Imposing Pay Cuts on Your Exempt Employees - Be Very Careful or the Cost-cutting Measure Can Cost You Big Time

Date: May 1, 2009

In today's unsettled economic climate, many employers are considering various ways to reduce payroll expenses. One common approach is to simply cut the salaries for your exempt employees.

Although such a practice can work, if it is not done correctly you may wind up losing the exempt status for your salaried employees, resulting in a significant unpaid overtime liability for all of those workers who may have been subject to the salary reduction.

In order to be considered exempt under the Fair Labor Standards Act (FLSA), the employee needs to be paid on a salaried basis of at least $455 per week and perform certain duties. Assuming that the employee meets the duties test, i.e., works as a professional, administrative or executive under Section 13(A)(1) of the FLSA, for example, the employee still needs to be paid on a salaried basis. That means that the employee receives a fixed guaranteed amount (above $455 per week) for all work performed during that work week.

Deductions to that salary cannot be made based on the operating requirements of the business. That means that if there is insufficient work to be done during the work week, the employer cannot send the exempt employee home and then deduct the time not worked from the employee's salary. To do so would defeat the salaried basis exemption, and the employee would thus be considered nonexempt entitled to overtime for all work in excess of 40 hours per work week, going back two, or possibly three, years.

Recognizing these restrictions, many employers today are looking for creative ways to reduce salaries but not run afoul of the FLSA. One common method is for the employer to simply reduce an employee's salary, but require the employee to continue to work on a full-time basis. While many employees find this to be a very bitter pill to swallow, in light of the tough economic times, it may ultimately be good medicine for the overall success of the company.

Other companies link the reduction in salary with a corresponding reduction in the number of hours that the employee is expected to work in the work week. For example, an employee may have a 20 percent salary reduction and then have a 20 percent reduction in the scheduled hours for that work week. Again, the salary level must exceed $455 per week for this practice to work.

Some employers have proposed cutting the employee's salary in half and at the same time reducing the work schedule by half, as well. That may work, provided that the reduced salary still exceeds $455 per week. Simply because the employee's standard work schedule has been reduced by half does not mean that the $455 salary minimum can likewise be reduced.

Yet another option that some employers have considered is to allow exempt employees to take time off on an hourly basis due to short-term business needs, i.e., low-patient census, shortened store hours, or other reasons related to the business downturn.

In one such case, the employer developed a system of allowing its exempt employees to take time off either "voluntary time off" (VTO), where employees could, at their option, use paid, annual personal or vacation leave, but continue to accrue employment benefits. If there were insufficient volunteers for VTO, the employer then proposed requiring "mandatory time off" (MTO) under a seniority-based rotational method. If the employee elected not to use accrued paid leave or did not have sufficient accrued paid leave to cover the VTO or the MTO, the employer would then deduct the amount equal to the VTO or MTO from the employee's salary, if it was shorter than one work week.

For unpaid VTO or MTO lasting an entire work week, the employer would not pay any salary for that period. Salaried exempt employees could also take VTO or be assigned MTO in one-day increments.

According to the DOL, such a practice of allowing or requiring exempt employees to reduce their hours based on the needs of the business, resulting in a loss of pay for those hours not worked, would be a violation of the FLSA. In a recent opinion letter, the DOL stated that salary reductions due to a reduction of hours worked for short-term business needs do not comply with the FLSA regulations. If the employee is ready, willing and able to work, deductions may not be made for time when work is not available.

Deductions from the fixed salary based on short-term business needs are different from a reduction in salary corresponding to a reduction in hours in the normal schedule work week, which is permissible if it is a bona fide reduction not designed to circumvent the salaried-basis requirement and does not bring the salary below the applicable minimum salary of $455 per week.

Deductions from the 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. Therefore, salary reductions due to MTO lasting less than a work week violate the salaried-basis requirement and may cause the loss of exempt status for those employees in that classification. The employer is not, however, required to pay the salary for MTO for a full work week.

Thus, if the employer were to impose MTO for a five-day work week, there would be no violation; however, if it is done on a day-to-day basis within the work week, then there would probably be a violation under the FLSA. (DOL Opinion Letter, FLSA-2009-14, January 15, 2009.)

Bottom Line
In these challenging economic times, employers are continually looking for creative ways to reduce expenses. However, when it comes to tinkering with the salaries of exempt employees, you need to be particularly careful because a mistake can be very costly and require you to pay overtime to your otherwise exempt employees. Such an award could significantly exceed the savings you were trying to achieve with the salary reduction. Indeed, before you take any action in this regard, you should discuss it first with your labor counsel. As they say, that would be money well-spent.