Exempt v.s. Non-Exempt: Common Misclassification Mistakes

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In the August edition of the MMC Newsletter we discussed the ever growing area of litigation regarding the classification of Employees versus Independent Contractors. In this month’s article we will assume that all persons have been properly classified as employees and the next question to consider: should the position be considered exempt or non-exempt?

A brief definition of each classification is as follows:

Exempt Employee: Exempt from the protections of Federal wage and hour laws under the Fair Labor Standards Act (FLSA) and/or the wage and hour regulations of their state of employment. Examples of exempt employees under Federal law are “executives,” “professionals” and outside sales persons as defined by the FLSA. Exempt employees must always be paid on a salary basis, not subject to reduction based on the quality or quantity of work performed. The rules regarding deductions from an exempt employees salary are very strict.

Non-Exempt Employee: Generally protected by the FLSA (Federal) and/or State wage and hour laws in the state of employment. Typically, employers are required to pay at least a certain minimum hourly rate and a premium rate for overtime work. They are also a guide for determining which on-the-job hours constitute work, and thus must be compensated.

The Department of Labor estimates that 70% of businesses are in some way out of compliance with the FLSA, and in 2008 alone there were over 23,000 registered complaints, with U.S. businesses paying over $185 million in back wages to over a quarter million employees. Misclassifying employees can have serious financial implications such as unpaid overtime, fines and penalties that can be assessed by federal, state, and in some cases, local agencies.

The Department of Labor estimates that 70% of businesses are in some way out of compliance with the FLSA, and in 2008 alone there were over 23,000 registered complaints

For this article we will focus on the Federal requirements under the FLSA. The majority of jobs are governed by the FLSA. However, there are some jobs that are excluded from FLSA coverage by statute. It is important to note here that many states have their own regulations regarding exempt status for employees and it is imperative for you to know the rules of your own state. Generally, if a state has its own equivalent of the FLSA employers are required to follow whichever rule is more beneficial to the employee. If your state has its own exemption rules you should speak to your legal counsel about the proper classification of employees.

To properly classify a position as exempt, it must pass a salary and a duties test. Many employers believe if they give a position a fancy title or pay on a salary basis the position will qualify as exempt. This belief has led many employers down a costly road of litigation. It is a requirement to pay an exempt employee on a salary basis. However, simply paying a salary is not enough to make the position exempt.

Under the FLSA, to qualify for exempt status, the minimum required salary is $455.00 per week or $23,660.00 annualized. Exempt employees must be paid a set salary for any week in which work is performed, regardless of the quality or quantity of their work.  As stated previously, there are strict rules regarding any deductions made from an exempt employee’s salary. If an impermissible deduction is made from an exempt employee’s salary, it can destroy the exemption and the federal and/or state overtime regulations will apply.

For example, in California the minimum salary for exemption is $33,280 annually and it is tied to the state’s minimum wage. The minimum salary required for exemption is two times the minimum wage, which means that when California increases its minimum wage, the minimum salary required for exemption will also increase.

The salary test is a relatively simple one to meet as either the salary meets the requirement, or it doesn’t. Now comes the hard part: the duties test. There are four major exemption categories, which are listed below with a very basic list of the duties required for exempt status.

    • Executive: To qualify for this type of exemption, employees must manage the operations of a business, department, or subdivision within the company. They must direct and supervise the work of at least two employees and have the authority to hire, fire, and promote. Typically, employees meeting these conditions include your VPs, Directors, and Chief level staff members.
    • Administrative: To qualify for this exemption, employees must exercise independent judgment and discretion performing non-manual work that is directly related to business operations. Typically, employees falling under the administrative exemption category include office managers, insurance agents, human resource professionals, and marketing personnel.
    • Professional: Employees in this exemption must have advanced knowledge in a field of science or learning through prolonged course of instruction (i.e. university, college, law or medical school). Occupations that require prolonged study include doctors, lawyers, dentists, professors, accountants, and the like.
    • Outside Sales: There is no salary requirement for this exemption, mainly because these employees typically work solely on a commission basis. Employees qualify for this exemption if their primary duties involve making sales away from their employer’s physical place of business.

 

Please note that the above information is a very brief summary of the duties required for exemption. The actual tests are much more comprehensive and can be found on the Department of Labor website. It is important to know that in many cases the tests contain language that quantify the amount of time an employee spends performing exempt duties, and those requirements must be met in addition to the salary and duties tests in order for a position to qualify for exempt status.

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Helpful Links

Read more information on U.S. Department of Labor website: The Fair Labor Standards Act (FLSA)

Exempt vs. Non-Exempt Classification Test

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