Compensating Commissioned Employees: A Three-Step Guide

July 9, 2012

Few areas of the law create bigger headaches for employers than minimum wage and overtime law.All too frequently, employers either fail to recognize that their employees are entitled to minimum wages or overtime, or fail to apply the proper methodology for calculating overtime. Employers may be especially prone to making these mistakes where employees receive pay from commissions. Despite a misperception to the contrary, only a small percentage of commissioned employees are exempt from state and federal overtime requirements. The following article provides a simple, three-step guide to properly compensating commissioned employees.

Background

Federal and state law provide an interlocking set of rules governing wages and overtime.Understanding the relationship between these sources of law is critical. Federal law, set forth in the Fair Labor Standards Act (“FLSA”), establishes a minimum regulatory floor, rather than a ceiling, with respect to wage and hour law. Commonly, state law provides additional – and in some cases more generous – rights to employees. This means that for compliance purposes, employers must not only abide by the requirements of the FLSA, but any additional, more employee-friendly requirements mandated by state law.

Step #1: Determine Whether Your Commissioned Employees Are Exempt or Non-Exempt.

The first step is to determine whether the commissioned employees are exempt or non-exempt. The FLSA requires most employees be paid at least the federal minimum wage for all hours worked and overtime pay at the rate of time and one-half the regular rate of pay for all hours worked in excess of 40 hours in a workweek. Where these requirements apply, the commissioned employee is considered a “non-exempt” employee; where the requirements do not, the employee is considered an “exempt” employee. This process is known as “classification” for wage and hour purposes.

To ensure proper classification, employers should begin with the assumption their commissioned employees are non-exempt, and then review the potential exemptions to determine whether they apply. The most common exemptions are the executive, administrative, and professional exemptions. In fields that typically involve commissions, the outside sales exemption and the retail sales exemption may also apply.

Step #2: Count and Compensate Every Hour.

For non-exempt commissioned employees, the next step is to determine which work activities constitute compensable work activities. The definition of compensable work is broad. Under both the FLSA and Wisconsin law, an employer must compensate its employees for “all time spent in physical or mental exertion (whether burdensome or not) controlled or required by the employer and pursued necessarily and primarily for the benefit of the employer’s business.” This includes all time during which employees are “suffered or permitted to work,” as well as time during which employees are working solely on their own volition. Additionally, as a general matter, employers must compensate employees for all hours within a continuous workday, which begins with the first principal job activity of the day and ends with the final principal job activity of the day.

This expansive definition of compensable work has particular importance in fields that traditionally pay by commission. For example, an employer may assign work vehicles to its commissioned sales force and allow them to bring the vehicles home at night. The employees may perform work at home, including completing sales orders, mileage reports, or other work-related tasks. Because these work activities will occur at the start and conclusion of the employees’ workdays, they establish the bookends of a single continuous workday. This may create a situation where commissioned employees habitually work far in excess of 40 hours per week, thus exposing the employer to significant overtime liability.

Step #3: Calculate the Correct Rate of Pay.

Finally, where commissioned employees are entitled to overtime, the last step is to apply the correct overtime calculation. The key to calculating overtime is to determine the regular rate of pay, which is generally calculated by dividing an employee’s total non-overtime compensation by the total number of hours worked. However, the methodology for determining the regular rate of pay may differ depending upon the specifics of the compensation system, especially where salaries are involved. Four common scenarios are discussed below.

A. Commissions Only.

Where the employee is paid only by commissions, calculating overtime is simple. Here, suppose Sarah earns $1,000 in commissions for 50 hours of work in a single workweek:

 • Regular rate = $1,000/50 hours = $20/hour

• Total compensation formula = earnings from commissions + (10 hours @ one-half the regular rate of pay)

• Sarah’s total pay = $1,000 + (10 hours x .5 x $20/hour) = $1,100

B. Commissions Plus Hourly Rate of Pay.

The formula is identical where the employee is paid through a combination of an hourly wage and commissions. In this scenario, imagine Sarah earns $1,000 in hourly earnings, plus an additional $500 in commissions. She earns this compensation for working 50 hours in a single workweek. The formula is as follows:

• Regular rate = $1,500/50 hours = $30/hour

• Total compensation formula = earnings from hourly wages and commissions + (10 hours @ one-half the regular rate of pay)

• Sarah’s total pay = $1,500 + (10 hours x .5 x $30/hour) = $1,650

C. Commissions Plus Salary, Where the Employee’s Salary Is Intended to Cover 40 Hours of Work.

The formula becomes more complicated where the employee is paid through a combination of salary and commissions. Here, calculating Sarah’s regular rate of pay requires the employer to determine how many hours of work Sarah’s salary is intended to cover. In this example, suppose Sarah and her employer have an understanding that Sarah’s base salary is intended to compensate her for 40 hours of work. Sarah earns a base salary of $1,000, plus $500 more in commissions. As in the previous example, the compensation is earned in a workweek where she worked 50 hours. The following formula applies:

• Regular rate = $1,500/40 hours = $37.50/hour

• Total compensation formula = base salary and commissions + (10 hours @ time and one-half the regular rate of pay)

• Sarah’s total pay = $1,500 + (10 hours x 1.5 x $37.50/hour) = $2,062.50

D. Commissions Plus Salary, Where the Employee’s Salary Is Intended to Cover More Than 40 Hours of Work.

A final variation on the formula occurs where the employee is paid through a combination of salary and commissions, and the salary payments are intended to cover more than 40 hours of work. Under both the FLSA and Wisconsin law, when this occurs the employee is entitled to an additional overtime premium for hours worked in excess of 40 at the rate of one-half the regular rate of pay. Thus, for this example, suppose that Sarah and her employer have an understanding that Sarah’s base salary is intended to compensate her for 50 hours of work. During a 50-hour workweek, Sarah earns a base salary of $1,000, plus $500 more in commissions. The formula is as follows:

• Regular rate = $1,500/50 hours = $30/hour

• Total compensation formula = base salary and commissions + (10 hours @ one-half the regular rate of pay)

• Sarah’s total pay = $1,500 + (10 hours x .5 x $30/hour) = $1,650

Conclusion

Preventive strategies can go a long way to avoiding regulatory audits or litigation over wage and hour policies. While the compensation formulas outlined should address the majority of situations, they are by no means exhaustive. For example, a different formula applies where the employer cannot determine the exact workweek during which the employee earned commissions.

To subscribe to email alerts from Axley Law Firm, click here.