How to Create a Commission Plan that
Satisfies the Law and Protects Your Company
Having a written commission plan is not just a good idea; effective January 1, 2013 it also is the law. Where a component of an employee's compensation is commission-based, the elements of the commission plan must be in writing and signed by the Company, with a copy given to the employee (with receipt acknowledged in writing).
A well-drafted commission plan not only creates shared expectations for performance, it also protects your Company from paying commission that is not earned.
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In our next issue we will cover "What is an independent contractor and how to avoid the expense of getting it wrong." If you would like to review the last months' newsletters with tips and tools for creating a Sustainable Workplace, click here.
The laws on when an employee can be paid on a commission basis, and how to document that commission relationship, can be confusing. Getting it wrong can mean owing employees overtime and incurring the risk of significant penalties not only for miscalculation of or failure to pay wages, but also for the act of misclassification itself. Here are just a few important facts about paying employees commission.
1. Can I Pay Every Type of Employee a Commission? No. In order to be eligible for a "commission" payment, the employee must be involved in selling a product or service, and the commission earnings typically must be calculated as a percentage of the price of the service or product sold. If the employee is not primarily engaged in sales and is not paid a percentage of sales, incentive compensation would be considered a bonus, not a commission.
2. Can I Pay My Salespeople on a "Commission Only" Basis and Not Worry About Paying Overtime Compensation? That depends on the nature of the sales position:
In California, "Outside Salespeople" may be paid on a straight commission basis. In order to qualify, the salesperson must customarily and regularly spend more than 50% of her time away from the employer's place of business, engaged in selling items or obtaining orders or contracts for products, services or use of facilities. Note that a home office is not "away from the employer's place of business."
"Inside Salespeople" in California may be paid (in whole or in part) on a commission basis so long as (1) the employee sells products or services (including by telephone) from inside the employer's place of business; (2) the employee works for an entity covered either by Wage Order 4 or Wage Order 7 and (3) the employee's total compensation exceeds 1.5 times the minimum wage for each hour worked during the pay period (currently 1.5 x $8, or $12.00/hour) and at least 50% of the employee's total compensation comes from commissions. Federal law is even more restrictive, and may make the Inside Salesperson eligible for overtime even if he meets the California exemption definition. Remember, inside salespeople are entitled to meal and rest periods even if they are exempt from overtime.
3. Do I Need to Pay Commission to an Employee when the Employment Relationship Terminates? That depends on whether the commission has been "earned" as of the termination date. If an employee can argue that she has done all of the tasks necessary to "earn" a commission, then she may be entitled to a commission even though she was terminated before the commission was paid. As outlined below, your commission plan should be clear in defining how a commission is "earned."
4. Do I Need to Pay Commissions to Employees During a Leave of Absence? That depends once again on the definition for "earning" a commission (see below). If tasks are required that an employee cannot perform during a leave of absence, the Company may be in a position to say that commissions are not earned during a leave of absence.
5. Can I Recover Miscalculations/Overpayments of Commission? This depends on whether you have been clear in the agreement that this is a possibility in the event of an "advance" that ultimately is not earned or an otherwise unearned commission. If the commission has been "earned" as defined by your plan, then you may not deduct it from future wages or commission. Further, the unearned but paid amounts should not be deducted from base salary, only "reconciled" against future commissions.
6. Do I Need to Pay Expenses for Commissioned Salespeople? Yes.
7. Do I Need to Provide Meal Periods to Salespeople? You do for Inside Salespeople. You are not required to provide meal and rest periods for bona fide Outside Salespeople.
8. Do I Need to Pay Earned Commissions on the Date of Termination or Within 72 Hours of a Resignation? The answer depends upon whether you can determine "earned" commission as of those dates. If not, then you may be in a position to pay "earned" commissions according to your regular commission pay schedule following the termination. Employees are not eligible for payment of unearned commissions (see why the definition of "earned" becomes so important?) Even if commissions may be deferred, remember that final wages, including accrued and unused vacation or PTO must still be paid according to this timing.
9. Do I Need to Have a Written Commission Plan? Yes. Effective January 1, 2013, California law requires that commission plans be in writing, signed by the Company with receipt acknowledged in writing by the employee. That plan will remain in place until it is amended in writing by the Company.
10. Can I Change my Commission Plan Whenever I Want? Yes, and you should reserve this right in writing, although frequent changes to the plan may not be the best way to set clear expectations or incentivize the behavior you want. Be careful: changing the plan cannot result in a forfeiture of commission that already was "earned" under a former plan, and any changes must be in a new writing signed by the employee.
Employees should be eligible for a commission when they meet the Company's sales performance expectations. The best way to ensure the employee provides the performance you want is to be clear about these expectations. A well-drafted commission plan will do that, and will also protect the Company from the surprise of having to pay an employee commission where behavior does not meet expectations. Here are some clauses to consider:
1. Who Is Eligible? The plan should be clear about the categories of employees who are eligible to earn commission.
2. Why Are You Paying Commission? The plan provides a great opportunity to remind the employee of his role in the larger picture of Company "success." The purpose for commission also will affect whether and when commission is earned. Is the commission in part to incentivize retention? Say so, and you may have a better argument for not paying commission in the event of early termination. Is the commission to incentivize ongoing client relationship behavior? Say so, and you will have an argument for not paying commission when an employee is not actively employed and not providing that ongoing client service.
