The Third Circuit Concludes that “Salary” Does Not Include PTO

27 March 2023 Labor & Employment Law Perspectives Blog
Author(s): Morgan McDonald

On March 15, 2023, the U.S. Court of Appeals for the Third Circuit (covering Delaware, New Jersey, and Pennsylvania) held that paid time off is not part of an employee’s salary for purposes of the Fair Labor Standards Act (FLSA).

As most of our readers are aware, the FLSA distinguishes between non-exempt employees, who are generally paid an hourly wage and are entitled to one-and-a-half time overtime pay, and exempt employees, who are not entitled to overtime. For most exemptions to apply, the employee must not only satisfy certain duties tests, but also must receive a guaranteed minimum salary (currently $655) without regard to the number of hours worked, for any week in which they perform any work. An employer may not deduct from such employees’ salary based on number of hours worked, lest they lose their overtime exemption status.

In the recent case, Higgins v. Bayada Home Health Care Inc., the Third Circuit reviewed a trial court’s grant of partial summary judgment (dismissing portions of the case) in favor of Bayada Home Health Care (“Bayada”), the employer. A number of Bayada’s healthcare employees alleged that the company, which provides home medical and support services, made improper deductions from exempt employees’ accumulated paid time off (PTO) which effectively amounted to a reduction in their salaries.

As part of their employment with Bayada, the exempt workers were required to accumulate a specified number of weekly “productivity points.” Productivity points were awarded in exchange for completion of particular tasks, and each were worth roughly 1.3 hours of work. Bayada employees could request an increase or decrease in their weekly productivity minimums that would correspond to a commensurate increase or decrease in their pay. When Bayada employees exceeded their productivity minimums, they received additional compensation. But when they failed to meet the minimums, Bayada reduced their available PTO to supplement the difference. Importantly, the company did not deduct from an employee’s guaranteed base salary when the employee lacked sufficient PTO to cover a productivity point deficit. 

The employees argued that, because the point values directly correlated to the amount of time Bayada expected certain job tasks to take, the productivity points system was a proxy for reducing compensation based on total hours worked. As such, they contended that Bayada treated them as wage-earners whose total compensation was tied to the number of hours they worked. According to the workers, Bayada’s deduction of PTO from their leave banks constituted actual and improper deductions under the FLSA, causing Bayada to forfeit the overtime-pay exemption. The employees also claimed that the company actively fostered confusion about the use of PTO time, thereby leading employees to believe that if their PTO was exhausted, they would only be paid for productivity points they actually earned that week.

The Third Circuit rejected all of these arguments. The court explained that the key question when determining the legal classification of an employee for FLSA purposes is not whether a pay structure approximates an hourly wage, or even whether an employer threatens to dock a salaried employee’s base pay. Rather, the question is whether the employer actually made the deduction. In this case, there was no evidence of any actual reduction in the employees’ base pay.

Further, though neither the FLSA nor its related regulations define “salary”, the court recognized a distinction between salary and fringe benefits like PTO. It reasoned that an employer does not reduce an employee’s weekly salary by deducting from PTO because, when an employer docks PTO rather than base pay, the predetermined amount that the employee receives at the end of a pay period does not change. That an employee might at some point be able to convert PTO into cash does not alter this fact.

The Court went on to explain that the meaning and historical usage of the terms “salary” and “fringe benefits” also support a finding that the terms are mutually exclusive. It described “salary” as “a fixed amount of compensation that an employee regularly receives” and PTO as “a fringe benefit, which has no effect on the employee’s salary or wages, and which may be irregularly paid out, such as when an employee separates from a company.” The concepts being distinct, according to the Court, the term salary is best understand as not including fringe benefits like PTO. 

The Third Circuit’s decision is welcome news for employers who wish to use their PTO policies as a tool to address exempt employees’ performance.

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