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California Employers Allowed to Deduct Vacation and Sick Leave in Hourly Increments

Last Updated: March 15, 2010

On November 23, 2009, the California Department of Industrial Relations (DIR) Division of Labor Standards Enforcement (DLSE) issued an opinion letter on the topic of an employer making deductions from an exempt employee's vacation or sick leave balances. This new opinion letter affirms that employers may make such deductions in hourly increments for partial-day absences by an employee without jeopardizing the employee's exempt status.

This is a significant change for California employers who, for many years, have had to wrestle with the fact that California wage and hour law differed significantly from federal law on this topic. To explain the background, exempt employees are not due overtime pay if they meet the salary test and the duties test of applicable federal or state law. At issue here is the salary test - in order to be classified as "exempt," an employee must be paid on a salaried basis equal to the minimum thresholds established by federal and state law. In California, the salary must be twice California's current minimum wage for the equivalent of full time work (currently $33,280 annualized). Under both federal and state law, if an employee works any portion of a week, the employee is due his/her full weekly salary. While there are some permissible deductions to the weekly salary, (see Vantaggio's article Deductions from Exempt Employees' Pay - Under California Law), an inappropriate deduction could result in the loss of the exempt status. Additionally, "docking" an exempt employee based on the quantity or quality of work performed can also result in the loss of the exemption.

Deducting money (sometimes referred to as "docking") from an exempt employee's pay and deducting time from the employee's vacation or sick leave banks are two related, but very different issues that are oftentimes confused by employers.

Federal law generally allows for an exempt employee's pay to be docked only in full-day increments if an employee absents him/herself for an entire work day due to personal reasons. Whether pay deductions are allowed when the employee is absent due to illness depends upon whether or not the employer maintains a bona fide sick leave plan that provides for a reasonable number of days off without loss of pay during absences due to illness. Without such a plan, employers are prohibited from docking an exempt employee's pay even for full-day absences, provided that the employee performs some work during the workweek. If the employer does maintain a bona fide sick pay plan, an employer can make salary deductions for full-day absences due to illness if the employee is not yet eligible for or has exhausted his/her benefits under the sick leave plan. However, while pay deductions can normally only be done in full-day increments, federal law does allow for deductions from vacation and sick leave balances in hourly increments.

California has generally followed the federal guidelines for deductions from sick leave balances, but has historically treated vacation balance deductions differently. Previous case law has established vacation as wages in California (as opposed to being considered a benefit under federal law) which has led to the interpretation that a deduction from a vacation bank is equivalent to a deduction in wages. In 2002, California's Labor Commissioner issued an opinion letter clearly stating that partial-day deductions from exempt employees' vacation balances would jeopardize his/her exempt status. As a result, to be sure of compliance, many companies required exempt employees to use vacation benefits in full-day increments only. In June of 2005, the new Labor Commissioner withdrew the controversial 2002 letter and stated instead that employees could be allowed to use vacation in partial-day increments but left it unclear at to whether or not an employer could require them to do so.¹

Soon thereafter, in July of 2005, the California First District Court of Appeal rendered a decision in Conley v. Pacific Gas & Electric Co. [PG&E] stating that PG&E's policy of charging its employees' vacation bank for partial-day absences of 4 hours or more did not violate the salary test nor render these employees non-exempt. Again, while somewhat good news for employers and while moving closer to federal law, this case left California employers with questions. The court expressly stated that it did not intend to comment on partial-day absences of less than 4 hours. As such, many California employers, to play it safe, started allowing vacation balance deductions in 4-hour increments only. Likewise, in response to this case, the DLSE updated its enforcement manual to reflect that employers could make deductions from vacation or sick leave balances for partial-day absences of 4 hours or more.²

The November 23, 2009 DLSE opinion letter moves California into closer alignment with federal law³ on this subject. It specifically states and/or confirms the following:

VACATION, PTO, SICK LEAVE CAN BE USED IN HOURLY INCREMENTS:
An employer may require that an exempt employee use available vacation, PTO, and sick leave in hourly increments for partial-day absences, even if the absence is less than 4 hours, as long as the practice is consistent with the employer's policies.

PARTIAL-DAY ABSENCES:
» An employer may not make deductions from an exempt employee's pay for partial-day absences. Such salary deductions are only permissible if the exempt employee is absent for a full work day.

» If an exempt employee's vacation, PTO, or sick leave balances are insufficient to cover a partial-day absence, the employee must still be paid for the full day. For example, if an exempt employee works for 2 hours and only has 4 hours of paid leave available, the 4 hours may be deducted from the leave bank, but the employee would still need to be paid for the entire day.

FULL-DAY ABSENCES:
» DUE TO ILLNESS: If an exempt employee's sick (or PTO⁴) leave balance is insufficient to cover a full-day absence due to illness, the leave balance may be deducted, but the employee would still need to be paid his/her full compensation for the day. For example, if an exempt employee took 8 hours off due to illness but only had 3 hours of paid leave available, 3 hours could be deducted from the leave bank, but the employee would still need to be paid for the entire day. If the employee's leave balance was 0, the employee would not be paid for a full-day absence due to illness.

» FOR PERSONAL REASONS: If an exempt employee's vacation or PTO balance is insufficient to cover a full-day absence taken for personal reasons, the vacation or PTO balance may be deducted, and the employee can be paid only for the amount of time that was available in the bank. For example, if an exempt employee took the whole day off for personal reasons but only had 4 hours of vacation or PTO available, the 4 hours could be deducted from the bank and the employee would not have to be paid for the remainder of the day.⁵

» COMBINING SICK AND VACATION: An employer may require that an exempt employee combine separate vacation and sick leave balances to cover either a full or partial-day absence. For example, if an exempt employee takes time off due to illness but has insufficient paid sick leave available, the employer can require that vacation time be used to cover the duration of the absence.

For more details and examples, please review the actual DLSE opinion letter DLSE Opinion Letter 2009.11.23.

What should employers do?

Review your current vacation, PTO, and sick policies for compliance with current federal and state law.
Decide if you would like to change your current policy with regards to the use of paid time off for exempt employees. Keep in mind that these new guidelines provide employers with more options and flexibility, but that having a policy where exempt employees can use paid time off in hourly increments also has its down sides. Remember that once those balances are exhausted, exempt employees will still need to be paid their full salary for partial-day absences. A new hourly usage policy may require additional monitoring by management, HR, and payroll.
Decide if you want to implement a policy that requires the use of vacation time if sick leave is exhausted.
Seek advice on any changes you wish to make and update your handbooks accordingly, giving proper notice to employees of these changes.

¹Please note that some exceptions exist which allow for hourly deductions such as for partial-day absences under an intermittent FMLA leave.

²The 4-hour rule only applied to sick leave plans that provided for a payout of unused time upon termination. If the sick leave plan did not provide for payout of unused time, the DLSE stated that employers could continue to make deductions from sick leave plans in hourly increments.

³It should be noted that the DLSE enforcement manual and opinion letters do not have the force of law and are not binding on courts in wage and hour cases. However, courts may find their arguments persuasive when rendering decisions. As such, they can be an important source of guidance for California employers but do not take the place of legal advice. We urge our clients to seek qualified counsel prior to implementing any major policy changes.

⁴As PTO plans generally provide paid leave benefits for absences due to both personal reasons and illness, we urge our clients to look at the reason for the absence, not the name of the benefit plan which may apply.

⁵Note the significant difference in treatment of full-day absences with insufficient leave balance between leaves taken for personal reasons and leaves taken for illness.