Reducing Hours and Pay of Exempt Employees May Run Afoul of "Salary Basis" Test

The U.S. Department of Labor's Wage & Hour Division has issued two new opinion letters addressing circumstances under which employers may not reduce the hours of exempt employees without running afoul of the "salary basis" test and risking loss of the employees' exempt status.  

First, some background.  Employees exempt from the FLSA's minimum wage and overtime requirements as professional, executive, or administrative employees must be paid a salary of at least $455 per week. Under 29 C.F.R. § 541.602(a),

[a]n employee will be considered to be paid on a "salary basis" . . . if the employee regularly receives each pay period . . . a predetermined amount constituting all or part of the employee’s compensation, which amount is not subject to reduction because of variations in the quality or quantity of the work performed. . . . An employee is not paid on a salary basis if deductions from the employee’s predetermined compensation are made for absences occasioned by the employer or by the operating requirements of the business. If the employee is ready, willing and able to work, deductions may not be made for time when work is not available.

In the first opinion letter, the employer sought to reduce the hours worked by employees using the following system:

Your client proposes occasionally reducing the hours worked by exempt employees due to short-term business needs (e.g., low patient census). In such cases, the employer offers “voluntary time off” (VTO), where employees may, at their option, use paid annual, personal, or vacation leave, but continue to accrue employment benefits. The employer approves VTO on a first-come, first-served basis. If there are insufficient volunteers for VTO, the employer requires “mandatory time off” (MTO) under a seniority-based rotational method. Exempt employees required to take MTO may use accrued paid leave or take unpaid MTO. If the employee elects not to use accrued paid leave or does not have sufficient accrued paid leave to cover the VTO or MTO, the employer deducts the amount equal to the VTO or MTO from the employee’s salary, if it is shorter than one workweek. For unpaid VTO or MTO lasting an entire workweek, the employer does not pay the salary for that pay period. Salaried exempt employees may take VTO or be assigned MTO in one-day increments.

The DOL opined that salary deductions due to MTO lasting less than a workweek violate the salary basis requirement and may cause the loss of exempt status.  "Deductions from salary due to day-to-day or week-to-week determinations of the operating requirements of the business are precisely the circumstances the salary basis requirement is intended to preclude." 

In the second opinion letter, the employer proposed requiring salaried exempt employees to stay home or leave work early during periods of insufficient work.  The employer would deduct the non-work time from the employees’ accrued paid time-off accounts. The employees would receive their regular salaries so long as they had sufficient hours in their PTO accounts to cover the non-work periods. If an employee’s accrued PTO was exhausted, the employee’s salary would be reduced in full-day increments, except that in no event would an employee’s salary be reduced below the $455 per week.

The DOL opined that this proposal would also run afoul of the salary basis test. 

If an employer requires that an exempt employee work less than a full workweek, the employer must pay the employee’s full salary even if: (1) the employer does not have a bona-fide benefits plan; (2) the employee has no accrued benefits in the leave bank; (3) the employee has limited accrued leave benefits, and reducing that accrued leave will result in a negative balance; or (4) the employee already has a negative balance in the accrued leave bank. 

The DOL also opined that if an exempt employee’s accrued PTO is exhausted and the periods of insufficient work continued, the employer would not be permitted to send the employee home and pay him a reduced salary for the week.  The DOL distinguished this situation from the scenario discussed in a 1970 opinion letter, in which the employer was considering a permanent change in the work schedule from 52 five-day workweeks to 47 five-day workweeks and 5 four-day workweeks. "In that case," the DOL noted, "the salary basis requirement was not circumvented because all the exempt employees were to be paid according to a bona fide reduction of one-fifth of their salaries for a fixed schedule of five annually recurring four-day workweeks."

The distinguishing principle was stated in a 1995 DOL opinion letter:

... a fixed reduction in salary effective during a period when a company operates a shortened workweek due to economic conditions would be a bona fide reduction not designed to circumvent the salary basis payment. Therefore, the exemption would remain in effect as long as the employee receives the minimum salary required by the regulations and meets all the other requirements for the exemption.

My takeaway from these opinion letters is this:  Employers that are considering reducing their exempt employees' hours due to insufficient work must proceed very carefully.  Reducing exempt employees' hours of work, and reducing their pay correspondingly, may be permissible if the changes are carried out in accordance with a fixed schedule over an extended period of time.  An employer may not make reductions in work hours and pay based on day-to-day or week-to-week determinations of how much work is available.  Such reductions will run afoul of the salary basis test, risk forfeiture of the employees' exempt status, and expose the employer to overtime claims from the employees when their workload increases.     

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