Reducing Salaries of Exempt Employees under the FLSA

As daily headlines have shown, the economic fallout from the COVID-19 pandemic has led businesses of all types to announce dramatic changes in workforce levels and employee pay. Many of these companies have made the decision to reduce the salaries they pay to their exempt employees. These reductions, which often range from 10 percent to 30 percent, have affected executives, managers, and professionals. On the positive side, salary reductions give employers an option for reducing labor costs that preserves more jobs and mitigates the loss of skilled employees.

If the prospect of reducing the salaries of exempt professionals or managers gives you pause, it should. If executed incorrectly, salary reductions can destroy an employee’s exemption from overtime eligibility under the Fair Labor Standards Act (FLSA). The loss of exempt status can be costly to a business; it means the employer may have to pay the affected employee overtime pay on top of his or her salary over some unknown number of workweeks. As discussed in greater detail below, employers are permitted to reduce the salary of exempt employees, but they must be careful when doing so.

The Salary Basis Test and the Fair Labor Standards Act

The core concern of salary reductions involves the FLSA’s “salary basis” test. Under the FLSA’s white-collar exemptions, one of the requirements to be exempt from overtime pay is that the employee must be compensated on a “salary basis.” This requires that an employee “regularly receives each pay period . . . a predetermined amount constituting all or part of the employee’s compensation, which amount is not subject to reduction because of variations in the quality or quantity of the work performed.” 29 C.F.R. § 541.602(a) (Emphasis added.) Except for seven exceptions specifically cited in the regulations, an exempt employee must receive his or her full salary for any week in which he or she performs any work. However, an employee is not considered paid on a salary basis (and thus is not exempt from overtime pay requirements) if deductions from his or her predetermined compensation are made for “absences occasioned by the employer or by the operating requirements of the business.” The regulations state that if the employee is “ready, willing and able to work, deductions may not be made for time when work is not available.”

The Dingwall Decision

At least one federal district court has relied upon the above language to hold that salary reductions tied to reduced work schedules are impermissible. In Dingwall v. Friedman Fisher Assocs., P.C., the employer reduced the length of workweeks for its exempt staff from five days to four, with a corresponding 20 percent reduction in pay for a period of six months during the economic recession of 1991–1992. The employer contended that the reduction in staff salaries was not a “deduction” but merely a change in the “regular” salaries to a new “predetermined” amount, and that the plaintiff received a fixed salary at all times.

The Dingwall court disagreed, relying upon the language of the FLSA regulations to hold that the salary reduction was not a mere alteration of the plaintiff’s fixed salary, but one made “on the basis of a reduction of days worked in response to an insufficient amount of work available.” The court ruled, “defendant’s reductions in the amount of days worked in response to a lack of available work and a proportionate reduction in fixed salary constitutes an actual and improper deduction.” Consequently, the Dingwall court held that the salary basis test was not satisfied, and the employee therefore was not exempt from overtime. At least one other federal court seems to have accepted Dingwall’s  rationale.

The U.S. Department of Labor’s Position

The U.S. Department of Labor’s Wage and Hour Division (WHD), which is charged with interpreting and enforcing the FLSA’s white-collar exemptions, has repeatedly reached the exact opposite conclusion from the Dingwall court. The WHD’s Field Operations Handbook (FOH) makes it clear that a prospective reduction in an employee’s predetermined salary due to a reduction in the employee’s normal scheduled workweek is permissible as long as it is not designed to circumvent the salary basis requirement. The WHD has opined expressly that a 20 percent reduction in an exempt employee’s salary “while assigned to work a normally scheduled 4-day reduced workweek due to the financial exigencies of the employer” would not violate the FLSA’s regulations.

The WHD provided further clarity in a fact sheet it released in September 2019. The WHD’s Fact Sheet No. 70: “Frequently Asked Questions Regarding Furloughs and Other Reductions in Pay and Hours Worked Issues, confirms that salary reductions are permissible as long as they are made to reflect the company’s “long term business needs, rather than a short-term, day-to-day or week-to-week deduction from the fixed salary for absences from scheduled work occasioned by the employer or its business operations.” Fact Sheet No. 70 goes on to state that “a predetermined regular salary reduction, not related to the quantity or quality of work performed, will not result in loss of the exemption,” as long as the employee is paid a salary at the level otherwise required by the FLSA. In contrast, Fact Sheet No. 70 explains, “deductions from predetermined pay occasioned by day-to-day or week-to-week determinations of the operating requirements of the business constitute impermissible deductions from the predetermined salary and would result in loss of the exemption.” (Emphasis added.)

