On November 6, 2007, the California Supreme Court decided the case of Gattuso v. Harte-Hanks Shoppers, Inc., unanimously holding that employers may satisfy their business expense reimbursement obligations under the Labor Code by increasing salaries and/or commission rates under certain circumstances.
The employer in Gattuso prepares and distributes advertising booklets and leaflets in California, including the PennySaver and the California Shopper. To sell advertising space in its publications, Harte-Hanks employed both inside sales representatives and outside sales representatives. While the inside sales representatives worked in Harte-Hanks’ offices and made telephone calls to potential buyers, the outside sales representatives drove their own automobiles to meet with customers around their assigned geographic area.
Gattuso was an outside sales representative for Harte-Hanks. Harte-Hanks did not separately pay Gattuso and other outside sales representatives for their automobile expenses associated with driving to and from client meetings. Instead, Harte-Hanks paid them higher base salaries and higher commission rates than Harte-Hanks paid to inside sales representatives. Gattuso argued that this arrangement did not meet Harte-Hanks’ reimbursement obligation under the Labor Code.
The Supreme Court rejected that argument, holding that an employer may use a lump-sum method of reimbursing employees for work-related automobile expenses, provided that the actual amount paid is sufficient to provide full reimbursement for actual expenses necessarily incurred, and the employer meets other requirements discussed below.
In order to understand the Court’s decision, it is first important to understand the reimbursement requirements under Labor Code section 2802, and the ways in which the amount of reimbursement may be calculated.
Section 2802 requires employees to reimburse employees for "all necessary expenditures or losses incurred by the employee in direct consequence of the discharge of his or her duties, or of his or her obedience to the directions of the employer, even though unlawful, unless the employee, at the time of obeying the directions, believed them to be unlawful." Section 2802 clarifies that "necessary expenditures or losses" includes "all reasonable costs." Section 2804 provides that the reimbursement rights under Section 2802 are not waivable by contract or agreement.
No one involved in the Gattuso lawsuit disputed that Section 2802 required Harte-Hanks to reimburse its outside sales representatives for the expenses actually and necessarily incurred in the use of their automobiles to make sales calls, or that Section 2804 prohibits Gattuso and other outside sales representatives from agreeing that they would forego reimbursement. The only issue was whether Harte-Hanks could meet its reimbursement obligation by increasing the compensation paid to the outside sales representatives by known amounts. In deciding this issue, the Court considered three methods by which employers might calculate reimbursements owed.
The Actual Expense Method
Employers may require employees to calculate the automobile expenses actually and necessarily incurred, and then separately pay the employee that amount. Neither party disputed that an employer could meet its reimbursement obligation using the actual expense method.
This method would require the employee to consider all actual expenses associated with the automobile use, including: fuel, maintenance, repairs, insurance, registration, and depreciation of the car itself. The employee would therefore have to keep detailed and accurate records of amounts of moneys spent in each category, the automobile’s purchase price and current resale value (or lease costs). The employee would then have to apportion those costs between business and personal use, to determine how much the business use actually cost his or her, and submit all of that information to the employer for reimbursement.
The employer would then have the option of objecting to the claim on the basis that some of the submitted expenses were not necessary for the performance of the employee’s duty. For example, the employer might claim that the employee chose a car with poor gas mileage, poor depreciation, or higher insurance costs.
The Court acknowledged that although the actual expense method is the most accurate way of ensuring that employees are fully reimbursed for their automobile-related business expenses, it imposes "onerous burdens" on both employer and employees, and is therefore rarely used.
The Mileage Reimbursement Method
Employers may also choose to reimburse employees based on the number of miles driven by the employee for business purposes. The IRS maintains a current rate calculated for federal income tax purposes, based on national average expenses for fuel, maintenance, repair, depreciation, and insurance. This IRS rate is widely used and accepted by private business employers for calculating reimbursable employee automobile expenses.
Neither party disputed that an employer could use the mileage reimbursement method to meet its obligation. However, this method results in an approximation of actual expenses, and is inherently less accurate than the actual expense method. Because employers are required to fully reimburse employees for expenses "actually and necessarily incurred," employees must be permitted to challenge reimbursement payments calculated using the mileage reimbursement method. If the employee can show that his or her actual expenses were higher than would be paid under the mileage reimbursement method, the employer must reimburse the higher amount.
The Lump Sum Method
Finally, employers might reimburse employees for automobile usage without asking employees to submit any information about the actual automobile use. Instead, the employer could simply pay a fixed amount for automobile expense reimbursement, typically based on the employer’s understanding of the employee’s job duties, including the number of miles that he or she must typically or routinely drive to perform his or her duties. This is the method that Harte-Hanks used, and the method to which Gattuso objected.
In discussing the propriety of using the lump sum method, the Court began by noting that nothing in the language of Section 2802 restricts the method that an employer may use to calculate reimbursement, or prohibits an employer’s use of a lump sum method in particular, provided that the amount paid is sufficient to provide full reimbursement for actual expenses necessarily incurred. However, the Court noted that there are a number of protections that must be provided to employees reimbursed under a lump sum method:
- Accuracy. Because the lump sum method is inherently less accurate than either of the other two methods described above, employees must still be permitted to challenge reimbursement payments by comparing the lump sum payment with the amount that would be payable under either the actual expense or the mileage reimbursement method. If the comparison reveals that the lump sum payment is inadequate, the employer must make up the difference.[FN1]
- Apportionment. Where an employer combines the lump sum payment with wages in a single compensation payment, or reimburses employees through an increase in base salary and/or commission rates, it must provide some "method or formula to identify the amount of the combined compensation payment that is intended to provide reimbursement." This is necessary so the employee and government agencies can determine whether the portion designated for reimbursement was sufficient to provide full reimbursement.[FN2].
- Paystub Reporting. In the future, employers who provide business expense reimbursement through increases in base salary and/or commission rates should modify employee paystubs to identify the amount representing payment for labor performed, and the amount representing business expense reimbursements, to satisfy paystub reporting obligations.[FN3].
In summary, the California Supreme Court in Gattuso concluded that an employer may satisfy its statutory business expense reimbursement obligation under Labor Code section 2802 by using a lump sum payment system with certain characteristics, instead of using the actual expense method or the mileage reimbursement method. The implications of this decision for employers are significant, and could change the way that some employers choose to reimburse some or all of their employees for business expenses.
Because of the potential for significant adverse consequences associated with incorrectly implementing any new plan (especially one newly approved by a court), employers interested in considering a lump sum reimbursement system should consult their employment counsel.
[FN1] The Court noted that, where the lump sum is paid as additional compensation, there may be tax consequences associated with the lump sum method. These consequences do not render the lump sum method unlawful under Section 2802, though they should be considered in determining whether a particular payment provides the full measure of reimbursement required.
[FN2] Although the Court found that this requirement was not explicitly required by Section 2802, it concluded that "providing an apportionment method is a practical necessity for effective enforcement of section 2802’s reimbursement provisions [and so] it is implicit in the statutory scheme."
[FN3] The Court found nothing in the language of Section 226, regarding paystub reporting requirements, that prohibited reimbursement through increased salary and/or commission, provided that employers communicated the method or basis for apportioning increases in compensation for labor performed and for business expense reimbursement for the enforcement reasons described above. The Court specifically provided that the paystub modifications were recommended for employers using the lump sum method "[i]n the future."