Exempt Status:  Understanding the Salary Basis Test

What does it mean to be paid on a “salary basis”?
Do you have to give paid vacation days, sick days, and holidays to exempt employees?
Do you have to pay exempt employees when work is not available?
What about for jury duty and military leave?
Do we have to pay exempt employees on days they cannot work because of inclement weather?
Can deductions be made from an exempt employee’s salary for partial day absences?
Can you make deductions for disciplinary reasons, such as a suspension?
Can you require exempt employees to work 40 hours a week or to be at work during set times?
Can you pay exempt employees extra compensation?
Can you keep track of the number of hours exempt employees work?
Penalties for Misclassification Are Severe

Are you sure you are classifying your exempt employees correctly?  If you are not paying them on a “salary basis,” as defined by the FLSA, you may owe up to three years of back pay and even be personally liable for penalties.

Exemption from the Fair Labor Standards Act (FLSA) and the concept of “exempt” status employees seem simple enough at first glance.  If an employee performs certain defined job duties and is paid on a “salary basis,” the employee is then considered “exempt” from the FLSA’s requirements, freeing you from obligations concerning the minimum wage or overtime.  However, even if you initially classify employees correctly, you must continue to treat them as exempt on an ongoing basis.  Many common practices, such as the tracking of hours worked or not giving paid sick days, may affect whether the employee is considered to be paid on a salary basis and, therefore, can adversely impact the exemption classification.  The Editors have analyzed the FLSA statute, regulations, and court cases to answer ten common questions concerning the salary basis requirement and to address the growing concern for HR personal liability for exemption decisions.

1.  What does it mean to be paid on a “salary basis”?

To be exempt from the FLSA, and not entitled to overtime, an employee must meet certain job duty requirements, generally involving the use of independent judgment and discretion, and be paid on a “salary basis.”  The FLSA provides for five broadly used classifications of exemptions, including: 

1. bona fide administrative employees,

2. bona fide executive employees,

3. bona fide professional employees,

4. outside sales employees, and

5. highly skilled computer-related employees.

Salary basis is defined as the payment on a weekly or less frequent basis of a predetermined amount that constitutes all or part of compensation, without reductions for variations in the quality or quantity of the work performed.  Under this definition, exempt employees generally must receive their full salary for any week in which they perform work, without regard to the number of days or hours worked.  Deductions may be made from their salary, but only in limited circumstances.  (See questions 2 through 7, below.)  It should be noted, however, that the FLSA regulations indicate that doctors, lawyers, and teachers (typically categorized as professional exempt employees) do not have to be paid on a salary basis to be considered exempt.  

2.  Do you have to give paid vacation days, sick days, and holidays to exempt employees?

Paid time off generally is considered a benefit given at the employer’s discretion.  However, if you make deductions from an exempt employee’s salary for unpaid time off, you should be sure that they do not violate the salary basis test or you may lose the exemptions.  The type and amount of time off taken determines whether you can make the deductions.  According to the FLSA regulations, you may make a pay deduction when an employee is absent for a full day for personal reasons.  Thus, if you do not provide paid vacation or personal days, you may deduct the day off from the employee’s salary.  Similarly, if you give paid vacation days and the employee has used them all, you may deduct any additional personal time off. 

You also may make deductions for a day’s absence due to illness or injury if you have a bona fide plan, policy, or practice that provides compensation for loss of salary due to sickness or disability, such as a policy that allows employees to accrue paid sick leave.  This deduction is permissible even if the exempt employee has not yet qualified for the plan or has exhausted the plan’s sick leave allowance.  However, according to the regulations, if you do not have a paid sick leave plan, you may not deduct the day from the employee’s salary if the employee has worked any day that week.  An exception to this rule is sick leave taken under the Family and Medical Leave Act (FMLA).  The FMLA allows deductions from an exempt employee’s salary for leave required by the FMLA.

The FLSA regulations do not specifically allow deductions for holidays.  Therefore, you should not make deductions from an exempt employee’s pay for unworked holidays

3.  Do you have to pay exempt employees when work is not available? 

If the exempt employee is ready, willing, and able to work, deductions may not be made for time when work is not available. 

4.  What about for jury duty and military leave?

Deductions for partial week absences caused by jury duty, attendance as a witness, or temporary military leave are not permitted.  You may offset any military pay or monetary payments received as jury or witness fees for a particular week against the employee’s salary for that same week.  Remember, however, that payment usually is not required if the employee does not work the entire week.

5.  Do we have to pay exempt employees on days they cannot work because of inclement weather?

The FLSA regulations do not specifically allow employers to reduce an exempt employee’s pay for time off related to inclement weather.  Therefore, exempt employees generally should be paid for absences resulting from bad weather if they have worked during any of the workweek in which the absences occur.

6.  Can deductions be made from an exempt employee’s salary for partial day absences? 

No.  Generally, the regulations indicate that if you make deductions from an exempt employee’s pay for absences of less than a day, you are considered to be treating the employee as an hourly worker, instead of an exempt employee paid on a salary basis.  (As discussed in question 2, above, you may make deductions for certain full day absences.)

