The Perils and Pitfalls of Commissions

Failing to properly structure your commission plans is a ticking legal timebomb. Misclassifying an employee or mishandling a payment doesn’t just result in a disgruntled worker; it invites federal Department of Labor audits, "savvy" plaintiff attorneys, and state-mandated penalties that can triple your original costs. In jurisdictions like California or New York, a single oversight regarding final payments can lead to massive liquidated damages and mandatory attorney fees that far exceed the commissions in question. If you don't get the math and the documentation right now, you are essentially handing your employees a blank check for future litigation.

Primary Directives for Your Project

• Secure the Salary Basis for Exemptions: If you are treating inside sales staff or financial brokers as exempt from overtime, you must pay a guaranteed weekly salary (currently $685). Never "bust" this salary by deducting for poor performance or draws, or you will lose the exemption and owe overtime for every hour worked over 40.
• Draft Precise Written Agreements: Avoid the "dumb" mistake of oral contracts. Your written plan must explicitly define when a commission is "earned" (e.g., upon receipt of customer payment) versus when it is "paid." Courts will strictly enforce your written language, even if it results in a payout far larger than you anticipated.
• Master the Outside Sales Criteria: Only classify employees as "outside sales" if their primary duty is physically visiting customers away from your place of business. If they spend more than 50% of their time in the office on the phone or computer, they are likely inside salespeople entitled to overtime and minimum wage.
• Audit Your Section 7(i) Compliance: If you operate a retail or service establishment, ensure your commissioned staff earns at least 1.5 times the minimum wage for all hours worked and that over 50% of their pay is commission-based. If they fall short in a single week, you may need to supplement their pay to maintain the overtime exemption.
• Standardize Timekeeping for Remote Work: In an era of constant connectivity, you must require employees to log all time spent on phones and computers after hours. If you "suffer or permit" them to work without logging it, you are liable for that overtime. Use mobile apps to track start times, breaks, and evening follow-ups to create a defensible record.
• Validate Deductions and Loans: If an employee owes you money, never unilaterally seize their final paycheck. Ensure you have a signed, voluntary deduction authorization. While you can often offset commissions, you must remain sensitive to state-specific laws that prohibit withholding wages upon termination.
• Adhere to State-Specific Timelines: Recognize that the laws of the state where the employee is located govern the payout. Be prepared to pay all earned commissions within 24 to 72 hours in strict states like California, or within 30 days in states like Georgia or Washington.
• Execute Changes Prospectively Only: You can change your commission structure at any time by issuing a new memo, but you cannot apply those changes to sales already made. Continuing to work after receiving notice of a new plan constitutes the employee's legal acceptance of those new terms.

To protect your project, you must transition from informal "handshake" agreements to a rigorous, documented compensation framework. The intersection of the Fair Labor Standards Act and aggressive state statutes leaves zero room for error. By locking in guaranteed salaries, enforcing strict time-tracking, and clearly defining the moment a commission is earned, you transform a significant legal liability into a controlled, performance-driving asset.

Les A. Schneider (00:00): Good afternoon. My name is Les Schneider, and I am joined by my partner, Larry Stine. Today, we are discussing the perils and pitfalls of paying commissions to employees. Many employers make costly mistakes in this area, often violating federal wage and hour laws or specific state regulations. Larry, many employers prefer commission-based compensation because they believe it incentivizes quality work and increases company income. Can you explain the basic concepts of commission? Does an employer have to pay purely on commission, or can there be a mixture of salary or hourly rates?

The Outside Sales Exemption

J. Larry Stine (01:25): Employers handle this in several ways. Under "pure commission," an employee only gets paid if they make a sale—the "eat what you kill" model. This is permissible under the Fair Labor Standards Act (FLSA) for "outside salespersons" because that exemption does not have a salary requirement and provides an exemption from both overtime and minimum wage. For example, an outside salesperson selling high-value items might go a year without a sale (and thus without income) and would have no grounds for a lawsuit.

Les A. Schneider (02:09): If an employee stays in the office all day making sales over the phone, does that person qualify as an outside salesperson?

J. Larry Stine (02:42): No. This is where many employers get into trouble. While the work may seem similar, inside salespersons almost always require a guaranteed draw of at least the minimum wage to avoid violating overtime and minimum wage laws.

Les A. Schneider (03:16): How does an employee qualify for the outside sales exemption?

J. Larry Stine (03:29): Their primary duty must be making sales away from the employer’s place of business. They must go out to visit customers. While there isn't a strict percentage test, the "primary duty" must be outside sales. If an employee is out 50% of the time and spends the other 50% inside performing follow-up tasks related to those outside visits, they would safely qualify. The situation becomes legally difficult if the salesperson only goes out once a week or once every other week.

Inside Sales and Administrative Exemptions

Les A. Schneider (05:50): So, someone doing telephone or computer sales from the office is definitely not an outside salesperson. Can they be classified under the "administrative exemption"?

J. Larry Stine (06:16): Generally, no. Courts typically apply the "production-administrative dichotomy." Sales are considered "production" work—the core output of the business—rather than the "administration" of the business. Therefore, inside salespeople are generally subject to overtime if they work more than 40 hours in a week.

