On May 24, 2024, the US Court of Appeals for the Fifth Circuit in New Orleans, which covers Louisiana, Mississippi, and Texas, recently upheld a district court’s decision that two highly compensated IT engineers were not properly paid on a salary basis and, therefore, not exempt from the Fair Labor Standards Act’s (FLSA) overtime requirements. The Fifth Circuit’s opinion reiterates that no matter how much money an employee earns, a guaranteed weekly salary must be paid in accordance with the FLSA’s specific rules and regulations in order to maintain most exemptions from the overtime pay requirements.

Highly compensated IT engineers sue employer for overtime compensation

Terry Gentry, an IT engineer, filed suit on behalf of himself and a putative class alleging that his employer, Hamilton-Ryker IT Solutions (HR-IT), violated the FLSA’s overtime protections by failing to pay overtime wages to its nonexempt, hourly paid employees. Another IT engineer, Marc Taylor, joined the lawsuit.

Both men were paid on a two-tiered system. They received a “guaranteed weekly salary” equal to up to eight hours of pay calculated at their hourly rates ($125 and $150, respectively). Then, for any hour they worked beyond the eight hours, they were also paid at their hourly rates. This same hourly rate was paid for hours worked over 40 in a workweek.

HR-IT argued that both men were exempt from the FLSA’s overtime requirements under either the “highly compensated employee (HCE)” or the “learned professional” exemption. The issue for the court was whether they were paid on a salary basis, a requirement for both exemptions. The district court determined that because the plaintiffs were not paid on a salary basis, they were not exempt from the FLSA’s overtime requirements. The district court awarded overtime pay owed to both employees plus liquidated damages in an amount equal to the overtime pay. HR-IT appealed to the Fifth Circuit.

Fifth Circuit affirms decision that IT engineers were not exempt

The FLSA guarantees employees overtime pay at one and a half times the regular rate when they work more than 40 hours in a workweek. There are exemptions to this requirement for employees working in a “bona fide executive, administrative, or professional capacity.” In addition, the regulations exempt HCEs and learned professionals.

To meet either the HCE or learned professional exemption, employees must satisfy three tests: (1) the job duties test, (2) the salary level test, and the (3) the salary basis test. The Fifth Circuit noted that the parties agreed that Gentry and Taylor met the job duties and salary level tests. The only issue was whether they satisfied the salary basis test.

What does payment on a salary basis mean?

The Fifth Circuit cited two ways to satisfy the salary basis test: through the regular method provided by 29 C.F.R. Sections 541.602(a) and 541.604(a) or through the alternative route established by 29 C.F.R. Section 541.604(b).

The general rule for considering an employee paid on a salary basis is found in Section 602(a) and states that the employee must regularly receive each pay period on a weekly or less-frequent basis a predetermined amount constituting all or part of the employee’s compensation. That amount may not be subject to reduction due to the quality or quantity of the work performed. In other words, absent specific exceptions, the employee must receive this set amount for any week in which the employee performs any work without regard to the number of days or hours worked.

Section 604(a) supplements Section 602(a) and explains: “[a]n employer may provide an exempt employee with additional compensation without losing the exemption or violating the salary basis requirement[] if the employment arrangement also includes a guarantee of at least the minimum weekly[]required amount paid on a salary basis.” Together, the two sections allow employers to pay a true weekly salary plus additional compensation in the form of commissions, profit sharing, or hourly wages for hours worked beyond the normal workweek.

Employees being paid an hourly rate can be considered paid on a “salary basis” pursuant to Section 604(b) only if: (1) they also receive a “minimum weekly required amount paid on a salary basis” and (2) there is a reasonable relationship between the weekly guaranteed salary and the employee’s actual earnings. The reasonable relationship test will be met if the weekly guaranteed salary is “roughly equivalent” to the employee’s usual earnings. The regulations explain that a weekly guaranteed salary is “roughly equivalent” to an employee’s actual weekly earnings when the ratio of actual earnings to salary is up to 1.5 to 1.

