Employer Cost-Cutting Measures May Jeopardize Employee Exempt Status Under FLSA

Labor & Employment Advisor, Spring 2009

By: KoKo Huang

As a result of the current economic climate, many companies are implementing furloughs as a cost cutting measure.  Furloughs typically consist of employer-mandated periods of unpaid employee time off.  In response, the Department of Labor (DOL)’s Wage and Hour Division issued two new letters on March 6, 2009, warning employers that such cost-cutting measures, if carried out improperly, could jeopardize the exempt status of salaried employees under the Fair Labor Standards Act (FLSA).  Generally, exempt employees must meet three tests: (1) the salary levels test; (2) the duties test (whether administrative, executive or professional); and (3) the salary basis test. The new DOL letters suggest that implementing a reduction of hours with a resulting reduction in salary may, if done incorrectly, deprive the employer of the ability to meet the “salary basis” test.

In the first Opinion Letter, the Division addressed whether employers could offer unpaid voluntary time off to workers on a first-come, first-served basis with a resulting reduction in accrued annual, personal or vacation leave, in order to maintain the workers’ current salary.  Absent volunteers, the employer proposed to select employees on a reverse seniority basis to take mandatory unpaid time-off and similarly tap into the employees’ accrued annual, personal or vacation leave.  If either the volunteers or the selected employees refused to allow the employer to tap into leave banks or had no leave left in them, the employer proposed to reduce the affected employee’s salaries in the amount of the time off.

The Division indicated that it had no problem with either voluntary or involuntary furloughs as long as exempt employee salaries were unaffected.  That is, it is permissible to dock leave banks for the time off.  However, if salaries are reduced due to furlough—either because there is no accrued leave or the employee opts not to use it—it must be done on a prospective basis as a result of a fixed reduction in salary corresponding to a fixed reduction in hours in a regularly scheduled work week, or where the voluntary time off is truly voluntary and not “occasioned by the employer or by the operating requirements of the business.”  29 C.F.R. § 541.602(a).  In this case, since the proposed furloughs did not involve a prospective and fixed work schedule and were clearly tied to the operational needs of the employer, if the employee’s pay was reduced, the proposed employer furlough—whether voluntary or involuntary—would violate the salary basis test if the employee’s pay was reduced, thereby resulting in a loss of exempt status for the effected employees.

In the second Wage and Hour Opinion Letter, the Division addressed an employer proposal tied expressly to available work for exempt employees rather than mandated furloughs.  Exempt employees who were low on work were to be sent home early or told to not report to work, with resulting deductions in their accrued PTO accounts so that their salary was not affected.  In the event their PTO was depleted, the employer proposed to cut guaranteed salaries in full-day increments commensurate with the periods employees were sent home or told not to report.  Again, the Division rejected the proposal stating that exempt employees would not meet the salary basis test if there were involuntary deductions from salary made for full- or partial-day absences occasioned by the employer or by the operating requirements of the business.

The Wage and Hour Division did state that if a prospective reduction in hours for the exempt employee was fixed and regular, and the resulting reduced salary still met the salary levels test, the salary basis test would still be met.  Employers are therefore urged to avoid any type of furlough program or reduction in hours for exempt employees which reduces salary (rather than PTO or leave banks) AND turns on sporadic factors such as employer work needs or the operating requirements of the business.  Any voluntary or involuntary program which cuts into exempt salaries must meet two criteria: (1) it is implemented on a prospective level with a “fixed” reduction in the work schedule and (2) even with the reduced salary, the employee continues to make the threshold salary level required under federal and state wage and hour laws—$455 per week.  For instance, announcing that the business will be closed every Friday so employees will be working 80% of full-time and their salary going forward will be 80% (or 75% or 60%, etc.) of their prior salary would seem to fit under the parameters of the opinion letters, as long as the new salary was at least $455 per week.  Employers are also allowed to make deductions from employee leave banks without changing the FLSA exempt status of employees, and employees may take “completely voluntary” unpaid time off in day increments without effecting their FLSA exempt status.  Only if these conditions are met will these employer cost-cutting measures not end up potentially costing employers much more in overtime based on the loss of exempt status for salaried employees.