The California Supreme Court in Gattuso v. Harte-Hanks Shoppers, Inc. recently addressed whether an employer may satisfy its obligation to reimburse employees for employment-related expenses by paying increased wages and/or commissions instead of separately reimbursing them for actual expenses. The Court held that employers may reimburse employee expenses in the form of "additional wages" payable in a "lump sum" instead of reimbursing each separate expense for the exact amount incurred, but only if there is a means to apportion the enhanced compensation to determine what amount is being paid for labor performed and what amount constitutes reimbursement for business expenses.
At issue was Labor Code section 2802(a), which requires that employers indemnify employees for expenses necessarily incurred in the performance of their job duties. The employer, Harte-Hanks, required its sales representatives to drive their own automobiles on sales calls and compensated them by either commissions on sales or a combination of salary plus commissions. One of Harte-Hanks' sales representatives filed the class action lawsuit, arguing that this method of expense reimbursement was not allowable and that the payments must be made separately from wages.
The employer responded that it satisfied its obligation to reimburse representatives for expenses related to the use of their own automobiles by paying them higher base salaries and higher commission rates rather than directly reimbursing them for their expenses.
The Court recognized the burden that would be imposed on both parties by requiring the use of the "actual expense" method, whereby employees must keep track of expenses to include fuel, maintenance, repair, insurance, registration and depreciation, and found that the "lump sum" payment method was lawful. However, the employee must be permitted to challenge the payment made under the "lump sum" method by comparing that amount to the amount due under the "actual expense" method or the mileage reimbursement method. The Court specified that employers using the "lump sum" method should, in providing wage documentation as required by Labor Code section 226, identify the amounts that represent payment for labor performed and those that constitute reimbursement for business expenses.
The consequences of the decision are as follows:
Full Reimbursement of Expenses is Still Required
Employers must reimburse their employees for all out-of-pocket expenses the employees incur in carrying out their duties. Since an employer and employee cannot agree to waive this reimbursement requirement, the employer still must make clear what portion of the salary or commission payments is meant to reimburse the employee for expenses versus compensation for the work performed.
If the amount meant to cover expenses is less than the actual amount of expenses incurred during a pay period, the employer must pay the employee additional money to make up the difference.
The "Lump Sum" Method, Although Permissible, is not a an Easy Option
The employer therefore must make certain that employees are paid any additional money owed above and beyond the "lump sum" payment. If the employees are no longer required to submit expense reports, it will be difficult - (if not impossible) for the employer to determine if it has fully reimbursed the employee, and the only alternative will be to pay a lump sum generous enough to cover any expenses. Employees would most likely have a windfall in the form of extra wages if they incur expenses totaling less than their "lump sum."
Income Tax Implications
If an employer chooses the lump sum method of reimbursement, it should make sure that the expense reimbursement portion is not taxed as "wages." To do so, the employer must follow very specific rules. The employer must verify that the expenses are work-related (i.e., incurred in connection with the employer's business), and that the employees are able to substantiate the expenses. This means that the employer and employee must still keep sufficient records to evidence the nature of the expense even though the employee is reimbursed in a lump sum. The employer should consult with its tax accountant or attorney for details.
Conclusion
Although Gattuso v. Harte-Hanks clarified that the "lump sum" payment method for expense reimbursement is legal, use of this payment method mandates an extremely fact intensive analysis, and raises potential problems for any employer who errs in its calculations. One might conclude, instead of creating a safe harbor, which was probably the Court's goal, the decision may have inadvertently scuttled the ship.
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