A sometimes-overlooked requirement for classifying an employee as exempt from overtime is that, with limited exceptions, the employee must be paid on a “salary basis.” [1] Indeed, when employers fail to pay their exempt employees on a salary basis, they may be subject to lawsuits alleging exempt misclassification. As such, properly paying employees on a salary basis is critical to classifying employees as exempt.

The General Rule

Among other requirements, in order for an employer to classify an employee as exempt from overtime, the employee generally must be paid on a “salary basis.”

This means that the employee must receive at least the same amount of pay each week regardless of the amount or quality of work they perform for a given week. Specifically, subject to limited exceptions, an exempt 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, which amount is not subject to reduction because of variations in the quality or quantity of the work performed.” [2]

As we explained here, as of January 1, 2020, that means paying employees at least $684 on a weekly basis for employees classified under the executive, administrative, and/or professional exemptions. (Many states – and some cities – have higher minimum salary levels for exempt employees. For example, the minimum weekly salary for most exempt employees in California is $1,120. In Washington, that minimum can be as much as $958.30.)

Exempt Employees Cannot Be Paid Less if the Quality or Quantity of Work Varies

The overarching principle of paying employees on a salary basis is that, subject to certain exceptions, the guaranteed minimum salary “must not be subject to reduction based on the quality or quantity of the work performed. [3] That means that “an exempt employee must receive the full salary for any week in which the employee performs any work without regard to the number of days or hours worked. Exempt employees need not be paid for any workweek in which they perform no work,” subject again to a few specific exceptions. [4]

In other words, simply because an exempt employee does not work a full 40-hour workday – but performs any work within that week – that employee’s salary may not be reduced. The employee’s pay also may not be reduced “for absences occasioned by the employer or by the operating requirements of the business. If the employee is ready, willing and able to work, deductions may not be made for time when work is not available.” [5]

An employee’s guaranteed salary may also not be reduced if the employee does not adequately complete a certain assignment, or if the employee is not productive as he or she should have been. Although performance issues can and should be addressed in such a circumstance, the employee’s guaranteed salary may not be reduced that week as a result.

Using Variable Compensation to Supplement the Guaranteed Salary

Effective January 1, 2020, “[u]p to ten percent of the [minimum] salary amount required . . . may be satisfied by the payment of nondiscretionary bonuses, incentives and commissions, that are paid annually or more frequently.” (29 C.F.R. § 541.602(a)(3).) That does not mean that such bonuses, incentives or commissions may be capped. Rather, it “means that the amount an employer may credit against the weekly standard salary level is limited to 10 percent of the required salary amount.” [6]

Paying Compensation beyond the Guaranteed Salary

So long as an exempt employee is paid a minimum guaranteed salary, “an employer may provide an exempt employee with additional compensation without losing the exemption or violating the salary basis requirement . . . .” [7]

However, when that additional compensation is “computed on an hourly, a daily or a shift basis,” the exemption would be lost if, despite paying a minimum guaranteed weekly salary, “a reasonable relationship” does not exist between the guaranteed amount and the amount actually paid to the employee. [8] [9]  “The reasonable relationship test will be met if 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.” [10]  Although there is no precise measure, the U.S. Department of Labor has opined that this test is met if the ratio between an employee’s “usual weekly earnings” and his guaranteed weekly salary is equal to or less than 1.5-to-1, but would not be met if a ratio of 1.5-to-1 would be “materially exceeded.” [11]

Exceptions to Paying on a Salary Basis

Notwithstanding the general rule that exempt employees must receive at least the same amount of pay each week regardless of the amount or quality of work they perform for a given week, there are some exceptions to the salary basis that allow employers to make certain deductions from the guaranteed salary. For a thorough discussion of those permissible deductions, please see our prior post here.

Putting It All Together

Although there are few of them, the requirements for paying exempt employees on a salary basis are critical. Employers should ensure that they are paying their exempt employees in accordance with these requirements. And, of course, they should also ensure that they are complying at all times with state and local laws, which can and do differ.

[1] 29 C.F.R. § 541.602(a); Cal. Lab. Code § 515(a). The exception to this general rule is that certain employees can be paid on a “fee basis.” 29 C.F.R. § 541.600(a). Given its seldom use, the fee basis is not addressed here. More information about paying on a fee basis can be found at 29 C.F.R. § 541.605.

[2] 29 C.F.R. § 541.602(a).

[3] 29 C.F.R. § 541.602(a)(1).

[4] 29 C.F.R. § 541.602(a).

[5] 29 C.F.R. § 541.602(a)(1).

[6] Wage and Hour Division U.S. Department of Labor Fact Sheet # 17U (2019).

[7] 29 C.F.R. § 541.604(a).

[8] 29 C.F.R. § 541.604(b).

[9] Note that a number of courts have concluded that this “reasonable relationship” test does not apply to employees classified under the “highly compensated” exemption. E.g., Anani v. CVS RX Servs., Inc., 730 F.3d 146, 149 (2d Cir. 2013); Litz v. Saint Consulting Grp., Inc., 772 F.3d 1, 5 (1st Cir. 2014)).

[10] 29 C.F.R. § 541.604(b).

[11] U.S. Dep’t of Labor, Wage & Hour Div., Opinion Letter No. FLSA-2018-25, at 2 (Nov. 8, 2018).