Retroactive pay is pay which an employee is owed for work which has already been completed. It is often made up in the form of a lump sum in which the difference between what the employee was paid and what the employee should have been paid is made over in a check. Sometimes an agreement may be reached in which the employer disburses small payments with each paycheck until the difference has been made up. There are a number of reasons why people might be entitled to retroactive pay.
The most common reason for this situation to occur is ongoing labor negotiations. While negotiations are underway, the employer continues to pay employees at the established rate. When the negotiations are over, they may include a clause that employees are entitled to retroactive pay, starting on a set date, because part of the agreement includes a wage increase. The employer is required to make up the difference as part of the overall enactment of the agreement.
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It is also possible for an employer to offer this type of pay increase. This may be done to reward or retain employees by not only providing them with a raise, but recognizing their hard work in prior pay periods. It is important to note that, in most cases, employers cannot engage in a retroactive pay cut; if wages are to be cut, employees must be notified at the start of the pay period in which the cut takes effect so that they can decide whether to accept the cut or seek other work.
Retroactive pay can also occur when an employee identifies an error. An employee may realize that he or she is classified at the wrong grade, that math was done improperly, or that the employee was entitled to overtime and did not receive it. In these cases, the employee brings the disparity to the attention of the employer, and the employer is required to make it up. Usually people need to identify these situations within a certain time period or they will lose out on some of the pay to which they are entitled.
Employees are required to pay taxes on retroactive pay, and the pay will be reported as part of their overall wages for the given year. People should be aware that, because their withholdings may have been based on their lower income, they could end up owing money in taxes at the end of the year due to the change in pay.