You’ve probably heard this many times: If you improperly deduct pay from the salary of an exempt employee, you risk losing the exemption. Losing the exemption means you become liable for overtime pay. A recent case from the Tenth Circuit Court of Appeals offers guidance on what steps you need to take in order to keep an isolated improper salary deduction from negating your employee’s exempt status. Ellis v. J.R.’s Country Stores, Inc., No. 13-1346 (10th Cir. Mar. 9, 2015).
Store Manager Claimed Exemption Lost After Improper Pay Deduction
In 2007, Sandra Ellis was hired to manage one of J.R.’s Country Stores convenience stores. Under the store’s manager pay plan, she received a weekly salary of $600 (later increased to $625) in exchange for working whatever number of hours per week was necessary to effectively run her store, with a minimum of 50 hours each week and a minimum five-day workweek. She also received a monthly bonus depending on the performance of her store. The company classified her as exempt.
In early April 2012, the company deducted $31.20 from her weekly salary because she had worked less than the requisite 50 hours that week. It was the only time during her four-plus years of employment that she had been paid less than her full weekly salary. Ellis soon quit and notified the company that it owed her over $42,000 in unpaid overtime compensation because she had lost her exempt status due to the company’s deduction when she didn’t work the full 50-hour week.
Although denying any improper deduction, the company agreed to “take the high road” and paid her for the overtime she worked during the time period in which the deduction occurred. Ellis wasn’t satisfied with the $332.88 check she received, so she sued the company in federal court claiming she was not exempt because she was not paid on a true salary basis under the Fair Labor Standards Act (FLSA), and sought to recover all unpaid overtime pay. She also intended to expand her lawsuit into a collective action on behalf of similarly-situated store managers.
Single, Isolated Salary Deduction
Exempt status for most of the white collar exemptions under the FLSA depends on the employee being paid on a salary basis. This means that the employee is paid a predetermined weekly amount, which currently must be $455 or more per week, that may not be reduced because of the quantity or quality of the employee’s work. Consequently, with limited exceptions, you must pay exempt employees their full salary for any week in which they perform work, regardless of the number of days or hours worked.
Under FLSA regulations, an actual practice of making improper deductions can show that the employer did not intend to pay the employee on a salary basis, resulting in the loss of exempt status. The number of improper deductions and the number of employees affected by the deductions are factors that can show an employer does not intend to pay on a salary basis.
In Ellis’ case, the company made a single pay deduction over one pay period. She argued that was sufficient to destroy the salary basis and her exempt status. The Court disagreed. Relying on earlier court decisions, the Court concluded that the single, isolated deduction from Ellis’ salary was not enough to show that the company did not intend to pay her on a salary basis.
Handbook Policy Prohibited Improper Deductions
Another factor to be considered is whether the employer has a clearly communicated policy permitting or prohibiting improper deductions and whether it provides a complaint mechanism for employees to seek a correction of an improper deduction. J.R.’s Country Stores had a policy in its employee handbook that stated the company “prohibits deductions from an exempt, salaried employee’s pay except under the circumstances set forth in the [FLSA] and state law. If you believe improper [deductions have occurred], it will promptly reimburse the employee and ensure the mistake will be corrected in the future.”
Ellis argued this policy was insufficient as it requires employees to know or research the law to determine which deductions are allowed. She also asserted that it did not adequately provide for a complaint mechanism. The Court disagreed with both of these assertions. It found the policy sufficient to show that the company intended to pay its exempt employees on a salary basis.
Correcting Improper Pay Deductions
According to FLSA regulations, if an employer reimburses an employee for an isolated or inadvertent improper deduction, it will not lose the exemption for that employee. This so-called “window-of-correction” defense essentially allows an employer to correct a mistaken deduction. In Ellis’ case, the Court found that the company was entitled to rely on this defense as the improper deduction was isolated and the company reimbursed Ellis shortly after it was made. In the end, the Court ruled that the company intended to pay Ellis on a salary basis and the single improper deduction did not cause her to lose her exempt status. Therefore, she was not entitled to overtime pay.
Proper Salary Deductions
As noted above, you generally are not permitted to make deductions from an exempt employee’s predetermined pay for days or hours missed. You are, however,permitted to make salary deductions for the following:
- If no work is performed in a given workweek, no salary need be paid for that week;
- Absences from work for one or more full days for personal reasons other than sickness or disability;
- Absences of one or more full days due to sickness or disability if the deduction is made in accordance with a bona fide plan, policy or practice of providing compensation for salary lost due to illness;
- To offset amounts employees receive as jury or witness fees, or for military pay;
- For penalties imposed in good faith for infractions of safety rules of major significance;
- For unpaid disciplinary suspensions of one or more full days imposed in good faith for workplace conduct rule infractions;
- For a partial initial or terminal week of employment; or
- For unpaid leave under the Family and Medical Leave Act.
Best Practices For Paying On a Salary Basis
Start with a policy that prohibits improper deductions from an exempt employee’s salary. Make sure the policy is communicated to employees through your employee handbook, intranet or other places where policies are posted. Make sure you include a complaint mechanism to notify employees how to raise questions about their pay and get improper deductions corrected. Be sure to train your payroll personnel and supervisors on the policy and what deductions are acceptable and not acceptable.
Be careful about requiring exempt employees to “clock in” or keep track of their hours. Although tracking hours of exempt employees is not itself a violation, if you pay the employee based on the hours tracked, you will not be paying on a salary basis.
Administration of sick time, vacation and leaves of absence must be tailored to address exempt employees. Even though you may track how much sick time, vacation time and other leaves an exempt employee uses, remember that you may not make pay deductions unless the circumstances fall within one of the exceptions listed above.
If an exempt employee isn’t putting in as much time as you require, or isn’t producing the volume or quality of work you expect, treat it as a discipline issue, not a pay issue. Similarly, if an exempt employee exhausts his or her time off benefits (e.g., PTO, vacation, etc.) and continues to take time off, handle it as a discipline issue rather than deducting pay (again, unless within a permissible exception).
Finally, if an isolated or inadvertent improper deduction is made, rectify it immediately by reimbursing the employee to make their salary whole. Then be sure to take steps to prevent a similar deduction from occurring in the future.