Salary or Hourly?

Misclassifying exempt employees can be a costly mistake.

Salary or Hourly?

As an attorney specializing in employment law issues, I will occasionally receive a call from a client who has an employee demanding to be paid overtime. The client will explain to me that all of the company’s employees are paid a salary and, therefore, the company does not pay overtime. While it seems logical that if an employer and employee agree to a form of wage payment—such as salary, hourly or commission-based—then there shouldn’t be a problem; this unfortunately is not the case.

The law provides very tight parameters regarding which employees may be paid strictly on a salary basis. These employees are considered “exempt” because they are exempt from most wage and hour rules, including those governing overtime, timekeeping and meal periods, which may apply in certain states.

There are also specific rules that determine who may be paid on a commission basis. These individuals are also considered exempt. But, unlike salaried employees, some wage and hour rules still apply to certain exempt, commissioned employees.

All other employees are considered non-exempt, which means they must maintain time records and be paid overtime. They must be provided certain rest breaks and meal periods (in some states), and the employer must provide pay stubs that show the number of hours worked and applicable rates of pay. These individuals are considered non-exempt because they are not exempt from the wage and hour rules.

The most important thing to understand is that, in order to qualify as exempt, the duties of the position held by the employee must meet certain, specific minimum standards. Title alone does not determine exempt status.

Who Is Exempt?

The federal Fair Labor Standards Act (FLSA) defines the types of positions that qualify as exempt. Many states have additional laws that define exempt status within that state. By law, an employee is exempt only if he or she meets all of the criteria listed under one (or more) of the following categories.

The Executive (or Managerial) Exemption: Under federal law, the individual must earn a fixed salary of no less than $455.00 per week. It is important to be aware that the minimum wage in some states is higher, so this would increase the minimum salary requirements for an exempt employee. For example, a California exempt employee must be paid no less than $3,120 per month, or $37,440 per year, based on the minimum wage of $9.00 per hour.

In order for an employee to be exempt under the Federal Executive Exemption, the person’s primary duty (the main or most important duty) must be managing the enterprise or a division of the enterprise and must also involve managing at least two employees.

If the employee performs the same tasks as the workers and, in addition, is the manager of those workers, the individual would probably not qualify as exempt. This is because the majority of his or her time is spent performing non-managerial tasks, even though he or she is always the manager. For example, a medical office manager who manages a staff of three, but spends most of the time answering telephones, scheduling appointments, and billing (tasks that are clerical, as opposed to managerial, in nature) will probably not qualify as exempt.

The individual must have authority to make management decisions, such as hiring, firing and evaluating workers. The individual must regularly exercise independent judgment and discretion. Keep in mind that this does not include decisions for which the company guidelines are fairly structured, but means the individual actually has authority to make material decisions. For example, a chief financial officer who: manages a group of five accountants; does not generally perform billing or bookkeeping functions; and decides who to hire, promote, demote, discipline and fire, is probably exempt.

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The Administrative Exemption: As with the Executive Exemption, in order for employees to be exempt under the Administrative Exemption, they must earn a fixed salary of no less than $455.00 per week, with that amount being substantially higher in some states. The individual’s primary duty must be performing high-level, nonmanual work that is directly related to the company’s general business operations or management policies. The individual is generally responsible for a significant department or a key aspect of the company’s overall management, but may not necessarily be responsible for managing large numbers of employees. For example, a marketing director or vice president of human resources of a medium to large company may not manage significant staff, but is integrally involved in the management of general business operations.

The individual must regularly exercise independent judgment and discretion. Again, this does not include decisions for which company guidelines are fairly structured, but means the individual actually has authority to make material decisions. For example, they may be authorized to negotiate and enter into material contracts on behalf of the company, to modify employee benefits, or to participate in other significant company decisions.

The Administrative Exemption requires that the individual fulfill one of the following: regularly and directly assist the owner or a member of the management team who qualifies under the Executive or Administrative Exemption; perform work with only minimal supervision that is specialized or requires special technical training, experience or knowledge; or perform special assignments and tasks with minimal supervision.

The Learned or Creative Professional Exemption: Again, in order to qualify for this exemption, the employee must earn a fixed salary of no less than $455.00 per week, with that amount being substantially higher in some states. (This requirement may not always apply to physicians. Check the rules in your own state for guidance.)

Additionally, the employee’s primary duty must be the performance of work requiring “advanced knowledge,” which is defined as work that is predominantly intellectual in character and requires the consistent exercise of discretion and judgment.

For the Learned Professional Exemption, the advanced knowledge must be in a field of science or learning, and the advanced knowledge must be customarily acquired by a prolonged course of specialized intellectual instruction. For the Creative Professional Exemption, the individual must be engaged in artistic work that is creative, original and depends on the invention, imagination or talent of the employee, as opposed to work that can be produced by a person with general manual or intellectual ability and training.

Licensed physicians, certified nurse anesthetists and certified nurse practitioners generally qualify as exempt professionals. Registered nurses and estheticians generally do not qualify as exempt professionals.

In addition to the categories listed above, certain outside commission-based salespersons are entirely exempt from all wage and hour rules. The factors that determine whether an employee qualifies as an exempt outside salesperson are tricky. Employers are encouraged to review any questionable classifications with legal counsel.

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Determining Exempt vs. Non-Exempt

Whether or not an employee qualifies as exempt takes into consideration both what the employee in the particular position is supposed to do, and what the employee actually does. Consider the following steps to assist you in determining whether or not a particular worker qualifies under one (or more) of the exemptions:

Step 1: Prepare a realistic job description for the position, including a list of all required duties. Estimate how much time an employee in this position should spend on each task (this can be based on actual minutes/hours or based on a percentage of the employee’s work time). Determine which specific duties qualify as exempt; the remaining duties are non-exempt. If more than 50% of the individual’s time is spent on non-exempt duties, the employee is not exempt.

Step 2: Instruct the employee(s) in the position to record for a period of one week (a) what they actually do each day; and (b) how much time they spend on each task. Review the employees’ reports. Determine which specific duties qualify as exempt; the remaining duties are non-exempt. Add up the total time spent on each list.

Step 3: Compare your job descriptions to the employees’ lists. This should assist you in determining whether the job description is realistic; whether the employees are, in fact, doing what they should be doing; and whether or not the position is exempt.

Paying a non-exempt employee on a salary basis is one of the most expensive mistakes an employer can make. If successfully challenged, the employer is liable for unpaid overtime, plus various other penalties that vary by state. For example, in California, misclassification can result in various penalties, including failure to provide meal and rest periods (one hour of pay for each day of a missed meal or rest period), failure to provide accurate wage statements ($50 per paycheck) and penalties for failure to pay all wages due on termination (up to 30 days pay). Challenges to employee classifications are some of the most common types of lawsuits filed against employers, so it is prudent to regularly review your employees’ duties and pay classifications.

Nancy Whitehead is a partner with Scott & Whitehead, a Newport, CA-based firm specializing in labor and employment law. Contact her at: 949.222.0166, nwhitehead@employerlaw.com.

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