Court Decisions

The clear weight of legal authority appears to be consistent with the WHD’s position and rejects Dingwall as incorrectly decided. In a 2005 opinion, the U.S. Court of Appeals for the Tenth Circuit explained that Dingwall wrongly proscribed reductions in salary for future pay periods based upon regulatory language intended to preclude salary deductions from current pay periods. The view accepted by the clear majority of courts is that an employer may prospectively reduce an exempt employee’s salary unless the reduction is done “with such frequency that the salary is the functional equivalent of an hourly wage.” The key, according to several courts, is that reductions in current salary are prohibited, but a prospective reduction in salary is permissible because the amount is predetermined before it takes effect, and the employee knows what the salary amount will be before he or she performs the work.

And Then There’s California

As is often the case in employment law, California law can be different. In an opinion letter dated March 12, 2002, the California Division of Labor Standards Enforcement (DLSE) embraced the Dingwall decision and rejected contrary opinion letters of the U.S. Department of Labor. Specifically, the DLSE’s Opinion Letter 2002.03.12 considered and rejected an employer’s proposal to reduce manager salaries by 20 percent prospectively for an indefinite period coinciding with a drop in production levels and the employer’s adoption of a 4-day workweek. The DLSE focused on the fact that the schedules for exempt employees were being reduced to 4-day workweeks, which matched the 20 percent reduction in their salaries. On that basis, the DLSE concluded, “the fact is, the employer has reduced the time he is making work available, and has reduced the salary pro rata to reflect this reduction.” The DLSE saw this proposal as an impermissible salary deduction and a “subterfuge which would not be countenanced.”

The DLSE changed course in 2009. In an August 19, 2009, opinion letter, the DLSE disavowed the Dingwall decision and joined the majority of courts that reject Dingwall’s interpretation of the salary basis test. Specifically, in Opinion Letter 2009.08.19, the DLSE declared that its “prior reliance upon Dingwall for the conclusion that the federal regulations prohibit the simultaneous reduction of a workweek schedule and salary  . . .  is not persuasive.”

Interestingly, the current version of the DLSE Enforcement Manual available on the DLSE website makes no mention of the 2009 opinion letter. The manual reflects the position that the DLSE adopted in its 2002 pro-Dingwall opinion letter, which it describes as follows:

51.6.7 A Reduction In Salary Based Upon A Reduction Of Hours Is Not Permitted.

DLSE has opined that its enforcement policy, in keeping with the stated intent of the Legislature and the California courts interpretation of the California law, will not permit a reduction in the salary of an exempt employee which is the result of a reduction in the number of hours in a workday or days in a workweek the employee is required to work. A complete discussion of this enforcement policy is found at O.L. 2002.03.12.

Guidelines for Implementing Salary Reductions

For employers that decide to reduce the salaries of exempt employees, the change in salary must be announced and implemented correctly, and the reduced salary must be administered correctly once it takes effect. Employers may want to consider the following guidelines:

1. The reduced salary can be implemented prospectively as of a future date, but cannot be applied to the current pay period.
2. The amount of the reduced salary must be determined in advance of the date on which it is scheduled to take effect.
3. In any communications about a salary reduction, employers may want to avoid linking the reduced salary to the quality or quantity of work performed before or after the change.
4. In any communications about a salary reduction, employers may want to avoid linking the reduced salary to a reduced number of hours or to any specific schedule of work. In reality, the duties and responsibilities an exempt employee is expected to perform do not correspond to a fixed schedule or a finite number of hours. Even once it is reduced, an employee’s salary compensates him or her for all hours worked in any workweek. Employers may want to include information to this effect in notices or communications to affected salaried employees.
5. The amount of notice that must be given to an employee before a salary reduction takes effect varies by state. There are a handful of states that require 30 days of notice or at least one pay period of notice. Most others require either seven days of notice or merely that the notice be provided “prior to” the reduction.
6. Providing written notice can help an employer establish that the notice was given in a timely manner and ensure that the reduced salary is lawful. In states with “wage theft” statutes, employers may face requirements to provide employees with statutory notices and to maintain records to show that employees have acknowledged the change in salary within a certain window of time.
7. Once the reduced salary takes effect, it cannot be adjusted based upon day-to-day or week-to-week determinations of an employer’s operating requirements.
8. There is no explicit durational requirement for how long a new salary needs to be in place before it can be readjusted or restored to its prior level. An employer may want to wait to restore a reduced salary back to its prior level until it can make a long-term determination of operating requirements.
9. Employers that restore reduced salaries to their prior levels may want to avoid making subsequent variations in response to business conditions, because these variations may create a risk of claims that the salary is a de facto hourly wage.
10. Employers considering salary reductions for exempt employees in California may want to keep Dingwall and the DLSE’s latest guidance in mind.