The Section 7(i) Exemption

Les A. Schneider (07:34): Let's discuss Section 7(i) of the FLSA, which provides an overtime exemption for certain commissioned employees in retail or service establishments. What are the three criteria for this?

J. Larry Stine (08:46): 1. Regular Rate of Pay: The employee’s average hourly earnings (base pay plus commissions) must exceed 1.5 times the federal minimum wage.

2. Retail/Service Establishment: The employee must work for a retail or service establishment (e.g., a restaurant or retail store). This does not apply to manufacturing, construction, or wholesale distribution.

3. Commission Percentage: More than half (50%) of the employee's total compensation for a representative period (usually a month or a quarter) must come from commissions.

Commission vs. Piece Rate

Les A. Schneider (11:57): How do you distinguish between a commission and a piece rate?

J. Larry Stine (12:10): A commission is typically a percentage of a sale (gross profit or net profit). A piece rate is based on the production of a specific unit, such as 10 cents for every widget produced or a flat rate for every square foot of sheetrock hung. Importantly, there is no overtime exemption for piece-rate workers. They must be paid overtime based on their total earnings.

Calculating Overtime for Commissioned Employees

Les A. Schneider (14:04): If an inside salesperson works 50 hours and earns $600 in commissions for the week, how is overtime calculated?

J. Larry Stine (14:50): You divide the total commission ($600) by the total hours worked (50) to get a "regular rate" of $12 per hour. Since the straight-time pay is already covered by the $600, you owe an additional "half-time" rate for the 10 overtime hours. That would be $6 per hour ($12 / 2) multiplied by 10 hours, totaling $60 in overtime.

Les A. Schneider (16:07): What if they are paid a base salary plus commission?

J. Larry Stine (16:38): If you pay a $500 salary plus $600 in commission for 50 hours, the total is $1,100. You divide $1,100 by 50 hours to find the regular rate ($22). You then owe 10 hours at half that rate ($11), totaling $110 in overtime. Alternatively, you can pay a percentage-based bonus that is "built-in" to the total pay, provided the math accounts for the overtime hours.

The Financial Industry and Salary Requirements

Les A. Schneider (18:24): In the financial industry, many brokers work in an office. Are they subject to overtime?

J. Larry Stine (18:56): Often, yes. Employers mistakenly believe these high earners are exempt, but to qualify for white-collar exemptions, you must pay the required guaranteed salary (currently $685 per week). You cannot waive overtime rights through a contract; if you don't pay the guaranteed salary, the employee is entitled to overtime regardless of how much commission they earn.

J. Larry Stine (20:20): It is critical to have a written commission plan. Oral contracts lead to "he-said, she-said" litigation. You can structure commissions to be "net" of the salary draw, but you must never "bust" the salary. Even if the salesperson is failing, they must receive that guaranteed weekly salary to maintain the exemption.

Hours Worked and Remote Work

Les A. Schneider (24:05): With technology, people are working from home and on cell phones. How should employers track this?

J. Larry Stine (24:22): Employers should use apps or logs to ensure employees record all work time, including evening calls or emails. If an employer "suffers or permits" the work—meaning they know it is happening and allow it—they must pay for it. Accurate records are the best defense against a lawsuit where an employee claims they worked far more hours than they actually did.

State Laws: Georgia, California, and New York

Les A. Schneider (27:23): Beyond federal law, what should employers know about state regulations?

J. Larry Stine (27:44): * Georgia: Under O.C.G.A. § 10-1-702, wholesale manufacturing representatives can sue for unpaid commissions, liquidated damages, and attorney fees. Commissions generally must be paid within 30 days of termination.

• California: This is the most difficult state. Commissions must often be paid immediately upon termination or by the next payday. Failure to do so results in substantial daily penalties.

• New York: Commissions are treated as wages earned. The state allows for double damages and attorney fees for non-payment.

Deductions and Loans

Les A. Schneider (30:07): Can an employer withhold commissions to pay back a loan made to the employee?

J. Larry Stine (30:31): Under state law, you can often offset a loan against a commission, provided it is a voluntary, written deduction. However, you must be careful not to deduct from the guaranteed salary required for exemptions. A common mistake is taking an employee's entire final paycheck to satisfy a debt; this often triggers a Department of Labor audit.

Contract Modifications and Termination

Les A. Schneider (35:56): Can an employer change a commission structure retroactively?

J. Larry Stine (36:46): No. Commissions are contractual. You can change them prospectively (going forward) with written notice, but you cannot unilaterally change the rate for sales already made.

Les A. Schneider (37:58): Can an employer mandate that commissions are forfeited if the employee is fired or quits?

J. Larry Stine (38:12): Many states prohibit the forfeiture of earned commissions. In states like Georgia, you can write specific "earning" criteria into the contract—for example, stating that a commission is only "earned" when the company actually receives the funds. If the wording is clear, you can legally require the company to be paid before the salesperson receives their cut.

Les A. Schneider (44:42): To summarize, check the specific laws of the state where your salesperson is located, as those laws usually apply. Illinois, Washington, and several other states have very specific timelines for payment.