The economy is on the upswing, but the recovery has not been felt across the board. some sectors like the service industry have lagged. This is causing increased pressure to cut costs. One of the possible ways to do this is by reducing compensation. Reducing pay is a viable option available to business owners that can cause problems down the road if not executed correctly. Fair Labor Standards Act (FLSA) governs how employers can reduce employee compensation. If the pay reductions are implemented incorrectly, they expose businesses to lawsuits and fines. This article is designed as a starting point for business owners. Every business is different, and we advise business owners to consult with a professional before implementing pay cuts.

Things to consider

Pay cut methodology

Like with many things concerning employees and employment law, pay and salary reductions need to be approached mindfully.

Business owners need to make sure they

  • Comply with the FLSA.
  • Apply the pay reductions equitably across their organization.
  • Carefully implement the pay reduction in a manner that does not discriminate.

Special considerations need to be taken to make sure to not discriminate against any protected classes. Protected classes are defined under equal employment opportunity laws. Some of these classes are protected federally and others vary based on your local laws.

Federally protected classes

  • Race.
  • Color.
  • Ethnicity/national origin.
  • Sex.
  • Sexual orientation.
  • Gender identity or expression.
  • Pregnancy.
  • Religion, belief, and spirituality.
  • Age.
  • Disability.
  • Use of family and medical leave.
  • Military status.
  • Genetic information

State and Locally protected classes

  • Marital status.
  • Sexual orientation.
  • Gender identity or expression and cross-dressing.
  • Legal off-duty conduct, such as smoking.
  • Whistleblowing
  • Taking leave to serve on a jury or to be a witness in a legal proceeding or to vote

There are a few situations you want to stay clear of when implementing pay reductions across your workforce.

Situations in which pay cuts are illegal

  • Not communicating: failing to notify employees of pay reductions or not adhering to the legally mandated lead time. Lead times vary based on local law.
  • Retroactive pay cuts: the pay reductions can only be applied to hours worked after the employer notifies the employee of the pay cut.
  • Discrimination: employers cannot reduce pay as a means of discrimination
  • Breaking a contract: the compensation reduction cannot violate the terms of a contract between an employer and employee
  • Retaliation: employers cannot reduce pay as a means of retaliation for an employee’s actions. For instance, if the employee is involved in a discrimination claim against the employer.

Nonexempt vs Exempt employees

Exempt employees

To keep your employee’s overtime-exempt status the FLSA mandates that their pay must stay above $648 per week. When annualized that pay rate adds up to a salary of $35,568. Some states have implemented their own thresholds for example in California the threshold is $54,080 annualized for employers with 26+ employees.

Another thing to keep in mind when reducing your employee’s compensation is to not modify their duties too much. If their duties deviate from exempt worker criteria under the FLSA they won’t qualify for overtime-exempt status. On July 20th, 2020 the Department of Labor (DOL) gave more guidance on this topic in repose to the Covid pandemic. The Department of Labor said that administrative and professional exemptions may temporarily perform nonexempt duties that are required by the emergency without losing their exempt status.

Each of the three white-collar exemptions has slightly different criteria:

Executive exemption. The employee’s primary duty must be managing the enterprise or a department or subdivision of the enterprise. The employee must customarily and regularly direct the work of at least two employees and have the authority to hire or fire workers (or the employee’s suggestions and recommendations as to hiring, firing, or changing the status of other employees must be given particular weight).

Administrative exemption. The employee’s primary duty must be performing office or nonmanual work that is directly related to the management or general business operations of the employer or the employer’s customers. The employee’s primary duty also must include the exercise of discretion and independent judgment with respect to matters of significance.

Professional exemption. The employee’s primary duty must be to perform work requiring advanced knowledge in a field of science or learning that is customarily acquired by prolonged, specialized intellectual instruction and study.

Non-Exempt employees

Pay reductions in nonexempt workers are a lot more straight forward. Employers have more mechanisms to reduce their labor costs when it comes to Nonexempt workers. Things to remember are to comply with the pay reduction notification standard in your state. Pay cannot go below the state minimum wage. Employers can also reduce an employee’s hours and can send employees home if their labor is not needed. You do not have to pay for hours not worked even when sent home due to Covid laws. Unless your city or state requires you to pay reporting time pay to nonexempt employees. In some states, the employer might not have to give reporting time pay if a state of emergency ordered (or recommended) business closure.

H-1B and E-3 Visas

If you have employees working under an H-1B or E-3 visa it is very likely that you cannot reduce their pay. You are limited by compensation stated in their DOL labor condition application for that individual. Paying less than the approval amount will most likely violate the prevailing wage requirements for those visas. The prevailing wage rate is defined as the average wage paid to similarly employed workers in a specific occupation in the area of intended employment. You can obtain the prevailing wage rates for occupations in your area by submitting a request with the DOL.

If the pay reduction lands between the prevailing wage rate, you will able to reduce the employee’s compensation. You will have to submit extra paperwork to the DOL and the U.S. Citizen and immigrating services before the reduction can take effect.

How to communicate the salary reduction

The need for good communication in the workplace permeates through every interaction. No matter the dynamics. This holds true when pay cuts are concerned. Clearly communicating why, the cuts are necessary and the other alternatives that were taken before arriving at pay cuts will cushion the morale drop. Having zero communication about a pay cut before its implementation will also have legal ramifications. There are laws that govern the amount of lead time and the employer must give employees about a pay cut. The time amount of time that must elapse between the communication and the implementation varies state by state. In many states, there are laws that govern the medium by which the pay cut notification must be given. So check your local laws or consult with a professional to ensure your business stays compliant and avoids any legal ramifications.

Compensation reductions are a painful but useful tool to help businesses ride out the economic downturn. Like most circumstances pertaining to employment law, things can get a little complicated. That is why we always advise that business owners consult with a professional who can guarantee that they stay compliant and protected through the process