How to prevent a FLSA suit against your company

Let’s talk about the Fair Labor Standards Act (FLSA), and how simple oversights can cause you major legal headaches.  As a background, the FLSA was passed by Congress in 1938 to protect “all covered employees from substandard wages and oppressive working hours.” Barrentine v. Arkansas Best Freight Sys., Inc., 450 U.S. 728, 789 (1981); see also 29 U.S.C. § 202(a) (stating that the FLSA protects “the minimum standard of living necessary for the health, efficiency and general well-being of workers.”). The FLSA requires that an employer pay overtime compensation to employees who work more than forty in a work week. 29 U.S.C. § 207(a)(1). The FLSA provides an exemption from the overtime requirement to “persons employed in a bona fide executive, administrative, or professional” capacity. 29 U.S.C. § 213(a)(1).

In order to classify an employee as exempt under the FLSA, the employer must be able to prove that (1) the employee performs executive, administrative, or professional duties; (2) the employee is paid at least the minimum salary level; and (3) the employee is paid on a salary basis.  Employers can find a substantial amount of guidance freely available on other legal publications and blogs regarding what duties satisfies the first requirement, and the minimum salary level required to satisfy the second requirement. However, very little guidance exists  discussing the salary basis test.

            The Department of Labor’s regulation, 29 C.F.R. § 541.602, governs the application of the salary basis test for exempt employees (i.e. salaried employees) under the FLSA. Under § 541.602, an employee is paid on a salary basis when: “(1) ‘the employee regularly receives each pay period on a weekly, or less frequent basis, (2) ‘a predetermined amount constituting all or part of the employee’s compensation,’ and (3) the amount ‘is not subject to reduction because of variations in the quality or quantity of the work performed.’”  29 C.F.R. § 541.602(a). To qualify under the salary basis test, “an exempt employee must receive the full salary for any week in which the employee performs any work without regard to the number of days or hours worked . . .” Id

            There are seven exceptions to the general rule, which are set forth in are listed in 29 C.F.R. § 541.602(b) (1) – (7).  One such exception provides that:

Deductions from pay may be made when an exempt employee is absent from work for one or more full days for personal reasons, other than sickness or disability. . . However, if an exempt employee is absent for one and half days for personal reasons, the employer can deduct only for the one full-day absence.

What does this mean?  You cannot deduct salaried employee’s salaries for showing up late. For example if you deduct a salaried employee’s paycheck for being tardy because his or her yoga class ran late, you’re violating the FLSA.

 Another exception provides, in part:

Deductions from pay can be made for absences of one or more days occasioned by sickness or disability . . . if the deduction is made in accordance with a bona fide plan, policy or practice of providing compensation for loss of salary caused by such sickness or disability. The employer is not required to pay for any portion of the employee’s salary for-full day absences for which the employee receives compensation under the plan, policy or practice. Deductions for such full-day absences also may be made before the employee has qualified under the plan, policy or practice, and after the employee has exhausted the leave allowance thereunder.   

What does this mean?  If you deduct from your salaried employee’s paycheck because he or she is sick, unless you have a PTO or sick leave policy and the employee has already exhausted the leave provided, you are violating the FLSA.

These two exceptions are easy enough, right?  Not so fast. Employers had best make sure their deductions are “proportionate” to the time the salaried employee missed, otherwise you have misclassified your otherwise salaried employee as an exempt/salaried employee, and you now owe the formerly salaried employee for all of the overtime he or she worked over at least the last two years.  And if you make that mistake with one salaried employee, chances are that your payroll department make it with all of your salaried employees.  29 C.F.R. § 541. 602(c) provides, in relevant part:

(c)  When calculating the amount of a deduction for pay allowed under paragraph (b) of this section, the employer may use the hourly or daily equivalent of the employee’s full weekly salary or any other amount proportional to the time actually missed by the employeeId. (emphasis added).

