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Bonus Plan May Trigger Overtime

The federal Fair Labor Standards Act (FLSA) provides that employers may not require their employees to work more than 40 hours per workweek unless those employees receive overtime compensation at a rate of not less than one and one-half times their regular pay. The FLSA contains certain exemptions from the overtime compensation requirement, one of which is for employees working in a “bona fide executive, administrative, or professional capacity.” In other words, if an employee works in such a capacity, the employer is exempt from the general requirement of paying overtime pay. Under the FLSA regulations, an employee’s position must satisfy three tests to qualify for this exemption: (1) a duties test, (2) a salary-level test, and (3) a salary-basis test.

The issue before a federal appeals court recently was whether the compensation plans used for management-level employees of a health club chain satisfied the salary-basis test.

Under its bonus plan, in particular, the employer could deduct bonus plan “overpayments” if an employee did not meet certain performance levels. The legal outcome for the employees was affected by the time frame in which the compensation plan was in effect. For the period after August 23, 2004, when a new Department of Labor regulation on the salary-basis test went into effect, employees were entitled to compensation for pay periods in which actual deductions from pay were made. The regulation provided that “[a]n actual practice of making improper deductions demonstrates that the employer did not intend to pay employees on a salary basis.”

Other employees also were entitled to overtime compensation for some pay periods before the regulation’s effective date, even when the employer made no actual deductions, but the employer had in place a policy that made such deductions significantly likely to occur. Under a then-controlling United States Supreme Court ruling, an employee was not paid on a salary basis, and thus was eligible for overtime compensation, if (1) there was an actual practice of salary deductions, or if (2) an employee was compensated under a policy that clearly communicated a significant likelihood of deductions.

In the case before the court, the policy fit within the “significant likelihood of deductions” category. The employer’s compensation plan targeted specific members of management; its policy set out a particularized formula whereby their pay would be in jeopardy; the employer took affirmative steps to demonstrate that the pay-deduction plan would be enforced (including the creation of a “performance pay committee” that made the case-by-case decisions); and it took actual deductions from employees’ salaries not long after the employees stopped meeting their performance goals.

Employers desirous of avoiding a similar outcome, in which overtime pay ultimately is owed to employees generally considered by the employer to have been “salaried employees,” should be cautious about making any alterations to the predetermined pay for such employees. An employee will be considered to be paid on a “salary basis” within the meaning of the regulations only if the employee regularly receives a predetermined amount constituting all or part of the employee’s compensation, and such amount is not subject to reduction because of variations in the quality or quantity of the work performed.

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