Exempt Employees: What Is the Reasonable Relationship Test and When Does it Exist Between Weekly Salary and Usual Earnings?
In Opinion Letter FLSA 2018-25, issued on November 8, 2018, Bryan L. Jarrett, the acting administrator of the U.S. Department of Labor’s (DOL) Wage and Hour Division (WHD), addresses the requirement in 29 C.F.R. Section 541.604(b) that a “reasonable relationship” exist between an exempt employee’s guaranteed amount paid on a salary basis and the amount actually earned by the employee. The reasonable relationship requirement exists so that an employer may compute an exempt employee’s earnings on an hourly, daily, or shift basis without the employee losing his or her exempt status or the employer violating the salary basis requirement.
In essence, when an employer compensates an exempt employee on an hourly, daily, or shift basis, a reasonable relationship must exist between the amount of compensation per week guaranteed to the employee and the amount of compensation the employee usually earns per week. The reasonable relationship requirement has been an enforcement policy of the WHD for over 40 years and is included in the agency’s Field Operations Handbook at Chapter 22g06. Without the reasonable relationship, the salary basis test could be circumvented by an employer that guarantees an exempt employee the minimum weekly salary—currently $455 per week—but actually compensates the employee based on an hourly, shift, or day rate. The employee’s actual compensation would thus vary based on the quantity of work performed, which would violate the salary basis requirement for exemption.
Opinion Letter Facts
The facts in FLSA2018-25 are as follows:
Exempt professional employees of an engineering firm receive a guaranteed weekly salary of $2,100
This guaranteed salary is computed based upon a rate of $70 per hour for 30 hours, which is the minimum number of weekly hours usually worked
Employees who worked in excess of 30 hours in a workweek are paid at $70 per hour
Predicting the number of hours an employee may work in a workweek is “virtually impossible.”
Employees’ average weekly compensation range from $1,793 to $3,761, with an overall weekly average for all employees of $2,721.
The opinion letter looks to the current regulations for an example of an acceptable reasonable relationship. Section 541.604(b) recognizes the existence of a reasonable relationship between a guaranteed weekly salary of $500 and usual weekly earnings that vary from $600 to $750 per week. The opinion letter states that the ratio of $750 to $500 per week, or 1.5 to 1, constitutes a reasonable relationship under the regulation.
FLSA 2018-25 concludes that usual weekly earnings of up to $3,150 per week bear a reasonable relationship to the guaranteed weekly salary of $2,100 per week because they have a ratio of 1.5 to 1, which is consistent with the regulation. However, it continues that a weekly compensation amount of $3,761 does not satisfy the reasonable relationship test because it exceeds the 1.5-to-1 ratio of actual earnings to guaranteed weekly salary. While the opinion letter acknowledges that the 1.5-to-1 ratio is not specified in the regulation as an “absolute maximum permissible ratio” to signify the existence of a reasonable relationship, it nonetheless states that where actual or usual earnings are approximately 1.8 times the guaranteed weekly salary—or nearly double—the guaranteed weekly salary “materially exceed[s]” the permissible ratio of the regulation. It also relies on 2016 federal district court case in which the hourly earnings of an employee’s usual earnings did not exceed his guaranteed salary by more than 30 percent. In that case, the examples of usual earnings to guaranteed weekly salaries relied upon by the court yielded ratios of 1.4 and 1.3 for two separate years.
The opinion letter also clarifies how an employer should compute employees’ usual earnings when their weekly hours of work vary and hence their earnings fluctuate and are not predictable. It notes that it is acceptable to compute the average weekly earnings for employees across a calendar year, even though it may not be the only reasonable method, because the one-year time period “should ordinarily provide ample representation of variations in an employee’s earnings and hours.” The opinion letter cautions, however, that the computation of average weekly earnings should be made on an employee-by-employee basis, as opposed to using a group of employees or a job classification, noting that such a group-based computation may not accurately reflect the average weekly earnings of each individual employee within such group or job classification.
Admittedly, this is a narrow topic, but it is an important one for employers that guarantee a certain salary to an exempt employee whose actual compensation is based upon an hourly, shift, or daily rate. This opinion letter strikes a balance between these two amounts so that the employee’s exempt status is not jeopardized. It nonetheless takes a conservative or literal reading of the current regulation and lays down a ratio of approximately 1.5 to 1 of usual earnings to guaranteed earnings as the outer limit of the reasonable relationship test. While there may be disagreement regarding this ratio, employers may find it reassuring that the WHD believes it is reasonable when scrutinizing an employer’s implementation of the requirement.