A year-end bonus is a great way to reward employees’ hard work. To keep employees motivated throughout the year, some employers pay employees, in addition to a base salary, monthly advances on the employees’ expected year-end bonus.
The problem, however, is that an employee who fails to meet performance standards may receive more in advanced bonus payments than he or she has earned by year-end. While it may seem obvious that the employer may deduct these “overpayments” at the end of the year, a recent case by the Minnesota Supreme Court reminds us that such deductions should be made from exempt employees with extreme caution.
Life Time Fitness
In Erdman v. Life Time Fitness, Inc., — N.W.2d —-, 2010 WL 3502811 (Minn. Sept. 9, 2010), the Minnesota Supreme Court analyzed whether deducting unearned, prepaid bonus payments from exempt employees’ paychecks caused the employees to lose their exempt status under Minnesota’s Fair Labor Standards Act (“MFLSA”). The suit involved state law because the plaintiffs’ federal Fair Labor Standards Act (“FLSA”) claims were venued in Ohio.
Life Time paid its managers an annual base salary, with the potential to earn an annual performance bonus. Although the bonus was earned yearly, the managers were paid monthly based on year-to-date performance. Accordingly, advancing annual bonuses in monthly installments could lead to overcompensation if the manager was unable to sustain the department’s performance through the year.
In Erdman, twelve Life Time Fitness managers in Minnesota failed to meet their performance expectations and Life Time deducted as much as $1,000 of “prepaid bonus” compensation from their final paychecks. The managers argued that the deductions caused them to lose their exemption under the MFLSA.
The Minnesota Supreme Court disagreed and held that the managers were exempt notwithstanding the wage deduction because the managers still received their predetermined weekly wage (i.e., base pay). This amount was contractually guaranteed and therefore the managers “never received less than their promised compensation on a year-to-date basis.” Id. at *6.
FLSA vs. MFLSA
The Minnesota Supreme Court recognized that federal courts have found that Life Time’s deductions rendered its employees non-exempt pursuant to the federal law. Specifically, in Baden-Winterwood v. Life Time Fitness, Inc., 566 F.3d 618 (6th Cir. 2009), the court held that the Life Time Fitness’ bonus deductions caused their managers to lose exempt status under the federal FLSA.
Nevertheless, in Erdman, the court noted that “[t]here is a difference in language between the FLSA and the MFLSA that is determinative.” Id. at *7. The federal FLSA requires the employee “receive the full salary” for each week where work is performed, 29 C.F.R. § 541.602(a), and that amounts cannot be deducted from that salary.
In contrast, “there is no regulation in the MFLSA regarding deductions and the effect a paycheck deduction has on an employee’s exemption status.” Id. Therefore, the fact that Life Time Fitness’ deductions caused the managers to receive a meager paycheck at the end of the year did not effect their exempt status under the MFLSA.
Bottom Line
Employers not subject to the federal FLSA may consider a prepaid bonus compensation structure similar to the one employed by Life Time. However, employers subject to the FLSA may cause their exempt employees to become non-exempt by taking deductions based on a similar compensation structure. Therefore, in general, Minnesota employers should exercise extreme caution before deducting any wages from an exempt employee.