Imagine an hourly employee works 43 hours in a week. Payroll pays 3 hours at time-and-a-half for the overtime, and 38 hours at straight time. That's only 41 hours of paid work for 43 hours worked — two hours simply vanish from the paycheck.
Is that legal? As of June 2026, the answer depends entirely on which federal circuit your business operates in — and the U.S. Court of Appeals for the Third Circuit just handed down a ruling that a lot of payroll systems are quietly getting wrong.
The Case: Secretary of Labor v. Comprehensive Healthcare Management Services
The ruling came out of an enforcement action the U.S. Department of Labor brought against Comprehensive Healthcare Management Services LLC, a Pennsylvania company operating 15 nursing, rehabilitation, and assisted-living facilities with roughly 6,000 employees. After a bench trial, a district court found "system errors" in how the company calculated pay and ruled for the DOL. Comprehensive Healthcare appealed.
On June 3, 2026, the Third Circuit sided with the employer on a narrower — but very consequential — legal question: does the Fair Labor Standards Act (FLSA) let workers sue for "overtime gap time"?
What "Gap Time" Actually Means
Gap time is the technical term for hours worked that are neither paid at straight time nor at the overtime premium — they just aren't paid at all, in a week where the employee also worked enough hours to earn overtime.
Using the example above: an employee works 43 hours. Overtime law requires the employer to pay time-and-a-half for the 3 hours over 40. But if the employer's system only counts 38 "regular" hours plus 3 overtime hours, 2 hours of work go completely uncompensated. Because the workweek's average hourly rate can still land above minimum wage once you blend in the overtime premium, this kind of shortfall can slip past a superficial compliance check — it's a rounding or scheduling error, not obvious wage theft, and it's exactly the kind of thing that hides in a payroll spreadsheet for years.
The Department of Labor argued that the FLSA's "regular rate" provisions in Section 207 implicitly require employers to pay for every hour before calculating the overtime premium, and that gap time is therefore recoverable under federal law. The Third Circuit disagreed, holding that "when the statutory language is clear, the text is the beginning and the end of our inquiry" — and that the FLSA's text simply doesn't create a gap-time remedy. One judge dissented, arguing the statute's language on this point is "far from clear."
A Circuit Split Small Employers Need to Know About
This isn't settled nationally. The Third Circuit's ruling aligns it with the Second Circuit, both of which now say gap time claims aren't cognizable under federal law — workers in those circuits have to look to state wage law instead. The Fourth Circuit reached the opposite conclusion in Conner v. Cleveland County, holding that FLSA protections do extend to gap time.
That split matters for two reasons even if you're not in litigation:
- Federal law isn't the only exposure. In circuits where gap time isn't an FLSA claim, many states still prohibit it under their own wage-payment statutes. "The FLSA doesn't cover this" is not the same as "this is legal everywhere."
- Circuit splits often get resolved by the Supreme Court. A payroll practice that's currently low-risk in your circuit could become high-risk with one appellate decision elsewhere, or a future cert grant. Building clean timekeeping now is cheaper than defending it retroactively across a multi-year class period.
Why This Matters More for Small Businesses Than It Looks
Big companies with dedicated payroll compliance teams and modern time-and-attendance software are the least likely to have gap-time errors in the first place. The businesses most exposed are the ones running payroll through a mix of spreadsheets, manual time cards, and averaging shortcuts — which describes a lot of small operations with hourly staff: restaurants, retail, home health, salons, warehouses, and trades.
The Wage and Hour Division doesn't need a gap-time theory to come after a small employer — off-the-clock work, misclassified overtime-exempt roles, and excluded bonuses in the "regular rate" calculation remain the most common findings in DOL enforcement actions, and back-wage recoveries routinely run into the hundreds of millions of dollars a year across all FLSA violation types. A recent DOL action recovered $1.7 million in back wages for 1,666 hourly employees denied overtime by a single multi-trade contractor — a reminder that these cases aren't hypothetical for mid-size operators.
What Small Business Owners Should Do
- Audit how your payroll system rounds and buckets hours. If your system (or your bookkeeper's spreadsheet) separates "regular" and "overtime" hours using anything other than a straightforward 40-hour-per-week threshold, have someone who understands FLSA math check it against actual clock-in/clock-out data.
- Never average hours across pay periods to smooth out overtime. Overtime is calculated on a workweek basis, period — averaging two weeks to avoid a 41st hour in either one is a violation regardless of how the gap-time question shakes out.
- Include all required pay in the "regular rate" before calculating overtime. Non-discretionary bonuses, shift differentials, and certain commissions must be folded into the regular rate; leaving them out is a distinct and very common violation.
- Check your state law, not just the FLSA. If you're in the Third or Second Circuit and assuming gap time is a non-issue federally, confirm your state's wage-payment law doesn't independently require it — many do.
- Consider the DOL's PAID program if a self-audit turns up a real gap. It lets employers self-report and pay back wages without the liquidated-damages penalty that usually doubles the cost of an FLSA violation, though it does require giving up the option to negotiate a lower settlement later.
Keep Your Payroll Records as Clean as Your Books
Wage-and-hour exposure almost always traces back to the same root cause as messy bookkeeping: nobody can reconstruct, after the fact, exactly what happened and when. Plain-text accounting with Beancount.io gives you a version-controlled, fully auditable ledger — so if a payroll question ever turns into a DOL inquiry or a lawsuit, your financial records aren't the weak link. Get started for free and keep every number traceable from day one.