In a first of its kind opinion, the U.S. Court of Appeals for the Third Circuit (which hears appeals from the federal district courts in Delaware, New Jersey, and Pennsylvania) ruled that an employer does not violate the Fair Labor Standards Act (FLSA) when it deducts time from FLSA-exempt employees’ paid time off (PTO) banks for failing to meet productivity targets.

To understand the decision, we first need a refresher on the FLSA and how it requires employers to pay exempt employees. Employees are presumptively entitled to be paid a minimum wage for all hours worked, plus overtime – 1.5x their regular rate of pay – when they work more than forty (40) hours in a workweek. An exception to the overtime requirement applies when an employee’s salary and job duties fall within one of the recognized overtime exemptions. The so-called “white collar” exemptions apply to executive, administrative, and professional employees who not only perform exempt job duties but are paid a guaranteed salary of at least $684/week that is not subject to deduction based on the quality or quantity of work they perform.

With that primer in mind, we turn to the facts in Higgins v. Bayada Home Health Care Inc., No. 21-3286 (3rd Cir. Mar. 15, 2023), a class and collective action brought by clinicians who worked for a home health agency. The agency established productivity point targets for each clinician, which they satisfied by completing tasks such as routine home visits, office work, or scheduling follow-up appointments. Productivity targets were linked to the clinicians’ base salary and PTO accrual and could be adjusted upward or downward with a corresponding adjustment to salary and accrual rate. When clinicians exceeded their productivity minimums, they received additional compensation. When they missed their weekly productivity minimums, the agency deducted hours from their PTO banks in an amount equivalent to the difference between their actual performance and their target performance. Although the home health agency never deducted wages from the clinicians’ base salaries to cover productivity deficits, the clinicians reasoned that PTO was a “proxy” for salary and alleged that these deductions “were effectively reductions in their salary.” By treating them as “wage earners whose total compensation is pegged to the number of hours they work,” the clinicians argued that the home health agency forfeited their exempt status, entitling them to overtime pay.

Both the district court and the appellate court rejected the clinicians’ “proxy” theory out of hand. Writing that their “arguments miss the mark,” the Third Circuit opined that the question is not whether a pay structure approximates an hourly wage, or even whether an employer threatens to dock a salaried exempt employee’s wages, “but whether an employer made an actual deduction from an employee’s base pay.” Looking first at the plain language of the Department of Labor’s (DOL) FLSA regulations, which provide that an employee is “not paid on a salary basis if deductions from the employee’s predetermined compensation are made for absences occasioned by the employer or by the operating requirements of the business,” 29 C.F.R. § 541.602(a)(2), the Court held that the only question before it was whether PTO constitutes “predetermined compensation.”

The Court resolved that question in favor of the employer. Neither the FLSA nor the DOL regulations define the term “salary,” but the Court nevertheless found “a clear distinction between salary and fringe benefits like PTO,” deriving support for this distinction from three general usage and legal dictionaries, all of which distinguish periodic wage payments (salary) from benefits provided in addition to basic wage rates (fringe benefits). Since the home health agency never deducted from the clinicians’ base salaries, the clinicians continued to receive their “predetermined compensation” – that is, their salaries – each pay period, irrespective of the deductions from their fringe benefit PTO banks. That PTO might be converted to cash in the future – such as by cashing it out at year-end or because the employer includes unused, accrued PTO in employees’ terminal wage payments – was irrelevant. The clinicians’ predetermined compensation for the weeks in which they did work did not fluctuate, so the potential monetary equivalent of PTO was immaterial.

Although the decision involved a legal issue of first impression, its rationale aligns with the DOL’s longstanding guidance on this subject. In a 2009 Opinion letter (DOL Op. Ltr. Jan. 16, 2009), the DOL’s Wage and Hour Division explained that the salary docking prohibitions in the FLSA overtime exemption regulations do not extend to nonmonetary compensation such as vacation time or sick leave:

In no event can any deductions from an exempt employee’s salary be made for full or partial day absences occasioned by lack of work[.] … Employers can, however, make deductions for absences from an exempt employee’s leave bank in hourly increments, so long as the employee’s salary is not reduced. If exempt employees receive their full predetermined salary, deductions from a leave bank, whether in full day increments or not, do not affect their exempt status.

Accordingly, employers safely can deduct missed work hours from exempt employees’ PTO or vacation banks without risking their exempt status. In addition, employers – at least those in the Third Circuit – can also dock PTO banks to discourage inefficiency or for other purposes without risking overtime liability.