What Is Retroactive Pay?
Retroactive pay (retro pay) is back wages owed when a pay increase is approved but takes effect for periods that have already been paid. If an employee was supposed to get a raise to $22/hr starting January 1 but payroll wasn't updated until March, you owe them two months of the difference between $20 and $22 per hour, plus any overtime recalculation that results from the higher rate.
Step 1: Calculate the Base Retro Pay
For each affected pay period, multiply the rate difference by hours worked:
Retro Pay = (New Rate − Old Rate) × Hours Worked in Period
Example: $2/hr difference × 80 hours per biweekly period × 4 periods = $640 base retro pay.
Step 2: Recalculate Overtime Liability
This is where retro pay gets more expensive than expected. If the employee worked overtime in any affected period, the higher rate changes the regular rate — which changes the overtime premium owed.
Under FLSA, when you pay a retroactive wage increase, you must also pay the additional overtime premium. For each period with overtime:
- Recalculate the regular rate at the new pay rate
- Determine the additional overtime premium owed (the difference between the new and old overtime premium)
- Add this to the retro pay
Example with Overtime
Employee worked 48 hours at $20/hr. After retro raise to $22/hr:
Old OT premium: $20 × 0.5 × 8 = $80
New OT premium: $22 × 0.5 × 8 = $88
Additional OT owed: $8 per affected OT period
Tax Withholding on Retro Pay
Retro pay is wages. Withhold federal income tax (typically at the supplemental rate of 22% if paid separately from regular wages), FICA, and applicable state taxes. The retro pay is reported in the W-2 for the year it's paid, not the year it was earned — even if you're paying in 2026 for 2025 work.
Documenting the Correction
Keep a clear record of: the intended effective date of the raise, when it was actually implemented, each affected pay period, the calculation of both base retro pay and overtime adjustment, and the paycheck on which the retro was paid. This documentation protects you if there are later questions about the correction and demonstrates good-faith FLSA compliance.
Use the Retro Pay Calculator to run the period-by-period calculation automatically, including overtime adjustments.