UPDATE: On August 31, 2020, the Wage and Hour Division of the U.S. Department of Labor issued an opinion letter confirming its longstanding position (discussed at length in its preamble to the final rule described in this Insight) that an employee’s work hours do not have to fluctuate above and below 40 per workweek for an employer to be able to use the fluctuating workweek method of calculating overtime pay; rather, it is sufficient that the hours fluctuate from week to week.

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On May 20, 2020, the U.S. Department of Labor (DOL) released its final rule revising its so-called “fluctuating workweek” regulation. The final rule confirms that incentive payments—such as bonuses, commissions, and other premium payments—made in addition to the salary are compatible with the use of the fluctuating workweek method of compensation. The DOL also clarifies other aspects of the fluctuating workweek method that have confused courts and employers alike. The final rule provides much-needed clarity to the regulated community and provides additional flexibility to employees and employers in structuring compensation arrangements that align with their objectives.

Background

The Fair Labor Standards Act (FLSA) requires employers to pay their nonexempt employees overtime pay of at least “one and one-half times the regular rate” at which the employee is employed for all hours worked in excess of 40 in a workweek. In Overnight Motor Transportation Co. v. Missel,¹ the U.S. Supreme Court held that where a nonexempt employee receives a fixed weekly salary for working hours that fluctuate from week to week, the employee’s regular rate is equal to the weekly salary divided by the number of hours actually worked. The employee is then owed an additional one-half times that rate for all overtime hours worked.

In 1968, informed by Missel, the DOL issued 29 CFR § 778.114, a regulation stating that when the parties have a “clear mutual understanding” that the “fixed salary” is compensation for all hours worked in a workweek (whether few or many), the employee’s “regular rate” in any workweek is equal to the employee’s salary divided by all hours worked during that workweek. Then, because the salary has already compensated the employee for all hours worked (including the overtime hours), the employer must pay only an additional one-half times that regular rate for all overtime hours worked in order to achieve total overtime pay of one and one-half times the regular rate. Because the employee’s regular rate will vary as hours worked fluctuate from one week to the next, this method of calculating overtime became known as the “fluctuating workweek” method.

The Final Rule Resolves Confusion about the Fluctuating Workweek Method

Here is a summary of the key takeaways from the final rule:

1.        Employers Can Make Premium Payments in Addition to the Fixed Salary

a.        Additional Payments are Compatible with Fluctuating Workweek Method

It had been the DOL’s longstanding view that the payment of bonuses and other premiums—beyond the “fixed salary” described in § 778.114—were consistent with the fluctuating workweek method. However, in the preamble to a 2011 final rule, the DOL announced a completely different position (which one court criticized as “an about-face”), suggesting that such payments would be “incompatible” with the “fixed salary” contemplated by § 778.114.

The language in the 2011 preamble generated substantial confusion for both employers and courts. In an attempt to reconcile the 2011 preamble with the DOL’s prior position, some courts adopted a dichotomy between “productivity-based” supplemental payments (such as commissions) and “hours-based” supplemental payments (such as night-shift premiums), reasoning that productivity-based payments are compatible with the fluctuating workweek method, but not hours-based payments. Not surprisingly, these cases merely generated additional confusion about whether certain premium payments were hours-based or productivity-based.

The final rule rejects both the 2011 preamble’s rejection of premium payments and the court-devised “dichotomy” between productivity-based premiums and hours-based premiums. Instead, the final rule confirms that premium pay “of any kind” made in addition to the fixed salary (including bonuses, premium payments, commissions, and hazard pay) are compatible with the fluctuating workweek method. The final rule emphasizes that all bonus and premium payments—whether hours-based or production-based, or based on any other metric—are compatible with the use of the fluctuating workweek method.

b.        Additional Payments Must Usually be Included in the Overtime Calculation

The final rule reminds employers that bonus and premium payments must be included in the regular rate calculation and overtime calculations unless excludable under section 7(e) of the FLSA. The final rule confirms that the regular rate is determined by dividing the amount of the salary and any non-excludable additional pay received each workweek by the number of hours worked in the workweek, and that payment for overtime hours at one-half such rate satisfies the overtime pay requirement.

c.        Fluctuating Workweek Method Does Not Incorporate Exceptions for Exempt Employees Paid on a Salary Basis

The DOL decided not to adopt the suggestion of certain commenters that the term “fixed salary” in the final rule be interpreted in a manner consistent with the term “salary basis” as used in the regulation defining the exemptions for executive, administrative, and professional employees. In that regulation, the term “salary basis” is defined to allow certain deductions from salary, such as when an exempt employee is absent from work for one or more full days for personal reasons, other than sickness or disability.² The DOL expressed the view that even though such deductions are consistent with being paid on a “salary basis” for exempt employees, deductions for days or hours not worked are incompatible with the payment of a “fixed salary” under the fluctuating workweek method.