3. What is the Term of the Plan? Is this an ongoing commission plan, or is the plan intended to govern a particular period of time? Be aware, effective January 1, 2013 if the plan is not amended in writing, the plan you have will continue.
4. What are the Salesperson's Threshold Eligibility Responsibilities? What behaviors and results do you need to see before the employee is entitled to a commission? Must they meet certain procedural requirements in addition to sales? Must they engage in ongoing client relationships? Are they responsible in part for collections? Do they need to understand the marketplace? Whether these responsibilities have been met will be part of the analysis of whether a commission has been "earned."
5. How is a Commission "Earned"? Whether an employee is entitled to a commission payment depends entirely on whether that commission is "earned." If an employee has completed all of the tasks you describe as the threshold for earning a commission, that commission is earned. You want to be crystal clear about at what point that commission is earned. Is it when the customer makes an order? Pays for the order? After a period of time, so that the Company knows whether a sale is complete? At year-end, because it is in part a retention commission? For employees who are entitled to a continuing commission after the order is placed, is there a task the employee needs to satisfy on an ongoing basis, such that commission may be terminated if the employment relationship ends?
6. When is the Commission Paid? Does your Company "advance" commission based on its understanding of the sale and its completion? Or is the Company able to determine immediately the value of the sale and thus the commission owed?
7. What is the Effect of a Return or a Miscalculation of Commission? Be clear in the agreement that the payment of commission is an advance of commission, and that in the event the Company discovers that an advanced commission was not, in fact, "earned," there will be a reconciliation of the unearned advance against future commission. The plan should never state that wages or commissions will be reduced or forfeited to address unearned or miscalculated commission.
8. Confirm Your At-Will Relationship. Remind employees that although this plan references possible future occurrences, nothing in this plan may be understood to guarantee employment for any specified length. Further, relationships with the Company are at-will, and that at-will relationship only may be changed through a written document signed by a designated representative of the Company.
9. What is the Effect of a Leave of Absence on the Commission? If the leave of absence prevents an employee from performing the threshold tasks for earning a commission, then the earning of commissions may be suspended during a leave of absence. This may not result in a forfeiture of already earned commission.
10. What is the Effect of Termination on the Commission? Commissions that have been earned should be paid at termination. Your plan should state that an employee must be employed at the time commissions are earned in order to be eligible for any commission. Again, be sure your "earned" definition accounts for all ongoing tasks. Earned commission may not be forfeited at termination, and overpayments should not be deducted from final wages even though they may be reconciled with future commission payments.
11. Reserve the Right to Modify the Plan at the Company's Discretion.
12. Sign the Plan, and Require that the Employee Acknowledge Receipt of the Plan in Writing. Remember, this now is required by law.
Carla, Karl and the Commission Plan
Carla works for "You Can Can It," a company that sells home-canning supplies. Her job consists of traveling year-round to trade shows and Costco-type stores, setting up a booth, demonstrating the ease of You Can Can It's home canning system, taking orders and making sales. She spends about half an hour each day, typically once she is back home or in her hotel room, on administrative tasks related to the sales she makes at the trade shows, etc. She spends no time in the Company's offices. The Company offers a thirty-day money back guarantee to customers.
Carla signed a commission plan that states that she will earn a commissions equal to 20% of every You Can Can It kit she sells. She does not receive any other compensation. The plan states that earned commission will be paid at the end of each month, and no sooner than 31 days after a sale is made. The plan states that commission only is earned if the kit is not returned within the 30 day money back guarantee period.
Carla sells 100 kits on January 3 and 100 kits on January 15. This means that she ordinarily would be paid any commission on February 28. 25 kits from the January 3 sale are returned on January 30, and 10 kits from the January 3 sale are returned on February 10. Carla begins a leave of absence on February 1. The Company wants to pay her commission on 165 kits once she returns from her leave of absence.
Meanwhile, Karl has a cubicle at You Can Can It headquarters in City of Commerce. He spends his entire day making calls to retail shops encouraging them to sell You Can Can It kits. He is governed by the same commission plan as Carla. He works full time, sometimes working 9 hours per day and skipping lunch, and over the course of the year he averages $100 in commissions each day. The business definitely is cyclical: in winter months, when there is less to "can," he will make as little as $50 in commissions per day. Then in tomato season, he will do much better.
In February, Karl is frustrated. He is working so many hours, with nothing to show for it. He tells the Company he wants to be paid a base salary and he wants to be paid overtime for those extra hours. The Company wants to remind him that he is an exempt "inside salesman."
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The law now requires that your commission plan be in writing, signed by the Company and acknowledged in writing by the employee. More importantly, a thoughtfully drafted commission plan will create a shared road map for success, and reduce the risk of unpleasant compensation surprises.
We are happy to help:
- Review your commission plans to ensure your expectations are clear. We are happy to review your existing commission plans and work with you to create clear plans that protect your Company.
- Commit your commission plans to a thoughtful written agreement. We can help you draft commission plans that incentivize the performance you want and reduce the risks you want to avoid.
Give us a call at 619-906-2400 or send us an e-mail. We are happy to help.
Keep an eye out for next month's newsletter, where we will cover "What is an independent contractor and how to avoid the expense of getting it wrong."
If you would like to review our prior newsletters with tips and tools for Creating the Sustainable Workplace, click here.