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Economic Relief for California Employers: Reducing Exempt Employees’ Workweeks and Their Salaries Does Not Violate Salary Basis Test

Sept. 10, 2009

Employers seeking ways to cut costs in California, according to an August 19, 2009, Department of Labor Standards Enforcement (“DLSE”) opinion letter, may now reduce exempt employees’ workweeks from five to four days, accompanied by a 20 percent reduction in pay, so long as the employees continue to receive the current minimum monthly salary requirement. The opinion letter was in response to an inquiry by an employer experiencing economic difficulties who sought to reduce hours and salary until economic conditions improved.

With this opinion letter, the DLSE has come full circle since its March 12, 2002, opinion letter which explained that an employer whose production levels “crumbled” would jeopardize the exempt status of its managers if it cut their salaries by 20 percent and charged them vacation time only if they chose to take a day off from Monday through Thursday. The March 2002 opinion letter put California at odds with the federal Department of Labor’s (“DOL”) nearly forty-year-old position that such a pay arrangement was permissible under the Fair Labor Standard Act’s (“FLSA”) salary basis test. The salary basis test requires employers to pay exempt employees a fixed salary not subject to reduction based on the quality or quantity of work performed in a workweek. Because many state wage and hour laws track the FLSA, employers with operations both inside and outside of California were, until now, required to either maintain different practices for their California employees based on state law or seek other ways to reduce costs.1

As support for its changed position, the DLSE states that it is appropriate for it to consider federal authority because the salary basis requirement is similar under federal and California state law. In 2002, however, the DLSE expressly refused to grant any deference whatsoever to the DOL. The DLSE also claims that the change is based on the Tenth Circuit’s decision in In re Wal-Mart Stores, Inc., 395 F.3d 1117 (10th Cir. 2005). The In re Wal-Mart case distinguished the decision the DLSE relied on in 2002, Dingwall v. Friedman Fischer Assoc., 3 F. Supp. 2d 215 (N.D.N.Y 1998),2 because it failed to consider the DOL opinion letters on point and considered salary deductions from current or past pay periods in contrast with prospective reductions. In In re Wal-Mart, the Tenth Circuit held that quarterly prospective adjustments to Wal-Mart’s full-time pharmacists' salaries based on fluctuation in the need for prescriptions did not violate the salary basis test. The Tenth Circuit explained, “[a]s a general rule, an employer may prospectively make adjustments in salary with a like adjustment in scheduled hours to accommodate its business needs.” Id. at 1189. The Tenth Circuit, however, did caution, as the August 19, 2009 opinion letter warns, that if “the salary changes are so frequent as to make the salary the functional equivalent of an hourly wage, [the Court] will treat the “salary” as a sham, and deny the employer the FLSA exemption.” Id.

What Employers Need to Know

Employers should consult with counsel before implementing any reduction in pay corresponding with a reduction in hours and should provide employees with adequate notice of any such changes. Any reduction in the hours of exempt employees corresponding with a reduction in their pay would need to meet the following minimum criteria to protect an employer from claims that the reductions were designed to circumvent the salary basis obligations set forth in the FLSA and California law:

  • Prospective nature of reductions.The reduction in pay based on hours must be prospective. This means an employer must fix a predetermined new salary going forward.
  • Reductions for a lengthy fixed period. The reduction in pay based on hours must be for a lengthy fixed period and may not fluctuate. For example, an employer may not decide on a weekly or monthly basis how many days the employee should work the following week, and accordingly reduce the employee’s salary.
  • No deductions from the newly fixed salary. An employer may not make deductions from the employee’s pay if the employee does not come to work on a given day in the newly defined workweek. While an employer may, of course, discipline its employees for failure to report to work, it may not make deductions in pay unless the employee performs no work during a given workweek.

 

For more information on this alert or any other labor and employment issues, please contact any of the lawyers listed below:

Boston
John Adkins, john.adkins@bingham.com, 617.951.8551
Louis Rodriques, Co-chair, Labor and Employment Group, louis.rodriques@bingham.com, 617.951.8340

Los Angeles/Orange County
Jacqueline Aguilera, jackie.aguilera@bingham.com, 213.229.8439
Debra Fischer, debra.fischer@bingham.com, 213.680.6418

San Francisco
James Severson, james.severson@bingham.com, 415.393.2242

New York
Douglas Schwarz, douglas.schwarz@bingham.com, 212.705.7437

Tokyo
Mie Fujimoto, mie.fujimoto@bingham.com, 81.3.6721.3138

Endnotes

1 For example, employers under both federal and California law do not have to pay exempt employees who do not perform any work in a workweek. Other methods of reducing costs include requiring employees to use their paid time off, instituting a sabbatical program and reducing salaries prospectively. Employment counsel should be contacted in each instance to ensure compliance with federal and state law.

2 In Dingwall v. Friedman Fisher Assoc., 3 F. Supp. 2d 215 (N.D.N.Y 1988), the Northern District of New York held that an employee was categorized improperly as exempt because the employer had reduced the workweek of its staff, including the employee at issue, from five days to four days for five months, and reduced their salary by one-fifth. The court expressly rejected the employer’s argument that the arrangement was not a deduction in salary, but merely a change in the “regular” salaries to a new “predetermined” amount and that plaintiff was thus at all times offered a fixed salary.

Circular 230 Disclosure: Internal Revenue Service regulations provide that, for the purpose of avoiding certain penalties under the Internal Revenue Code, taxpayers may rely only on opinions of counsel that meet specific requirements set forth in the regulations, including a requirement that such opinions contain extensive factual and legal discussion and analysis. Any tax advice that may be contained herein does not constitute an opinion that meets the requirements of the regulations. Any such tax advice therefore cannot be used, and was not intended or written to be used, for the purpose of avoiding any federal tax penalties that the Internal Revenue Service may attempt to impose.

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