While not incorporating the “salary basis” definition into the final rule, the DOL reaffirmed its longstanding position that an employer using the fluctuating workweek method may take occasional disciplinary deductions from the employee’s salary for willful absences or tardiness or for infractions of major work rules, provided that the deductions do not cut into the minimum wage or overtime pay required by the FLSA. The DOL cautioned, however, that if such deductions are consistently or frequently made, it would raise questions as to the validity of the compensation plan.

2.        Hours Need Not Fluctuate Below 40

There has been some confusion about whether an employer can use the fluctuating workweek method if the employee’s hours worked rarely, if ever, go below 40 in the workweek. The DOL clarified that there is no requirement that the employee’s hours of work must fluctuate below 40 hours per week. Instead, the employee must only work hours that fluctuate from week to week.

3.        The Salary Must be “Reasonably Calculated” to Provide Minimum Wage

Section 778.114 provides that the salary needs to be “sufficient” to provide compensation to the employee at a rate not less than the applicable minimum wage in those workweeks in which the number of hours the employee works is greatest. This requirement generated questions about what would happen if an employee occasionally worked such extremely high hours that the regular rate fell below the minimum wage. Did such an occurrence, however rare, invalidate the fluctuating workweek method altogether? Or did it merely trigger an obligation for the employer to provide a supplemental payment to comply with the minimum wage?

In response, the DOL clarified that the fixed salary need only be “reasonably calculated” to provide compensation at a rate not less than the applicable minimum wage. If there are “occasional and unforeseeable” workweeks in which an employee works extremely high hours due to unusual circumstances, and the regular rate falls below the minimum wage, this does not invalidate the fluctuating workweek method. In those cases, the employer must provide a supplemental payment to satisfy the minimum wage. On the other hand, the employer will not be able to rely on § 778.114 where the employer could have foreseen that the employee’s salary was not sufficient to provide compensation at a rate of at least the minimum wage (for example, where the salary did not cover the minimum wage “with some degree of frequency”).

4.        The “Clear Mutual Understanding” Applies Only to the Fact that the Salary is for All Hours Worked, Not to the Details of the Calculation

Section 778.114 provides that the fluctuating workweek method requires an employer and employee to possess a “clear mutual understanding” that the fixed salary is compensation for all hours worked each workweek. There has been some debate about whether the employee must fully understand the entire fluctuating workweek calculation in order to be subject to it. While the final rule retained the “clear mutual understanding” language, the preamble emphasizes that the required “understanding” extends only to the fact that the salary represents compensation for the total hours worked each workweek regardless of the number of hours. The “understanding” need not extend to the specific details of the method used to calculate overtime pay.

5.        The Fluctuating Workweek Method Does Not Supersede State Law

The DOL reminded employers that the FLSA does not preempt state law and that states may enact overtime laws that are more restrictive on employers than the federal standard. Thus, employers must still comply with state law that restricts the use of the fluctuating workweek (including, for example, Alaska, California, New Mexico, and Pennsylvania).

The Fluctuating Workweek Method is Merely One Example of How to Comply With the Statutory Requirement

There has long been confusion about the impact of failing to comply with the specific technical requirements of § 778.114, with some arguing that § 778.114 is a half-time “exception” to time-and-a-half overtime and that any “violation” of § 778.114 should result in a recalculation of an employee’s overtime based upon an assumption that the fixed salary was only compensation for a 40-hour week, instead of for all hours worked. Of note, the DOL agreed with commenters that § 778.114 is merely one of several “examples” of how to properly compute the regular rate and overtime pay to satisfy the FLSA’s statutory pay requirements. The DOL confirmed that as an example of the statutory overtime calculation, § 778.114 is not an “exception” to time-and-a-half overtime and does not impose additional requirements that are inconsistent with the statutory requirements. Rather, § 778.114 is just one example of how to properly compute overtime pay owed under the FLSA in the circumstances described in the regulation itself.

The discussion of § 778.114 as a mere example of the FLSA’s statutory pay requirement was foreshadowed in a 2016 decision by the U.S. Court of Appeals for the First Circuit upholding the employer’s payment of commissions as part of a valid fluctuating workweek arrangement because the compensation plan “complies with the DOL’s regulatory examples.”³ While the court did not “separately analyze” the compensation plan under statutory text of the FLSA itself, it did suggest that a compensation plan need not “fall within a regulatory example” in order to “comply with the statute.”⁴

In the preamble to its final rule, the DOL agreed that the “general FLSA principle”—that when an employer pays straight-time compensation for all hours worked in the workweek, the employer’s resulting overtime obligation is only an additional one-half the regular rate for the overtime hours—applies “regardless of whether the specific compensation scheme at issue satisfies the technical requirements of § 778.114.” In other words, even if an employer’s compensation plan does not strictly adhere to the “technical requirements” of § 778.114, it may still comply with the FLSA if it results in payment for hours worked in excess of 40 per workweek “at a rate not less than one and one-half times the regular rate” at which the employee is employed.⁵