To pay or not to pay OT

Date Published: 
March, 2005
Original Author: 
Michael S. Pepperman, Esq. and Jacob M. Sitman, Esq.
Obermayer Rebmann Maxwell & Hippel LLP
Original Publication: 
ICFM Magazine, March 2005

Are your salespeople who are paid commissions covered by or exempt from overtime under the new federal regulations? It depends.

As most of you are aware, last year the United States Department of Labor issued final regulations that modified the rules for determining whether employees are exempt from the mandatory overtime payment requirement of the Fair Labor Standards Act.

Under the general rule, employers must pay all employees overtime in the amount of one and one-half times the employees' regular rate for all time they work in excess of 40 hours per week, unless the employees qualify under one of the exemptions from the act.

A number of ICFA members have asked us about whether the new DOL regulations change the exemption from overtime for certain commission-paid salespeople under Section 7(i) of the FLSA.

Although the new final regulations do not make any changes to Section 7(i) of the FLSA, we would like to take this opportunity to review the Section 7(i) exemption and its application to commission-paid salespeople.

Two conditions must be met
Section 7(i) of the FLSA exempts retail salespersons paid on a commission basis from the mandatory overtime provisions if the following two conditions are met:

1)    the employee's regular rate of pay exceeds one and one half times the federal minimum wage; and
2)    more than half of the employee's compensation for a representative period (not less than one month) represents commissions on goods or services.

For new employees, the Section 7(i) exemption applies if:

1)    it can reasonably be expected, based on the performance of other workers in their group, that the new employee will meet the test; or
2)    it can reasonably be expected that the new employee will meet the test based on the track record of the prior occupant of the employee's position.

The Section 7(i) exemption applies to overtime, but not to the minimum wage law.  Employees who are paid on a straight commission basis must still receive at least the minimum wage for each hour worked, no matter how little commission the employee earns.
Be careful—both of the conditions must be met for the exemption to apply. If either condition is not met, then the employee is not exempt. Exemptions are determined on a workweek basis.

The following example serves to illustrate the application of the Section 7(i) exemption. Peggy Plots is employed by the ABC Cemetery as a salesperson paid on a straight commission basis. Plots works nine hours a day, five days a week. The commissions earned by Plots during a recent four-week period are reflected in the table above (Peggy Plots' Pay).

Condition One: Was Peggy Plots' regular rate of pay greater that 1.5 times the federal minimum wage?

The applicable federal minimum wage is currently $5.15 per hour. One and a half times the federal minimum wage is $7.72. Therefore, ABC Cemetery must pay Plots at least $7.73 per hour during the representative period for Plots to be exempt under Section 7(i).

As shown in the rate/hour column of the table, Plots' hourly rate of pay ranged from a low of $8.44 to a high of $12.89. Since ABC Cemetery paid Plots at a regular rate which exceeded the required regular rate of $7.73 in all four weeks, the first condition for exemption under Section 7(i) was satisfied.

Condition Two: Was more than half of Peggy Plots' compensation for the representative period commissions on goods or services?

Plots also satisfies the second condition for application of the Section 7(i) exemption because all of her compensation for the representative four-week period came from sales commissions.

When a condition is not met
Obviously, the example above is very simplistic and does not address what happens when one of the conditions is not met. When either of the conditions is not met, the exemption is destroyed and the employee must be paid overtime according to the general rule.

One strategy employers can use to effectively limit destruction of the exemption is to guarantee a base-level hourly wage for commissioned sales people that exceeds $7.72 per hour.

Also, employers sometimes set a minimum guaranteed level of commissions to ensure that commissions comprise at least 50 percent of employees' total compensation.

The application of the Section 7(i) exemption to various scenarios can be complex. If you have questions concerning the Section 7(i) exemption or require assistance in determining whether one of your salespeople is exempt based on his or her particular circumstances, you should seek the advice of an attorney experienced in wage and hour issues.

Recordkeeping requirements
To rely on the section 7(i) exemption, employers also must abide by a number of recordkeeping requirements.

To prove application of the Section 7(i) exemption, employers must maintain and preserve the following payroll and related information for all employees paid on a commission basis for at least three years:
1)    full name and Social Security number;
2)    home address, including zip code;
3)    date of birth, if under 19;
4)    sex and occupation in which employed;
5)    time of day and day of week on which the employee's work week begins;
6)    hours worked each work day and total hours worked each work week;
7)    total additions to or deductions from wages paid each pay period, including employee purchase orders or wage assignments (also, in individual employee records, the dates, amounts and nature of the items which make up the total additions and deductions);
8)    date of payment and the pay period covered by payment;
9)    a symbol, letter or other notation placed on the payroll records identifying each employee who is paid pursuant to Section 7(i);
10)    a copy of the agreement or understanding under which Section 7(i) is used or, if such agreement or understanding is not in writing, a memorandum summarizing its terms including the basis of compensation, the applicable representative period and the date the agreement was entered into and how long it remains in effect; and
11)     total compensation paid to each employee each pay period, showing separately the amount of commissions and the amount of non-commission, straight-time earnings.

Proper application of the Section 7(i) exemption and recordkeeping can save employers money. On the other hand, the improper application of the 7(i) exemption can prove quite costly.

Therefore, seek legal counsel if you have any questions regarding the application of the Section 7(i) exemption or related recordkeeping requirements.