            So, how can your payroll practices cause you legal headaches exceeding your worst nightmares?  In many ways, but one easy way is to use a semi or bi-monthly pay period and then calculate your employees’ deductions based on a percentage of time missed relative to the amount of working hours (or days) in any given pay period.  While that might seem like a logical way to allocate deductions, and some employers certainly do it, you have created a system that will give you disproportionate deductions for your employee’s missed workdays.  The reason being is that in semi or bi-monthly pay periods, you have some pay periods that have 72 hours (9 workdays), some with 80 hours (10 workdays), some with 88 hours (11 workdays), and the occasional 96 hours (12 workdays) that employees are expected to be at work.

 Let’s assume you pay your salaried employee $2,0000 each pay period, and for the purposes of making deductions, you attribute an effective hourly wage of $25 per hour (80 hours X $25 per hour = $2,000 salary). If you calculate a deduction for an employee who missed 8 hours (1 workday) during an 80 hour (10 workdays) pay period by subtracting the 8 hours (time missed) from the 80 hours you expected that employee to work during that pay period, and then multiply the amount of hours worked (e.g. 72 hours) by the employee’s effective hourly rate ($25 per hour), you will be deducting $200, or 10% of the employees paycheck during that pay period.  That deduction is perfectly proportionate and does not violated the FLSA’s Salary Basis test because the employee missed 10% of the hours/workdays during that pay period. 

            The calculation for the deduction of an employee who missed a single day in an 80 hour pay period (10 workdays) will look like this:  80 (hours in pay period) – 8 (hours missed) = 72 (hours actually worked); 72 (hours actually worked) X $25 (per hour) = $1,800 (salary). This is a $200 reduction from the $2,000 semi-monthly salary, which is directly proportionate to the time missed.

            If, however, your employee misses a single day of work during a 72 hour pay period (9 workdays), your calculation for the deduction will look like this: 72 (hours in pay period) – 8 (hours missed) = 64 (hours actually worked); 64 (hours actually worked) X $25 (per hour) = $1,600 (salary).  This is twice as much as the deduction from the 80 hour pay period, and is unquestionably disproportionate to the time the employee missed.

            That is a relatively cut and dried example of a Salary Basis violation.  How much will that cost you?  First you will be required to pay your employees all of their overtime for at least the past two years.  Then double that for the FLSA’s near mandatory liquidated damages, which can only be avoided if the employer shows “good faith” or “reasonable grounds” for the employer’s belief that they were not violating the FLSA—which is much more difficult to prove than employers typically believe. Then add in all of the Plaintiff’s attorney’s fees—who probably won’t be anywhere as efficient as your attorney—under the FLSA’s attorney’s fees requirement, which is one of the strictest and most certain fees shifting provision under federal law.  Don’t forget about your attorneys’ fees. In short, you will be paying a ridiculous amount of money.

            One way to calculate proportionate deductions would to be to calculate an equal amount for every day in a fixed period of time—like one week, two weeks, or even a full year.  For example, an employee makes $2,000 per semi-monthly pay period makes $48,000 per year (24 pay periods X $2,000).  Since there are 52 weeks per year, you divide $48,000 by 52 and you get a weekly salary equivalent of $923.08 per week.  Assuming a general workday is from 9 to 5 on Mondays through Fridays, divide the weekly salary equivalent of $923.08 by 40 hours in a general workweek to get an effective hourly rate of $23.08 (you can skip this multipart calculation by dividing the annual salary by 2080, which is 40 hours a week multiplied by 52 weeks a year).  If an employee misses a day of work, and the FLSA permits you to make a deduction, multiplying the effective hourly rate of $23.08 by 8 hours for the day missed, and you have a proportionate deduction of $184.64.  The Courts will not scrutinize minor variations in the amount deducted if it is comparable to the rate the employee is paid for the time he or she actually worked.

            With the FLSA, the old adage “an ounce of prevention is worth a pound of cure” might be an understatement.  In retrospect, spending a couple of thousand dollars to make sure you have all of your FLSA ducks in a row can save you from, at best, an extreme legal headache down the road.