Beware incentive plans that deduct pay from exempt employees

The Fair Labor Standards Act (FLSA) sets strict rules for who can be classified as an exempt employee not entitled to overtime pay. One of those is the so-called salary-basis test.

Exempt employees must be paid the same salary regardless of the quality or quantity of their work in any given pay period. In other words, employers can’t make deductions from pay for poor work.

Recent case:
Amy Baden-Winterwood and several other current and former employees of Life Time Fitness, a health club chain, received salaries as exempt administrative employees. They also worked under a compensation plan that set certain goals for selling memberships in the clubs. The company called this a “bonus plan” and made payments under the plan each pay period.

In other words, the bonus payments were included in the employees’ regular salaries.

The trouble began when the company started making deductions from regular pay when some employees didn’t meet their performance and membership goals.

Baden-Winterwood and other employees sued, alleging that the deductions destroyed their exempt status and that they were therefore entitled to overtime payments for any hours worked in excess of 40 hours in any workweek.

The company argued that the deductions weren’t made because of the “quality or quantity” of the work.

The 6th Circuit Court of Appeals disagreed. It said that the bonus plan clearly was tied to individual performance and therefore making the deductions violated the salary-basis test and destroyed the exemption. (Baden-Winterwood, et al., v. Life Time Fitness, No. 07-4437, 6th Cir., 2009)

Legitimate salary deductions for exempt employees

The U.S. Department of Labor’s FLSA regulations do allow some salary deductions for exempt employees, but only in specific circumstances:

  • To penalize in good faith employee infractions of disciplinary rules
  • For absenteeism, if the employee is off for a full day to tend to personal business (but not for sickness or disability)
  • For absences of one or more full days due to sickness or disability, as long as the deduction is made in accordance with a bona fide plan, policy or practice of providing compensation for salary lost due to illness (in other words, sick pay)
  • For unpaid leave taken under the FMLA (full- or partial-day deductions)
  • To offset military or jury duty pay.

Employers also don’t have to pay the full salary in the initial or final week of work if the employee does not work the entire week.

Employers must let exempt employees know that they should notify a supervisor or HR if they believe an improper deduction has been made. The Department of Labor suggests the notice read as follows:

It is our policy to comply with the salary basis requirements of the FLSA. Therefore, we prohibit all company managers from making any improper deductions from the salaries of exempt employees. We want employees to be aware of this policy and that the company does not allow deductions that violate the FLSA.