Can a company deduct a negative leave balance from an exiting employee's final paycheck?

An employer is permitted under federal law to make a deduction from a nonexempt employee's final pay to recover a negative paid-leave balance. However, a deduction from an exempt employee's final pay in these circumstances is not recommended.

A Department of Labor (DOL) opinion letter indicates that an employer may deduct advanced paid leave from a nonexempt employee's final pay when:

• It is communicated to employees before leave is advanced that such a deduction will be made; and
• The deducted amount will reflect the rate of pay earned when the advanced leave was taken.

Advancing leave to a nonexempt employee is considered a loan or cash advance that may be recouped by the employer even when the deduction drops the employee's pay below minimum wage. State laws may not allow such deductions or may require prior, signed authorization and therefore need to be checked for compliance.

The guidance above does not mention exempt employees, whose weekly salary cannot be reduced except in limited situations, and even then in full-day increments only. While regulation 541.602(b) of the Fair Labor Standards Act (FLSA) allows for these pay deductions, the regulation does not address whether deductions could be made in a prospective workweek, such as the final week of employment. What the FLSA does make very clear is that compliant pay deductions are only allowed when an exempt employee takes a full day off; partial days off can never be deducted from pay. Therefore, even if an employer advances an exempt employee five half days of paid leave, it could never deduct this amount from pay, as each half-day event will not be an allowable deduction under the FLSA regulations. There is an exception in the regulation allowing for partial-day pay deductions for absences covered by the Family and Medical Leave Act (FMLA); however, there is no guidance indicating that an employer may recover leave advanced for partial-day FMLA absences and employers should seek legal counsel in these circumstances.

So, what about full-day deductions? In the preamble to the 2004 revised FLSA regulations, the DOL states the following:

"… a few commenters… suggest that employers should be able to recover leave and salary advances from an employee's final pay. Recovery of salary advances would not affect an employee's exempt status, because it is not a deduction based on variations in the quality or quantity of the work performed. Recovery of partial-day leave advances, however, essentially are deductions for personal absences and would constitute an impermissible deduction. Whether recovery for a full-day leave is permissible depends on whether such a leave is covered by one of the section 541.602(b) exceptions."

While preamble statements do carry some weight, they are still subject to legal challenge as are the regulations themselves. One could theorize, then, that full-day deductions could be made from final pay with very careful, detailed recordkeeping that would separate negative leave hours for partial-day absences (not a permissible deduction) from negative leave hours for full-day absences (a permitted deduction). The rate of pay at which each day of leave was advanced would likely need to be tracked as well so that the appropriate amount would be deducted. The likelihood of an employer having such detailed records and being able to justify the deduction from final pay is slim and makes this practice problematic. Even with thorough recordkeeping, state wage payment and wage deduction laws may still prohibit this type of deduction or impose additional requirements.

Two options that pose the least amount of risk for employers faced with this situation (where state law allows) are:

• Establish a maximum number of leave hours an exempt employee can be advanced. Ideally, this should be a number that the employee could earn back relatively quickly, within a single pay period or a few pay periods. Any absences taken over this amount would be deducted from pay in the week the absence occurred, as allowable. If the employment relationship ends before the negative leave is earned back, the employer would not deduct this amount from the employee's pay, but the potential for loss is lessened because of the limit placed on the number of leave hours advanced.
• Do not advance paid leave for full-day absences; make any allowable full-day deductions in pay in the week the absence occurs. Consider advancing half-day deductions from the leave bank only; while pay can never be deducted for these absences, leave bank deductions are allowable and may help an employer recover required wages paid for lost time as the employee "earns" back the time. If any negative leave remains at termination, the employer could not take a deduction from final pay.

Legal counsel should review any policy or practice on recouping negative leave balances from an employee's final pay to ensure compliance with all applicable state and federal wage deduction laws.