DOL Provides Opinion Letter Concerning “Reasonable Relationship” Test for Exempt Status

By: Attorney David A. Richie – Weld Riley, S.C.

If you’re reading this blog, you’re probably familiar with the Fair Labor Standards Act (FLSA); it’s the law that requires employers to pay their employees for overtime and at least minimum wage.  What you might not be as familiar with is the “executive, administrative, or professional employee” exemption that allows employers to avoid these requirements.  29 U.S.C. § 213(a)(1).  Typically, an employee must be paid on a “salary basis” to take advantage of the exemption.  What happens, though, when an employee earns a guaranteed weekly salary, but also gets paid on an hourly, daily, or shift basis?  Can such an employee still qualify for the exemption?   Thankfully for employers – who are subject to steep penalties for misclassifying their employees – the Department of Labor’s Wage and Hour Division (WHD) addressed this question in a recent opinion letter.

In its opinion letter – issued on November 8, 2018 – WHD addressed a scenario where an engineering firm classified its engineers as “exempt professionals.”  The engineers were paid a guaranteed weekly salary of $2,100, which was calculated by multiplying $70 by 30 hours (the minimum hours the employees typically worked per week).  This guaranteed amount was paid even if an employee worked fewer than 30 hours.  But, if an employee worked more than 30 hours, the employee earned $70 for each additional hour.  So, for example, if an employee worked 45 hours in a week, he or she received $3,150 (the $2,100 weekly guarantee plus $1,050 for the extra hours worked [$70 x 15 hours]).  On average, these employees’ weekly compensation ranged from $1,793 to $3,761.

In its letter, WHD made clear that to qualify for the exemption, the employee typically must be compensated on a salary basis.  However, the FLSA’s implementing regulations allow an employee’s earnings to be calculated on an hourly, daily, or shift basis if two conditions are met.  29 C.F.R. § 541.604(b).  First, the employment arrangement must include a guarantee of at least the minimum weekly required amount paid on a salary basis regardless of the number of hours, days, or shifts worked.  Second, a “reasonable relationship” must exist between the guaranteed amount and the amount the employee actually earns.

The regulations go on to say that a “reasonable relationship” between the employee’s guaranteed compensation and the amount he or she actually earns is found if the two are “roughly equivalent.”  Of course, the regulations do not define “roughly equivalent” (If they did, WHD wouldn’t have had to issue its opinion letter and I wouldn’t have had to write this blog post!).  While the regulations do not define the term, they do give an example of what constitutes “roughly equivalent.”

In the example found in the regulations, an exempt employee is paid $150 per shift, normally works four or five shifts each week, thereby earning $600 or $750 per week.  The “reasonable relationship” test is met if the employee is guaranteed at least $500 in weekly salary.  29 C.F.R. § 541.604(b).  The ratio of $750 in actual earnings to $500 in guaranteed earnings is 1.5 to 1.  Accordingly, a 1.5-to-1 ratio of actual earnings to guaranteed weekly salary is a “reasonable relationship” and “roughly equivalent” under the regulations.

Turning back to the scenario addressed by the opinion letter, WHD determined that a 1.5-to-1 ratio of actual earnings to guaranteed salary must satisfy the reasonable relationship test.  Thus, the employees of the engineering firm – who have a $2,100 guaranteed weekly salary – could earn up to $3,150 per week and undoubtedly qualify for the FLSA exemption (since $2,100 x 1.5 = $3,150).

WHD went on to note that “the regulations, of course, do not provide that a 1.5-to-1 ratio of actual earnings to guaranteed weekly salary is the absolute maximum permissible ratio to satisfy the ‘reasonable relationship’ test.”  With that being said, WHD stated that a ratio of 1.8-to-1 (i.e., $3,761 in actual earnings with only a $2,100 guaranteed weekly salary) would “materially exceed” the 1.5-to-1 ratio, such that the two amounts are not reasonably related.  In other words, actual earnings of $3,761 are not “roughly equivalent” to a guaranteed weekly salary of $2,100, and an employee earning these amounts would not qualify for the FLSA exemption.

While WHD felt comfortable saying a 1.5-to-1 ratio satisfies the reasonable relationship test and a 1.8-to-1 ratio likely does not, WHD did not even discuss whether a ratio somewhere in between would be acceptable.  Accordingly, to play it safe and avoid harsh potential penalties, employers that pay their exempt employees on an hourly, daily, or shift basis should ensure that their weekly earnings don’t exceed their weekly guarantee by a ratio of more than 1.5-to-1.