With the rise in wage and hour litigation, employers need to watch out for potential pitfalls in how they structure and operate compensation plans that include sales-based incentives and commissions.
In a recent Littler Mendelson webinar, presenters Daniel Thieme and R. Brian Dixon outlined common mistakes and offered tips on how to keep commission-based pay plans in compliance with the Fair Labor Standards Act and state wage-hour laws.
When drafting a plan where employee compensation is based on sales, employers should take care in defining key elements, such as deliverables, the term “earned,” and payment on termination, according to Thieme and Dixon.
• The plan’s language needs to define what the deliverable is and what employees have to complete in order to trigger the employer’s obligation to pay them a certain percentage in commission.
• A plan’s definition of the term “earned” should not only spell out the deliverable, but also the circumstances and conditions that apply to the earning of commission. When plans contain clear earning rules, they are generally enforced by the courts, Thieme and Dixon said.
• Payment on termination is an important issue to address in earning definitions, but it’s also one of the tricky areas under state law. In many jurisdictions, courts will enforce language in a plan that says “if an employee resigns prior to payment by customer, the employee doesn’t earn commission.” The presenters added, however, that if a plan cuts off commissions at separation of employment, such language wouldn’t be likely to pass muster in nine states: California, Colorado, Kansas, Louisiana, Maryland, New Jersey, New York, Ohio, and Oregon.
Employers also need to choose a method for paying earned commission. One option is to link payments to the booking of sales, with salespeople earning a percentage of a sale’s value at the time they close the deal. Another common method links commissions to monthly revenue, with salespeople receiving payments over time as the company “recognizes” revenue from the sale.
Thieme and Dixon said more companies seem to be paying on a monthly revenue basis, especially for long-term contracts. But they reminded employers about the nine states mentioned above, where revenue streaming in over a long period raises the payment-on-termination issue for salespeople who leave the company.
Cleaning up past overpayments by making deductions from current commissions might seem simple enough, but employers can run afoul of wage-hour laws if they don’t handle chargebacks properly. For example, some states require that employees sign off on any deductions from pay prior to an employer making such deductions.
The terms used in defining certain payments can make a big difference. Thieme and Dixon cited two terms in particular: “bonus” and “advance.” Money paid out as an advance generally isn’t considered “wages,” making it much easier for an employer to take back a portion of an advance. Therefore, the language in the plan should differentiate between the two types of payments and define when an employee will earn an advance.
Thieme and Dixon predicted that there will be more litigation involving overtime liability with respect to commissioned employees. One of the issues they noted is the requirement under the FLSA’s white-collar exemption tests that employees receive a minimum base salary. Commissions can’t be counted toward the salary basis test, because “straight commission” isn’t within the definition of a “salary,” they said.
The FLSA also offers other options. The exemption for “outside salespersons” can be satisfied without meeting a salary test, and the exemption for “highly compensated employees” can be satisfied by including commissions and incentives as a portion of the six-figure annual income needed to qualify.
On the topic of commission payments and minimum wage requirements, Thieme and Dixon said some states regard commissions as not providing any compensation for non-sales time, and employers can’t cover such periods by stretching commissions. In states where this is an issue, some employers have decided to instead pay employees on an hourly basis. This is a trend that seems prevalent with employers in California, they said.
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