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To Cut or Not to Cut: Reducing Wages During Difficult Economic Times

by The Human Equation, Inc. on 6/22/2009
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As an alternative to laying off employees, we are considering the option of implementing a 4-day workweek, along with a commensurate reduction in pay. Is such a course of action permissible under the Fair Labor Standards Act?

Making the decision to lay off productive employees in an effort to cut costs is never easy. Unfortunately, the protracted economic downturn has forced precisely such a predicament on many employers. Ensuring an organization’s continued viability in the midst of a struggling economy means that the option of cutting payroll expenses can no longer be dismissed outright. However, in an effort to avoid (or at least delay) layoffs, some employers are implementing a compromise of sorts by foregoing the all-or-nothing approach of layoffs in favor of reducing the number of hours worked by employees along with a reduction in pay.

Although the Fair Labor Standards Act (FLSA), the federal wage and hour law, does not directly address the propriety of cutting an employee’s hours or compensation, it must be considered before implementing such a course of action. Otherwise, any cash flow surplus resulting from the reduction of payroll expenses will likely be negated by costly FLSA litigation.

The extent to which the FLSA will be implicated in situations involving a reduction of hours and compensation will depend largely on whether such reductions involve exempt or non-exempt employees. Employees who are considered non-exempt under the FLSA (commonly referred to as “hourly” employees), are generally required to be paid only for the number of hours worked. If non-exempt employees’ hours are reduced, then the amount of pay they receive will consequently be reduced. Moreover, provided the hourly wage is not reduced below the applicable minimum wage, an employer may also decrease the actual hourly rate of non-exempt employees. Thus, as a practical matter, the FLSA does not operate as an obstacle to reducing the hours and pay of non-exempt employees.

Unfortunately, the same cannot be said in cases involving exempt employees. Exempt employees are those individuals who, by virtue of satisfying specific criteria, are considered exempt from the FLSA’s overtime requirements. Since some of the FLSA’s exemptions, including the executive, administrative, and professional exemptions require that the employee be paid on a salary basis, the goal of preserving such employee’s salaried status is necessary to avoid negative consequences under the FLSA.

The need to preserve the salaried status is significant because under the regulations interpreting the FLSA, salaried employees must generally be paid their full salary for any week in which the employee performs any work without regard to the number of days or hours worked. Moreover, an employee paid on a salary basis cannot suffer a salary deduction for absences occasioned by the employer or by the operating requirements of the business. According to the regulations, “if the employee is ready, willing and able to work, deductions may not be made for time when work is not available.”

This express prohibition against salary deductions due to a lack of work appears to forbid employers from reducing an exempt employee’s compensation during difficult economic times. And, since the consequence of improperly reducing an employee’s salary may be the inadvertent loss of the FLSA exemption altogether, many employers are reluctant to initiate such a course of action because of its potentially devastating consequences. However, if done properly, employers may prospectively reduce an exempt employee’s salary to accommodate the employer’s business needs.

In a 1998 opinion letter issued by the Wage and Hour Division, the Department of Labor (DOL) noted that “a bona fide reduction in an employee’s salary does not preclude salary basis payment as long as the reduction is not designed to circumvent the requirement that the employees be paid their full salary in any week in which they perform work…Consistent with this position, we have stated that a fixed reduction in salary effective during a period when a company operates a shortened workweek due to economic conditions would be a bona fide reduction not designed to circumvent the salary basis payment.”

The DOL’s position that a bona fide salary reduction would not serve to negate an employee’s salaried status was recently echoed by the Tenth Circuit Court of Appeals, which held that an employer may prospectively reduce salary to accommodate the employer’s business needs unless it is done with such frequency that the salary is the functional equivalent of an hourly wage, in which case the court will treat “the ‘salary’ as a sham and deny the employer the FLSA exemption.”

These two separate pronouncements of an employer’s ability to prospectively reduce a salaried employee’s wages without jeopardizing their status as being paid on a salary basis contain an implicit qualification: the reduction(s) must be done infrequently enough to avoid the appearance of treating salaried employees as hourly employees. Moreover, according to the DOL, salary reductions due to short-term business needs do not comport with being paid on a salary basis. Thus, employers electing to reduce the salary of exempt employees must do so infrequently and only when the need precipitating such a course of action cannot be considered short-term.

Finally, employers considering the option of reducing exempt employees’ salaries must be aware of any consequences that may otherwise jeopardize their exempt status. For example, exempt employees who have had their hours and salaries cut must still make at least $455 per week to be considered exempt under certain exemptions. Additionally, employers must make sure that the reductions do not otherwise impact the duties of such employees in a way that would no longer make them exempt under the FLSA. Other consequences that are not necessarily related to the FLSA should also be considered, such as benefits eligibility that are tied to the number of hours worked.

Making the decision to cut costs by reducing hours and salaries is not necessarily an easy one to make. However, since the economy has forced many employers’ hands in this regard, the only decision left is to ensure that such reductions are done legally because once fees and expenses associated with an FLSA violation start, they are difficult to control.

For more information about the Fair Labor Standards Act, please click here.

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Categories: 2009

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