Inside Sales Exemption

This blog post provides general information concerning the Fair Labor Standards Act (FLSA) and California law overtime exemption to retail or service establishment employees who are paid on a commission basis - also known as inside sales employees.

Both federal and California laws create an exemption from standard overtime rules for employees engaged in inside sales that satisfy specific criteria.

To qualify as exempt, inside sales employees must satisfy the exemption criteria under both state and federal law in order to be treated as exempt employees.

California Inside Sales Exemption Criteria

If a retail or service employer elects to use the overtime exemption for commissioned employees, three conditions must be met:

• the sales employee must be employed by a retail or service establishment;
• the employee's regular rate of pay must exceed one and one-half times the applicable minimum wage for every hour worked in a workweek in which overtime hours are worked, and
• more than half the employee's total earnings in one pay period must consist of commissions.

Unless all three conditions are met, the inside sales exemption is not applicable, and the employee is entitled to overtime pay for all hours worked over 8 hours in a day or 40 in a workweek at a time and one-half the regular rate of pay.

If an employee is employed by the central office of a retail chain enterprise as a sales instructor working in various retail establishments, because this employee is employed by the employer's office and not "by" the retail "establishment," the exemption does not apply.

Inside Sales Exemption Example

The inside sales exemption only applies to employees if: (1) more than half of their earnings derive from commissions and (2) their earnings exceed one-and-a-half times the applicable minimum wage.

For example, a mechanic, who doesn’t persuade customers to let him fix their cars, doesn’t engage in “sales.” Thus, any compensation he earns for fixing a car is a bonus or piece rate, not a commission.

For example, if an employee earns $1,000 in a pay period, but only $100 of those earnings come from commissions, then the employee does not qualify for the inside sales exemption.

Pay Periods

The representative period for determining if enough commissions have been paid may be as short as one month but must not exceed one year. The employer must select a period representative of a typical wage order to determine if this condition has been met.

Based on their earnings, an employee may qualify for the inside sales exemption in one pay period but not qualify for the exemption during the next pay period. Whether or not an employee has earned over half their compensation from commissions must be evaluated on a pay period by pay period basis.

What Counts As A Commission?

If the employee's earnings are entirely by commissions or draws and commissions, or if commissions are always greater than salary or hourly amounts paid, the more than half commissions condition will have been met.

If the employee is not paid in this manner, the employer must separately total the employee's commissions and other compensation paid during the representative period. The total commissions paid must exceed the total of other compensation for this condition to be met.

To determine if an employer has met the "more than one and one-half times the applicable minimum wage" condition, the employer may divide the employee's total earnings attributed to the pay period by the employee's total hours worked during such pay period. If the result is greater than time and one-half the minimum wage, this exemption condition has been met.

Tips paid to service employees by customers may never be considered commissions for the purpose of this exemption.

Service Industry Charges

Hotels, motels, and restaurants may levy mandatory service charges on customers, representing a percentage of the amounts charged for services. Suppose part or all of the service charges are paid to service employees. In that case, that payment may be considered commission, and if other conditions are met, the service employees may be exempt from the payment of overtime premium pay.

Inside Sales Still Entitled To Meal Periods and Rest Breaks

Suppose an employee qualifies as an exempt inside sales representative. In that case, they are not entitled to overtime compensation for hours worked more than 8 hours in a single day or over 40 in a single week.

Still, California law entitling non-exempt employees to meal breaks remains applicable, meaning that employers must provide meal periods and rest breaks to otherwise exempt inside sales representatives.

Failure to provide duty-free meal periods or paid rest breaks in accordance with California law to inside salespersons can expose employers to missed meal periods or rest break premiums at the employee's regular rate of pay.

Commission Agreements Must Be In Writing

California Labor Code Section 2751 requires that anyone paid a commission must be provided with a written commission agreement. The agreement must explain how the commissions shall be computed and when paid. The commission agreement must also be signed by the employer, and the employer must obtain a signed receipt from the employee.

FLSA Inside Sales Exemption Requirements

The criteria that an employee must satisfy to qualify as an exempt inside sales representative under federal law are similar, but not identical, to those applicable under California law.

Under federal law, the inside sales exemption applies only to employees who (a) earn more than 150% of the minimum wage, (b) derive at least 50% of their income from commissions, and (c) work in the “retail and service industry.”

To qualify as a “commission” within the meaning of the inside sales exemption, incentive-based compensation must be roughly proportional to an employee’s sales productivity. If an employee earns a fixed amount of incentive compensation for achieving a particular milestone, the compensation does not constitute a “commission” (it is more accurately characterized as a bonus), and the employee will not qualify for the inside sales exemption. Incentive compensation need not be calculated purely as a percentage of sales to constitute a commission but must be roughly proportional to the employee’s sales productivity.

Employers are engaged in the “retail and service industry” within the meaning of the FLSA if they derive at least 75% of their annual sales revenue from goods or services not for resale and are recognized as a retail or service establishment in their industry.

Employment Law

Many employers have classified inside sales personnel as exempt employees without clearly understanding the exemption criteria. Employers who treat inside sales personnel as exempt should review the validity of their classifications in light of the abovementioned criteria.

Employers should also recall that California law now requires commission agreements to be outlined in writing and acknowledged by the affected employees. In the event that an employee appears misclassified, employers should confer with counsel to discuss the courses of action available to them.

If you have questions regarding the inside sales exemption or any other issue related to employment law, contact us at Freeburg & Granieri, APC, today for a free consultation.