Companies will sometimes take a chance on a new (or old) salesperson by allowing him/her to work on pure commission. This “eat what you kill” compensation system seemingly creates an incentive to sell with little risk to the company. But is there really little risk? There is a real and potentially expensive risk of violating the Fair Labor Standards Act (FLSA) and/or state wage hour law.

As a general principle, the FLSA requires employers to pay an overtime premium of one and a half times the employee’s regular rate for all hours worked in excess of 40 within a workweek and to also pay at least the minimum wage for all hours worked. However, the FLSA establishes certain exceptions to these requirements. If the employee does not fit within an exception, then the employer must comply with the FLSA.

What exceptions apply to commission paid employees?

• EMPLOYEES WHO PERFORM WORK COVERED BY THE WHITE COLLAR EXEMPTIONS. These include executives, administrators, and professionals. However, as a threshold, to qualify for these “white collar” exemptions, the employee must be paid a salary of at least $455 per week (that is, until new anticipated new federal regulations become effective that will substantially increase the minimum salary requirement). If this salary test is met, the employee must also satisfy the respective duties test. Some commission-paid employees will satisfy these duties test. A commission paid sales manager who supervises two or more employees might fall under the executive exception. A salesperson who advises the client on the proper product to purchase might be an administrative employee. A lawyer who is paid a percentage of the fees he collects is likely exempt as a professional employee. However, in all instances, the employee must receive a salary (or guaranteed draw) of at least the required weekly amount. By definition then, a pure commission paid employee cannot be exempt under the FLSA White Collar exemptions.

• OUTSIDE SALES EXEMPTION. To qualify for the outside sales employee exemption, the employee’s primary duty must be the sale of goods or services or the rental of facilities and the employee must be customarily and regularly engaged away from the employer’s place of business. It is this last prong — working away from the workplace — which disqualifies many commission paid employees. If the employee is an outside salesperson, the company need not pay him/her a salary or minimum wage. The typical salesperson who maintains an office at the company’s facility, but is expected to meet with customers, is not generally able to fit under the outside sales exemption.

• EMPLOYEES PAID COMMISSIONS BY RETAIL ESTABLISHMENTS. To qualify under this exemption, the employee must be employed by a retail or service establishment, which are defined as establishments 75 percent of whose annual dollar volume of sales of goods or services (or of both) is not for resale and is recognized as retail sales or services in the particular industry. If the employee works at a retail establishment, then the employer must demonstrate that the employee’s regular rate of pay exceeds one and one-half times the applicable minimum wage for every hour worked in a workweek in which overtime hours are worked, and more than half the employee’s total earnings in a representative period (at least one month and no more than one year) must consist of commissions. If these criteria are satisfied, the employee may be compensated on pure commission with no overtime premiums.

In addition to navigating the restrictions imposed by the FLSA, states are permitted to (and often have) wage hour laws more restrictive than the FLSA. In other words, an exemption under the FLSA will not necessarily constitute an exemption under state overtime and minimum wage laws.

Even though successful commission paid employees often are the highest compensated employees, companies can face huge liabilities for paying only commissions to employees who do not qualify under one of the three narrow exemptions. It is therefore never a bad idea for employers compensating employees on any commission basis – and especially for employees on a pure commission basis – to double check whether they are satisfying the FLSA’s minimum wage and overtime requirements for those employees if those requirements apply.