Question:

My company is debating whether or not to reduce the salaries and hours of many of our exempt employees in response to economic hardship. However, we are worried that if this change causes these employees to lose their exempt status, we will not be able to achieve the positive aspects of the reductions. If we are obligated to pay those employees overtime, when we were not so obligated in the past, the reductions may actually have a negative financial impact. Could you please explain if we can implement the reductions without the employees losing their exempt status?

Answer:

The current state of the economy has many employers facing significant difficulties and dilemmas. On the one hand, most employers need to cut costs to positively affect their bottom line to stay profitable. But simultaneously, employers desire to keep their trained and talented employees who have proved to be invaluable to the success of their companies. As a result, many employers are considering reducing the salaries and hours of their employees while maintaining their workforce. However, employers such as yourself are uncertain as to the ramifications of salary and hour reductions on the status of exempt employees.

In fact, there is a good reason for such uncertainty, as there is an absence of case law on this issue in California. Pursuant to the California Labor Code and the Industrial Welfare Commission Wage Orders, for an employee to be considered exempt, the employee must satisfy what are known as the duties test and the salary basis test. As to the salary basis test, there is no express restriction in the applicable law preventing a fixed reduction of the salaries of exempt employees during a period when a company operates a shortened workweek due to economic conditions.

However, in a 2002 Opinion Letter, the Division of Labor Standards Enforcement (DLSE), the agency that enforces California employment laws, opined that a reduction in hours and a corresponding reduction in salary would result in the salary basis test not being satisfied. Accordingly, employers who conducted such reductions would be obligated to pay overtime to their formerly exempt employees. That 2002 Opinion Letter was discussed in a previous Workplace Law article on furloughing exempt employees.
But recently, the DLSE changed its stance on the affect of salary and hour reductions on the exempt status of employees. In an August 2009 Opinion Letter, the DLSE reviewed a proposed reduction whereby an employer sought to reduce the number of its exempt employees’ scheduled workdays from five days to four days per week and to reduce their salaries by twenty percent. The employer represented to the DLSE that the reductions were unusual and temporary, and based on current economic challenges. The employer stated that it intended to restore the full five-day workweek and the full salaries of exempt employees as soon as business conditions permitted.

In forming their new opinion, the DLSE looked at federal law and precedent for guidance. They noted that the federal Department of Labor has consistently concluded that the salary basis test does not preclude a bona fide fixed reduction in the salary of exempt employees to correspond with a reduction in the normal workweek so long as the reduction is not designed to avoid the requirement that the employees be paid their full salary in any week in which they perform work. The DLSE explained that several federal appellate courts have addressed this issue and concluded that such reductions do not violate the salary basis test under the Fair Labor Standards Act (FLSA). Therefore, the DLSE concluded that in their opinion, under California law, an employer is not prohibited from implementing the above-described reductions in the work schedules and salaries of exempt employees so long as the employees still meet the salary basis test by earning a monthly salary equivalent to no less than two times the state minimum wage for full time employment. The duties test for the applicable exemption must also be satisfied.

The DLSE’s August 2009 Opinion Letter stated that reductions in the work schedules and salaries of exempt employees will not result in a violation of the salary basis test provisions of the California Labor Code, the Industrial Welfare Commission Wage Orders, and applicable federal law. While this Opinion Letter provides welcome guidance for employers and employees, DLSE Opinion Letters provide administrative guidance only, and are not legally binding on California courts. Thus, until the issue is addressed in California courts, there is still some legal uncertainty surrounding reductions of the salaries and hours of exempt employees. If you are considering reductions in the work schedules and salaries of exempt employees, contact your employment law attorney for specific guidance.
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