The California Supreme Court has opened a can of worms for employers after holding that they cannot apply commissions paid in one pay period to another pay period in order to satisfy state law governing the overtime-exempt status of inside salespeople.

The case is significant and any company that has inside salespeople needs to pay close attention to this ruling and apply it to how they pay their sales staff.

And while the decision seems simple enough, it will increase payroll costs for companies and could end up causing some inside salespersons to not qualify for the overtime exemption under state law.

Remember, under California law, an inside salesperson will be exempt from overtime pay if they earn more than 1.5 times the state minimum wage and more than half their income comes from commission.


<b>The case</b>

Susan Peabody was a Time Warner account executive selling advertising on the company’s cable television channels. Every other week, she was paid $769.23 in hourly wages, which works out to $9.61 per hour for a 40-hour work week. About every other pay period, Time Warner paid commission wages.

Peabody said she worked more than 40 hours per week, and in some weeks as many as 48 hours. She contended in her lawsuit that in those weeks, she was essentially paid less than the minimum wage per hour if she was not paid commission in that week.

Meanwhile, Time Warner claimed Peabody was an exempt, inside salesperson. To qualify under the inside sales exemption, she must, among other things, satisfy two compensation criteria, particularly that “an employee’s earnings exceed one and one-half times the minimum wage” – that is, $12 per hour.

But on weeks that she worked overtime and was not paid commission, she actually earned closer to $8 an hour in base pay. The court wrote that for the exemption to apply, commissions would have to make up the difference.

Because Time Warner paid its commissions about once a month, it argued that the commission payment should be allocated over the course of the month for purposes of determining overtime pay, since she technically earned the commissions throughout the month.

Time Warner argued that the commissions it paid Peabody counted towards the period during which the commissions were earned.  So, if the commission check was paid on March 23 for commissions earned in February, then the minimum wage calculation had to take into consideration those commission wages.

The court disagreed, saying that it was clear that Peabody did not receive 1.5 times the minimum wage for the hours worked on many of her paychecks.

The court held that commissions may be earned over time. It may be that a sale occurs in January, but is not earned until payment is received in April. That’s fine with respect to wage-hour law governing commissions.

But if the commission check is paid in April because the commissions are finally earned, then those commissions are counted towards minimum wage only during the (bi-weekly or semi-monthly) pay period for which the paycheck is paid.

Whether the minimum earnings prong is satisfied depends on the amount of wages actually paid in a pay period.

In other words, an employer may not attribute wages paid in one pay period to a prior pay period to cure a shortfall.


<b>The takeaway</b>

The ruling can make accounting a bit tricky for some employers if they are not paying commissions in every pay period.

And under this decision, based on California’s current minimum wage, to satisfy the exemption, the employee must receive in each paycheck at least 1.5 times the minimum wage, for the hours worked during the applicable workweeks covered by that paycheck. That means $13.50 per hour worked as of July this year.

An employer who pays commissions less frequently than semi-monthly or bi-weekly must pay a sufficient hourly rate to ensure the 1.5 times minimum wage threshold is met.

If you don’t pay commission every pay period and are thinking that you can get away paying sales staff less than $13.50 an hour in base pay, you may need to change your commission payment policies.

If you don’t, this ruling will increase inside salespersons’ non-commission earnings, by increasing the hourly pay required to maintain the exemption. And it will be more expensive in other ways:

Payroll expense will increase absent a reduction in the commission rate.

Remember that the inside sales exemption depends on a second criterion:  the employee must make more than 50% of wages from commission. Well, if you end up paying a higher hourly rate to avoid getting caught up in the overtime quandary, you will make it harder for employees to meet that 50% threshold.