Application of rules to pay scheme for IT engineers

The Fifth Circuit first determined that Gentry’s and Taylor’s guaranteed weekly salaries were actually valued by their individual hourly rate times eight hours. The court concluded the employees were paid on an hourly basis and not by the week as required by Section 602(a). The court noted that HR-IT could not reasonably argue that eight hours of pay constituted a weekly rate. Thus, the Fifth Circuit concluded that HR-IT did not pay the plaintiffs a salary on a weekly basis and Section 602(a) did not apply.

Next, the Fifth Circuit considered HR-IT’s argument that its payment scheme satisfied Section 602(a) in conjunction with Section 604(a). It argued that as long as employees receive a minimum, predetermined, and guaranteed sum every week, any hourly compensation is permissible under Section 604(a). The court disagreed, explaining that Section 604(a) builds upon Section 602(a) and makes clear that salaried employees may receive “additional” or “extra” compensation only if “the employment arrangement also includes a guarantee of at least the minimum weekly[]required amount paid on a salary basis.” The court had already decided that HR-IT did not pay the employees on a salary basis and, so, Section 604(a) was inapplicable.

Employer also failed the reasonable relationship test 

Additionally, HR-IT’s argument that its pay structure was allowable pursuant to Section 604(b) failed. Section 604(b) recognizes that hourly rate employees may be paid on a “salary basis” so long as “[1] the employment arrangement also includes a guarantee of at least the minimum weekly required amount paid on a salary basis regardless of the number of hours, days or shifts worked, and [2] a reasonable relationship exists between the guaranteed amount and the amount actually earned.”

The reasonable relationship test, in turn, is satisfied so long as the “weekly guarantee is roughly equivalent to the employee’s usual earnings at the assigned hourly, daily or shift rate for the employee’s normal scheduled workweek.” As previously stated, a 1.5 to 1 ratio of actual earnings to a guaranteed weekly salary satisfies this test.

Here, Gentry’s and Taylor’s guaranteed payments of $984 and $1,200 per week, respectively, were grossly disproportionate to their actual earnings. For instance, the ratio of Gentry’s average actual weekly earnings, $5,347.66, and the guaranteed weekly amount of $984 was 5.42 to 1. Taylor’s ratio was similar. These ratios did not meet the requirement that the actual earnings be “roughly equivalent” to the guaranteed weekly salary.

Accordingly, because HR-IT could not establish that the plaintiffs were paid on a salary basis, the plaintiffs were not exempt from the FLSA overtime compensation requirements. See Gentry v. Hamilton-Rikers IT Solutions, L.L.C., No. 22-40219 (5th Cir. 2024).

Takeaways for other employers

Strict adherence to the salary basis test is needed to maintain employees’ exempt status under the FLSA. As we have been reminded in recent years, it does not matter if an employee is making well into six figures a year. If the payment structure is incorrect, the employer risks losing the exemption from the overtime pay requirement. If found liable for a violation, this would mean that the employer would have to compensate the employee for the overtime premium for all hours worked over 40 and also potentially pay an additional equal amount as liquidated damages.

An audit of payroll practices regarding exempt employees will help avoid these costly errors. To ensure your company is in compliance, take the following steps:

1. Verify that exempt employees receive a set amount per week that meets or exceeds the applicable salary level. Beginning July 1, 2024, that amount will be $844 per week.
2. This weekly salary should be paid in any week in which the employee performs any work, unless specific allowable deductions set forth in regulations are taken for full-day absences for certain reasons. However, if the weekly guarantee is meant to compensate the employee for 40 hours per week and the employee only works 30 hours, they must still receive the full guaranteed weekly salary.
3. If an employee is paid additional compensation for additional hours worked in a week, ensure that the total amount of pay for that week is not more than one and a half times the amount of the guaranteed weekly compensation. Consider spot-checking these ratios every quarter.

Much attention is given to the analysis of whether employees considered exempt meet the job duties test of the exemptions from the overtime pay requirements. The Fifth Circuit decision discussed above shows us that equal attention must be paid to whether the employee’s pay structure meets the salary basis test.