Many employers have attempted to avoid the partial day pay docking issue by requiring exempt employees to use paid leave for these absences.  The Department of Labor (DOL), the agency that enforces the FLSA, traditionally has permitted this type of arrangement since the employee does not experience an actual reduction in salary.  There also are special rules for exempt public sector employees that allow them to be considered exempt even if their pay is reduced for partial day absences.

A number of courts have sided with the DOL’s position on this issue.  However, other courts have disagreed and have determined that this practice does, in fact, treat an exempt employee like an hourly, nonexempt employee and, therefore, causes loss of the exemption. 

Because of the split in the courts, you should consult legal counsel on this matter if you are a private sector employer.  As a practical matter, you may find that exempt employees resent being required to use paid leave for partial day absences, particularly if they regularly work more than 40 hours per week.  Under this type of policy, they are not entitled to additional pay when they put in long hours, but are required to use vacation or sick leave if they need a few hours off.

Finally, as discussed in question 2, above, the FMLA allows employers to require the use of accrued paid leave for partial day absences for any hours taken as intermittent or reduced FMLA leave, without affecting the employee’s exempt status.

7.  Can you make deductions for disciplinary reasons, such as a suspension?

No, unless you suspend the exempt employee for a full week.  However, you may make deductions for penalties imposed for infractions of “safety rules of major significance.”  These infractions include rules relating to the prevention of serious danger to the worksite or to other employees, such as no smoking rules in explosives plants, oil refineries, and coal mines.  Remember, you can suspend an exempt employee for less than a week as long as you pay him.  Since a suspension is often the final step before termination, the employee will most likely understand the seriousness of the suspension even if he does not lose any pay.

8.  Can you require exempt employees to work 40 hours a week or to be at work during set times?

If you require exempt employees to work a specific number of hours or arrive at a specific time, you will appear to be treating them like nonexempt employees and may, thus, jeopardize their exempt status.  Instead of focusing on the number of hours an employee works or his starting time, you are better advised to focus on the employee’s job requirements and output.  For example, if an employee manages nonexempt employees who must be at work between 9 a.m. and 5 p.m., then you can require that employee to be at work during the same hours to supervise properly.  Similarly, you may discipline an employee who does not complete a project on time or is not available for a meeting because he left at noon on Friday.

9.  Can you pay exempt employees extra compensation?

Generally, you may pay extra compensation to exempt employees without affecting the salary basis qualification.  The FLSA regulations give only limited examples of acceptable additional compensation, and these include the payment of commissions and  bonuses. 

Some employers pay exempt employees additional compensation that is based on the number of hours the employees work in excess of 40 in a single workweek.  The regulations do not specifically discuss this practice; however, the courts that have addressed the issue disagree. Some courts have held that an otherwise exempt employee who receives extra payments based on the number of hours worked in excess of 40 is not “paid on a salary basis” and must therefore be paid overtime.  Other courts, however, have determined that payment of an hourly rate in addition to the salary does not affect the exempt status of the employee.  Because of this split in the courts, most experts recommend paying extra compensation in the form of bonuses or other lump sum payments so that it does not look like overtime pay.

10.  Can you keep track of the number of hours exempt employees work?

Employers that require exempt employees to account for their work time on an hourly basis may jeopardize the status of these employees if the accounting has the effect of treating them like hourly workers.  For example, if the employee’s salary fluctuates based on the number of hours worked, the employee most likely will not be considered exempt.  However, you generally may keep track of hours worked for other purposes unrelated to the employee’s pay, such as to account for work time to be billed to clients or under a federal contract.  You also may record daily attendance.

Penalties for Misclassification Are Severe

As indicated in the above discussion, if an employee is classified as exempt but does not meet the necessary salary basis tests, you may lose the exemption.  Under the FLSA, the employer can be liable for back overtime pay of up to two years for any employee who is misclassified as exempt.  This back pay liability typically is extended to three years if the FLSA is determined to have been willfully (intentionally) violated.  In addition, a single misclassification can trigger a loss of exemption for a whole group of employees if the rest of the group has been treated similarly under the organization’s policies and practices.  And as a final legal wake-up call, some court decisions interpreting the FLSA have found that the individual decisionmaker can be personally liable for any violations under the Act.  In other words, you could be personally responsible for any back pay and other penalties. 

As a practical matter, it is unlikely that you will be assessed personal remedies by the DOL or a court unless you intentionally violate the FLSA.  However, you need to realize that many disgruntled employees and their attorneys threaten legal action against the individual decisionmaker as a way to put pressure on the employer.  Therefore, you should make sure you are not exposing your organization or yourself to unnecessary legal actions.  The best way to do this is to be familiar with the FLSA regulations, in particular the regulations dealing with the salary basis requirements, and then document your exempt classification decisions.  A good starting point is to compare your policies that affect exempt employee pay with the ten questions and answers addressed above.  A final common sense tip to help ensure that exempt employees are paid on a salary basis is to focus on their job duties and completed work, not on the number of hours worked or their arrival and departure times.