Exempt vs. Non-Exempt Employees

As a small-business owner, you might be getting ready to hire employees for the first time. If you’re about to take this step, it’s critical to understand the difference between exempt and non-exempt employees. This federal designation established by the Fair Labor Standards Act (FLSA) affects aspects of employment such as eligibility for overtime pay and laws regarding wages and hours. Small business owners are responsible for classifying and paying employees correctly, so here’s what you need to know before adding a new person to the payroll of your enterprise.

What Is a Non-Exempt Employee?

Most workers are considered non-exempt by the FLSA guidelines. Employees who fall into this category are entitled to overtime pay if they work more than 40 hours in a single week. The federal definition of overtime pay is 1.5 times the employee’s regular hourly rate, though state laws may establish a different amount.

It is illegal to provide non-exempt employees with paid time off or other benefits in lieu of overtime pay. Non-exempt employees must be paid at least the federal minimum wage of $7.25 per hour and at least the overtime hourly minimum of $10.875 for work time exceeding 40 hours in a single week.

What Is an Exempt Employee?

An exempt employee (sometimes referred to as a salaried employee) is not entitled to overtime pay for a work week that extends beyond 40 hours. These employees fall into one of many exception categories established by the FLSA. These categories include but are not limited to administrative, professional and executive employees. While exempt employees are not entitled to additional overtime pay, employers can still require them to work overtime and/or to record their daily hours by using a time clock. In general, exempt employees are paid for completing their assigned work, whether it takes fewer or more than 40 hours a week.

Historical Implications

The FLSA was originally written to protect workers in the 1930s. At that time, exempt employees were rare; according to the 1940 U.S. census, only 24 percent of Americans had graduated high school and fewer than five percent had earned a college degree. Most workers thus fell into the non-exempt category and were legally guaranteed overtime wages. Today, college-educated employees are much more common, so the division between exempt and non-exempt employees is more difficult to discern. Because the language of the act has not been updated since it was passed, employers are left to fill in the blanks and make complex determinations with minimal guidance when it comes to classifying employees.

Guidelines to Determine Exemption

In general, employees can be considered exempt if they perform sales, scientific and technical, executive, administrative or professional duties and if they are paid a salary that exceeds $455 per week ($23,665 per year). Employees that earn less than $455 per week must be paid overtime wages even if their duties fall into one of the job categories indicated. This is not the case, however, for employees who are covered by a government or education grant. Determining whether an employee is exempt based on how much he or she gets paid is known as the salary level test.

Employers should also consider the salary basis test. In general, this means that the employee in question is guaranteed a minimum amount of pay each week regardless of the amount of work completed. If you pay your employee by dividing an annual salary by the number of pay periods, he or she is likely considered an exempt employee.

The duties test is also used to determine employee exemption. Only employees who perform certain high-level duties can be considered exempt. These are divided into executive, professional and administrative categories.

Employees who are considered executives must primarily serve as managers, must supervise at least two other employees and must have some level of genuine oversight of hiring, firing, job assignments and promotions. Whether an employee primarily performs management duties is examined on a case-by-case basis. In general, duties that fall into this category include interviewing and hiring; setting pay rates and work hours; planning and dividing work; planning budgets; and monitoring the workplace for compliance, safety and security.

Roles that fall into the professional category include but are not limited to jobs in law, teaching, medicine, architecture, engineering and science. In general, this category covers work that requires an education and is primarily intellectual in nature.

The administrative category includes jobs that do not require manual labor, are directly related to business operations, and must exercise important judgment about significant business matters. Examples include business support staff that work in human resources, finance, marketing, public relations, quality control, technology and related areas. Secretaries and others who perform strictly clerical duties without independent oversight are not considered exempt, though they may do administrative work.

Several professions outside of these categories are also exempt, including computer systems analyst, computer programmer, software engineer and others who design, implement, modify and/or test computer programs and systems. Employees engaged in outside sales are also exempt, provided they regularly travel away from the primary business location.

Highly compensated employees, defined as those who earn more than $100,000 annually, are exempt if they frequently perform at least one of the duties outlined in the administrative, professional and executive categories. This means that blue-collar workers are eligible for overtime pay no matter how much they earn. This designation includes any employee engaged in manual labor, such as painting, construction, plumbing, carpentry, electrical and mechanical work and related areas. Paramedics, police officers, firefighters and other first responders are also legally classified as non-exempt even when they earn more than $100,000 per year. Creative professionals such as writers and graphic designers may be considered exempt if imagination and artistic talent is required for the tasks they were hired to perform.

Expected Changes to Exemption Laws

A new rule scheduled to take effect on December 1, 2016, would have increased the threshold for overtime wage eligibility to $913 per week, or $47,476 per year. In addition, this salary threshold would be reviewed and updated every three years, starting in 2020. However, a federal court in Texas filed an injunction barring these changes, and the law was dropped in August 2017. A new exemption law is currently under review.

