Can Commissions Affect an Employee's Overtime Eligibility?

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By Keith M. Hill

“I work over 40 hours each week yet I cannot receive overtime,” Dan, a salesman for a cruise line, asked Dick, the company's payroll manager. “Why is that?”

“Because you receive most of your compensation through commissions and you work for a retail establishment, you fall under an exemption for people like you,” Dick said.

FACTS: An employee of a cruise line worked for a year as a personal vacation consultant who also sold trips to consumers. In addition to a fixed weekly salary, the salesman earned commissions from cruise bookings. The commissions made up more than 60 percent of his earnings.

The salesman, who frequently worked 60 to 70 hours a week, filed a lawsuit claiming that his former employer violated the Fair Labor Standards Act by not paying him overtime wages during his employment and for not inaccurate recordkeeping practices.

The cruise line claimed that the former salesman was not entitled to overtime wages because he was a commissioned employee and fit the FLSA retail sales exemption. The employer and former salesman disputed whether the exemption applied.

ISSUE: Was the former salesman exempt from overtime?

DECISION: The former salesman was exempt from overtime under the FLSA retail sales exemption, a federal district court ruled.

An employee is exempt from receiving overtime pay under the retail sales exemption if his regular rate of pay exceeds one and one-half times the applicable minimum hourly rate, and if more than half of the employee's compensation for not less than one month is earned through commissions, the court said.

The salesman and the company disputed how to calculate the salesman's regular rate of pay, court documents showed.

The court determined that the company's method of averaging the total hours the salesman worked and total wages and commissions he earned during his employment was better than computing his wages each week. Because of the nature of a commissioned employee’s wages, it was unlikely that the rules of the exemption “meant to require employers to pay overtime in the lean weeks when the fat weeks more than make up” the difference, the court said.

Federal regulations permit other reasonable and equitable methods to distribute deferred commissions when it is “not possible or practicable to allocate the commission among the workweeks of the period in proportion to the amount of commission actually earned or reasonably presumed to be earned each week.” It was not possible to allocate the salesman's commissions to each workweek in this case because he received lump-sum commission payments for sales completed in prior weeks, the court said.

Thus, averaging the total base pay and commissions across the salesman’s employment hours was a reasonable and equitable way to determine his hourly regular rate of pay, which was more than one and one-half times Florida's minimum wage in 2014, the court said.

The company's alleged recordkeeping errors do not prevent it from using the retail sales exemption, the court said.

Although the salesman did not dispute using his one-year employment as an appropriate representative period, he claimed that the company's failure to note in its payroll records which employees were subject to the retail sales exemption or to track employee hours each workweek prevent the exemption's use.

Case law and federal guidance allow the application of the retail sales exemption despite these recordkeeping flaws, the court said. Because there was no conflict over the total number of hours worked, the total commissions and wages earned or the representative period used, these flaws are not germane to the case, the court said ( Freixa v. Prestige Cruise Services LLC, S.D. Fla., No. 1:15-cv-22732, 5/23/16 ).

POINTERS: In addition to receiving a regular rate of pay in excess of one and one-half times the federal minimum wage and being principally paid on a commission basis, sales representatives must work for a retail or service establishment to qualify for the FLSA retail sales exemption.

A retail or service establishment is a business that derives at least 75 percent of its annual sales revenue from goods or services that are not for resale and is recognized as retail.

Several explanations have been presented as to why the exemption exists.

Congress's intent in enacting the exemption was so businesses would not face the jolt of having to pay overtime that was calculated based on a large commission earned in a short period, Sachin Pandya, a professor at the University of Connecticut School of Law, told Bloomberg BNA.

The U.S. Court of Appeals for the Seventh Circuit said in 2007 that an employee whose income was based on commissions was exempt from overtime because the amount earned by that employee would not be tied to the duration worked as closely as the income of an employee who earned only an hourly wage ( Yi v. Sterling Collision Centers Inc., 7th Cir., No. 06-2645, 3/13/07 ).

For more information, see PAG's “FLSA Exemptions” chapter.

By Keith M. Hill

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This analysis illustrates how courts resolve pay-related disputes. The names and dialogue are fictitious.

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