Commission vs. Compliance: Why “More Than Half” of Your Employees’ Pay Must Be Commissions to Skip Overtime
Does the “More Than Half” Commission Rule Really Exempt My Employees from Overtime Pay?
Yes, it can. However, this is one of the most complex and misapplied exemptions in the entire Fair Labor Standards Act (FLSA). The short answer is that the FLSA Section 7(i) Exemption does allow retail and service establishments to avoid paying overtime to commissioned employees. You must satisfy three strict tests for the exemption to apply.
Ignoring these rules invites massive non-compliance risk. Therefore, it is essential to understand all three conditions thoroughly. Furthermore, the exemption only applies to employees of a retail or service establishment like many restaurants and hospitality businesses.
The Three Crucial Tests for the FLSA Section 7(i) Exemption
The FLSA Section 7(i) Exemption is from overtime pay only, not minimum wage. This is a critical distinction. To lawfully skip overtime, your employee must meet all three of these conditions:
- The Retail/Service Establishment Test: The employer must be a retail or service establishment. This means 75% of the establishment’s annual sales volume cannot be for resale and must be recognized as retail/service in the industry (e.g., most restaurants qualify).
- The Regular Rate Test: The employee’s regular rate of pay must exceed one and one-half times the applicable minimum wage for all hours worked in any workweek where overtime is due.
- The Commission Earnings Test: More than half (plus one penny) of the employee’s total compensation for a defined “representative period” must represent commissions on goods or services.
The Commission Earnings Test is often the biggest hurdle. Consequently, this test requires painstaking record-keeping and regular, recurring analysis.
Defining the “Representative Period”: Setting the Compliance Clock
The concept of a “representative period” is vital for the FLSA Section 7(i) Exemption. This period is the timeframe you use to calculate the commission-to-pay ratio. You must prove that commissions represent more than half of the employees’ total compensation during this time.
Rules for the Representative Period
- Minimum Length: The period must be at least one month. The U.S. Department of Labor (DOL) suggests a calendar month. However, many employers use a period that aligns with their payroll system. Recent DOL guidance indicates that periods like four consecutive weekly pay periods or two bi-weekly periods are generally not long enough. Conversely, six consecutive weekly periods or three bi-weekly periods would satisfy the minimum.
- Maximum Length: The period should not exceed one year. A period longer than one year is unlikely to qualify as truly representative.
- Must be Representative: The period must truly typify the employee’s typical earning pattern. You cannot choose a seasonal spike month to meet the ratio. Therefore, the period should reflect normal fluctuations between commission and other pay.
- Designation is Key: You must designate the chosen representative period (or a formula for establishing it) in your official records.
Why Choosing the Correct Period is Critical
Choosing the wrong period is an instant route to non-compliance. For example, a new hire might be paid mainly through salary or a “draw” early on. Selecting their first month of employment as the period would likely fail the “more than half” commission test. You must use a period that fairly reflects the employee’s regular work and pay structure. Furthermore, the chosen period should be the most recent one practicable for making the necessary compensation computation. Consequently, you must re-test the ratio periodically (e.g., every quarter or year) to ensure continued compliance.
The Documentation Problem: Substantiating the “Greater Than 50%” Condition
The most significant administrative burden of the FLSA Section 7(i) Exemption is accurate documentation. Without meticulous records, you cannot prove the exemption applies, especially under audit.
Essential Record-Keeping Requirements
Employers must accurately total two distinct components during the representative period:
- Total Commission Pay: All earnings that legally qualify as commissions must be summed up. In the restaurant industry, this can include a mandatory portion of certain service charges that are distributed. However, tips do not count as commissions for this exemption’s purpose.
- Total Other Compensation: This includes all other forms of pay, such as base salary, hourly wages, and non-commission bonuses or incentives.
The employer’s total commission payments must exceed the total of all other compensation. If the ratio is slightly below, the employee is non-exempt and due overtime pay.
Actionable Advice for Employers
- Track All Hours: Since the Regular Rate Test must be met every work week, you must track the employees’ daily and weekly hours worked—even if they seem exempt. You need these hours to calculate their regular rate of pay (Total Earnings Total Hours).
- Designate the Period: Document your chosen “representative period” clearly in your employee records.
- Perform Regular Audits: Do not assume your employees are still exempt. Commission earnings often fluctuate. Therefore, you must perform the commission test at the end of every representative period.
For more information on managing wages and hour compliance, see our detailed guide on calculating the regular rate of pay for tipped employees.
Conclusion: Simplify Your Commission-Based Compliance
Navigating the FLSA Section 7(i) Exemption is a dance between commissions and stringent legal compliance. The “more than half” commission rule provides a pathway to cost savings. Nevertheless, it carries significant administrative overhead and legal risk. Miscalculation or poor documentation can lead to expensive back-pay liabilities.
Simplifying your record-keeping and testing process is essential. See how our platform automatically tracks and tests the commission-to-pay ratio across custom representative periods. We handle the complex calculations for you. This ensures you maintain the necessary documentation for the FLSA Section 7(i) Exemption.
Book a free consultation today! Let us show you how our tailored payroll and HR solutions can help your restaurant remain compliant and protect your bottom line.