Exceptions to FLSA

Some workers are considered neither exempt nor non-exempt employees and are therefore not legally entitled to overtime pay. These exceptions include hourly movie theater employees, agricultural workers and employees whose jobs fall under another federal labor law. The latter category primarily includes truck drivers and railroad workers.

FLSA Grievances

The burden of proof is on the employer to ensure that all employees are categorized and paid correctly based on the FLSA and applicable state guidelines. Employers can choose to offer overtime pay to exempt employees or provide added benefits and incentives for those who choose to work overtime; however, this is at the employer’s discretion.

Employees who believe they have been wrongly categorized as exempt can file a grievance through the U.S. Department of Labor. The Department’s Wage and Hour Division is responsible for investigating these claims. If an employee has a valid claim, the DOL will likely order the employer to pay the difference between what they were paid for the overtime hours and what they should have been paid, an amount often referred to as “back pay.” In some cases, the employee will also receive an additional amount equal to the back pay as liquidated damages. It is illegal to demote or fire an employee who files a complaint with the Department of Labor.

As an employer, it’s important to keep impeccable records about wages and hours. Even if an employee does not file a complaint with the DOL, the department may investigate any business at any time. This investigation typically includes an evaluation of the labor laws that apply to your specific business, an examination of the payroll records and interviews with owners and employees. If your business has violated the terms of the FLSA, you may also be liable for a fine of up to $1,000 per violation.

Tax, Benefit and Disciplinary Implications

Exempt and non-exempt employees are taxed the same way regardless of whether they earn hourly income or an annual salary. Both types of employees share the right to a safe and healthy work environment, the right to equal employment opportunities and the rights granted under the Family and Medical Leave Act. Both exempt and non-exempt employees can usually collect unemployment benefits, although regulations about this vary by state.

In some cases, employers require employees to take a furlough — unpaid time off designed to cut costs by saving money on payroll. Although under FLSA exempt employees must earn the same salary each week, it is permissible to require them to take a week-long furlough provided that they do not perform any work duties during the week in question. For this reason, furloughs that only last part of the week can cause employees to lose their exempt status, meaning the company would be required to pay them overtime. In this case, some employers require employees to receive vacation pay on the furlough days by using their existing paid time off. Permanent furlough arrangements that change the employee’s schedule, from five days to three days, for example, are permitted as long as they are paid an adjusted salary that remains the same from week to week.

Employers may suspend exempt employees without pay for one or more days without jeopardizing their exempt status. However, this measure is only permitted under FLSA for serious disciplinary infractions, such as workplace violence or misconduct and may not be used for attendance or performance issues.

Employers cannot deduct a partial-day salary for an exempt employee who misses part of a workday. In most cases, having the employee take paid time off for the missed hours is the best solution. Pay deductions are only permissible when the employee misses more than a full day of work for personal reasons or when he or she is taking time off under FMLA.

Controversial Cases

Several major employers have fallen under fire in recent years for inappropriately classifying employees as non-exempt. For example, a class-action lawsuit covering 1,400 non-exempt Starbucks managers and assistant managers charged that although these staff members supervised other employees, they spent more than half their workweeks on customer service, cleaning, making coffee and other tasks that are considered exempt under FLSA. Radio Shack managers brought a similar class action suit against their employer.

In 2001, the Farmers Insurance Group was ordered to pay a $90 million settlement to a group of employees who were incorrectly classified as exempt. The court ruled that these insurance adjusters should be non-exempt because they were handling customer claims, considered a production rather than an administrative role.

Supervisors at Riverside Press-Enterprise newspapers also won a settlement since although they were considered non-exempt, they were responsible for filling in and delivering papers when the independent contractors they managed failed to show up for work.

Computer work is also a gray area. IBM was ordered to remit back pay to a group of employees who primarily installed computer software and hardware for customers. The court ruled that these workers were not required to use independent discretion and thus should be considered non-exempt.

Advice for Employers

Deciding whether to classify an employee as exempt or non-exempt is complex. In general, employers should use the broadest possible standard when classifying employees as non-exempt. Although paying overtime wages can be costly, doing so is much less costly than court costs and fines if your business is found to have violated the Fair Labor Standards Act. On the other hand, some high-level employees may prefer the added flexibility and stable paycheck of a non-exempt position. When making this determination, always rely on the salary level, salary basis and duties tests.

If you’re building up a staff for your small business, capital becomes more important than ever as you have responsibility for paying your workers as promised in a timely manner. Consider applying for funding from an online small business lender. These companies offer flexible, easy-to-understand solutions for the cash flow woes of independent proprietors.

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