allowances claimed, such as the number of dependents.

Social Security Tax

Employers withhold 6.2 percent of the maximum taxable wage base, or the maximum dollar amount subject to Social Security taxes ($94,200 in 2006). The employer also contributes this same amount out of pocket to Social Security on your behalf. For example, let’s say you earn a salary of $45,000 a year. During the course of a year of your employment, your employer would withhold $2,790 from your paycheck and contribute an additional $2,790 for a total of $5,580 paid to Social Security. Assuming you are paid twice a month, that would mean $116.25 is subtracted from each paycheck for Social Security.

The information filled out in a W-4 form determines the amount of taxes withheld from an employee's paycheck.

Other Taxes

Employers also pay 1.45 percent of wages for Medicare taxes and withhold 1.45 percent. Federal unemployment taxes are required for the first $7,000 paid to each employee, and some states require employers to pay state unemployment taxes. Unemployment tax rates vary among the states.

A summary of these taxes and all wages received appears on a W-2 Form, which an employer must give to an employee by January 31. The employer also files copies of this form with the IRS and with the state. Oh, and if you’re still wondering about FICA -- that stands for the Federal Insurance Contributions Act, the law that determines how much money must be paid toward Social Security and Medicare.

A W-2 Form contains a summary of all taxes and wages received. Employers are required to give each employee a W-2 Form by January 31.

For more information on wages, taxes and related topics, check out the links on the next page.

Related HowStuffWorks Articles

More Great Links

Sources

  • "The Minimum Wage Debate." American Enterprise Institute. 12/19/06. http://www.aei.org/publications/filter.all,pubID.25332/pub_detail.asp
  • Bernstein, Jared and Shapiro, Isaac. "Buying Power of Minimum Wage at 51 Year Low." Center on Budget and Policy Priorities. 6/20/06. http://www.cbpp.org/6-20-06mw.htm
  • "Minimum Wage." Center for Policy Alternatives. http://www.stateaction.org/issues/issue.cfm/issue/MinimumWage.xml
  • "Characteristics of Minimum Wage Workers: 2005." U.S. Department of Labor: Bureau of Labor Statistics. 5/19/2006. http://www.bls.gov/cps/minwage2005.htm
  • "Compliance Assistance by Law - The Fair Labor Standards Act." U.S. Department of Labor: Office of Comppliance Assistance Policy. http://www.dol.gov/compliance/laws/comp-flsa.htm
  • "Wage Garnishment." U.S. Department of Labor: Office of Compliance Assistance Policy. http://www.dol.gov/compliance/guide/garnish.htm
  • "Fact Sheet #8: Police and Firefighters Under the Fair Labor Standards Act (FLSA)." U.S. Department of Labor: Employment Standards Administration. http://www.dol.gov/esa/regs/compliance/whd/whdfs8.htm
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  • "Minimum Wage." Almanac of Policy Issues. 9/10/02. http://www.policyalmanac.org/economic/minimum_wage.shtml
  • "Minimum Wage Issue Guide." Economic Policy Institute. 1/2007. http://www.epinet.org/content.cfm/issueguides_minwage
  • "Money101 Lesson 18: What's FICA again?" CNNMoney.com. http://money.cnn.com/pf/101/lessons/18/page3.html
  • "OHRM - Premium Pay - Hazard Pay." U.S. Department of Commerce: Office of Human Resources Management. 8/18/05. http://ohrm.os.doc.gov/Premium_Pay/PROD01_000906
  • "Payroll Taxes." FindLaw. http://employment.findlaw.com/employment/employment-employee-wages-benefits/employment-employee-wages-benefits-taxes-payroll(1).html
  • "SERS: Social Security Integration Coverage for SERS Members." Pennsylvania State Employees' Retirement System. 11/29/06. http://www.sers.state.pa.us/sers/cwp/view.asp?a=546&Q=227405&sersNav=%7C2622%7C