Proper employee classification can have a significant impact on an organization. The penalties for non-compliance can put a large dent into the growth and long-term stability of your business. On the federal level, penalties can include back wages, fines, interest and liquidated damages. In addition, employers with incorrectly classified workers may also be subject to penalties imposed by the state(s) in which their business operates.
The Department of Labor is responsible for the administration of the Fair Labor Standards Act (FLSA), which establishes minimum wage, overtime pay, record-keeping, and youth employment standards. Shown below are three recent settlements obtained by the Wage and Hour Division (WHD) of the DOL. These settlements may seem small, but it is important to note they are for local companies. Penalties are not limited to small companies; larger corporations such as Walmart have amassed penalties in the millions for various wage-and-hour infractions over time.
- Structural Systems Inc.: $17,154 for nonpayment of travel time and also misclassification of workers as exempt resulting in unpaid overtime.
- Rice Precision Manufacturing: $92,727 in back wages and liquidated damages for failure to pay overtime.
- Downtown Hilton Head Inc.: $23,155 for three restaurants found to have overtime and record-keeping violations.
Employment Classification 101
The FLSA defines specific criteria for each type of employment classification. Both classification categories are governed by a set of requirements every business owner should be familiar with. We’ll start with the most basic definition of each classification as follows:
- Exempt: Workers exempt from the overtime and minimum wage provisions of the FLSA.
- Non-Exempt: Workers subject to all FLSA provisions, including the payment of overtime.
There are a number of exempt classifications; the most common include the Professional, Executive and Administrative exemptions. For the purposes of this article we will focus on the Administrative Exemption. To qualify for the administrative employee exemption, all of the following tests must be met:
- The employee must be compensated on a salary or fee basis (as defined in the regulations) at a rate not less than $455 per week;
- The employee’s primary duty must be the performance of office or non-manual work directly related to the management or general business operations of the employer or the employer’s customers; and
- The employee’s primary duty includes the exercise of discretion and independent judgment with respect to matters of significance.
The third bullet point above mentions “the exercise of discretion and independent judgment with respect to matters of significance” and this is where many employers run into trouble with the exempt designation for a position. The DOL has issued guidance on this which in part reads:
Discretion and Independent Judgment: implies that the employee has authority to make an independent choice, free from immediate direction or supervision. Factors to consider include, but are not limited to, whether the employee:
- has authority to formulate, affect, interpret, or implement management policies or operating practices
- carries out major assignments in conducting the operations of the business;
- performs work that affects business operations to a substantial degree;
- has authority to commit the employer in matters that have significant financial impact;
Matters of Significance: refers to the level of importance or consequence of the work performed. An employee does not exercise discretion and independent judgment with respect to matters of significance merely because the employer will experience financial losses if the employee fails to perform the job properly. Similarly, an employee who operates very expensive equipment does not exercise discretion and independent judgment with respect to matters of significance merely because improper performance of the employee’s duties may cause serious financial loss to the employer.
It is important to remember that all of the tests mentioned above must be met in order for a position to be properly classified as exempt. If all tests are not met, the position must be classified as non-exempt and all FLSA requirements must be observed. Please see dol.gov for all federal exemption requirements.
It is imperative to know if the state(s) your business operates in have their own requirements/tests to determine exempt-vs.-non-exempt status. For example: California has a much higher minimum salary required for exemption, currently $33,280 annually; the federal requirement is $455 per week, which on an annual basis is $23,660. You may have positions that meet the federal requirements but do not meet the state requirements.