One of the most costly mistakes that a business can make is misclassifying its employees as exempt. Although it's become commonplace to equate the word "salaried" with "exempt," the words have two completely different meanings under the law.
When an employee is salaried, it simply means that an employer has chosen to pay that person a fixed amount per week or year. When an employee is exempt, it means that the employee meets a specific definition under the law (explained below) and is therefore not entitled to overtime (and other benefits or requirements that apply to non-exempt employees only).
This article will clear up some of the misconceptions around salaried employees and explain how to determine if an employee is truly exempt. Because misclassifying employees can cost an employer thousands (or even millions) of dollars in unpaid overtime and penalties, it's important for businesses to have a working understanding of the different types of exemptions and how to apply them.
The Fair Labor Standards Act (FLSA)—the federal law that governs wage and hour issues—creates several different categories of exempt employees. The most commonly used are the executive exemption, the professional exemption, and the administrative exemption. These are often referred to as the "white-collar" exemptions because they apply to people who work in offices or other professional environments.
There are a couple of requirements that apply to all three of the white-collar exemptions. First, the employee must earn at least $455 per week, which amounts to $23,660 per year. (Starting in 2020, the Department of Labor has raised the threshold to $684 per week, or $35,568 per year.)
Second, the employee must be paid on a salary basis. This means that the employee must receive a preset amount for each pay period, regardless of the hours worked or the quality or quantity of the work performed.
In addition to the requirements described above, each exemption has its own requirements relating to the specific duties that the employee performs.
The executive exemption is usually reserved for high-level managerial employees. For an employee to qualify, all of the following requirements must be met:
While most of these requirements are relatively straightforward, you might be scratching your head at what it means to "manage" the business. Fortunately, the U.S. Department of Labor (DOL) provides some guidance. According to the DOL, management duties include, but are not limited to, the following:
Example: Jane is the Executive Chef at a high-end French restaurant. She oversees the kitchen, including a staff of twelve employees. Jane plans out the menu, guides the kitchen staff on how to cook and present each dish, and performs quality control on all dishes that leave the kitchen. She also handles hirings and firings, sets the schedules of the employees, gives them feedback on their performance, and disciplines them when appropriate. She creates and manages the budget and selects the produce and other inventory for the kitchen. Because these tasks take up the majority of her time, she only spends a small portion of her time actually cooking. Jane makes $85,000 per year (or $1,635 per week). Jane falls within the executive exemption.
The learned professional exemption applies to employees who work in professions that typically require an advanced degree (college or higher), a period of specialized training or instruction, or a license from the state. For the learned professional exemption to apply, all of the following must be true:
Each of these requirements calls for a more in-depth look. Work is "largely intellectual," if it requires high-level analysis, interpretation, or deduction from a situation or set of facts. An employee exercises "discretion and independent judgment" when the employee has the authority to make important decisions that affect the business. According to the U.S. Department of Labor, this means the employee has the authority to perform at least some of the following tasks:
The second requirement limits this exemption to specific fields such as law, medicine, accounting, engineering, teaching, architecture, science, and other similar occupations. And the third requirement means that the employee must have a special or advanced degree, or have received some other specialized instruction.
Example: Dave is a Certified Public Accountant (CPA). He earned a bachelor's degree in accounting and worked under a CPA at an accounting firm for three years. Dave took the CPA exam in his state and passed. He also fulfilled the other requirements set by his state, including passing an ethics exam. Once Dave received his CPA license from the state, he went to work for a large accounting firm in its auditing department. He earns a salary of $85,000 per year. Dave qualifies as an exempt employee under the learned professional exemption.
Other professionals that are likely to qualify are doctors, lawyers, registered nurses, dentists, architects, pharmacists, professors, physician's assistants, and engineers.
There is a second type of exemption called a "creative" professional exemption for employees who perform work that requires invention, imagination, originality, or talent in a field of the arts. Employees who usually fall under this category include actors, musicians, illustrators, and novelists.
The administrative exemption applies to employees who perform work that keeps the business up and running and who are authorized to make relatively important decisions. To qualify, all of the following requirements must be met:
The administrative exemption is probably the most difficult to apply because it can be hard to know when work is related to "general business operations." To help you figure this out, ask yourself: Is the work necessary to keep the business running, or is it to produce or sell the company's product or service? If it's directly related to producing or selling a product, it probably won't qualify under this exemption. For example, someone who works on an assembly line or in customer service will not qualify.
The U.S. Department of Labor gives the following examples of work that relates to general business operations: tax, finance, accounting, budgeting, insurance, quality control, purchasing, marketing, research, public relations, Internet and database administration, safety and health, human resource functions, legal compliance, and similar activities.
Example: Nancy is a Marketing & Advertising Specialist for a small game company. Nancy's main duties are to perform market research, create marketing strategies and campaigns, prepare press releases, secure and approve advertisements, and create policies and procedures for the marketing department. She reports to the CEO and makes $75,000 per year. Nancy qualifies as an administrative employee.
Because the white-collar exemptions are fact specific, you must consider the actual duties the employee performs, rather than just the job title. The exemptions are designed to apply only to a narrow set of employees.
When in doubt, you should talk to a lawyer about how to properly classify an employee, especially when you have several other employees in the same position. A lawyer can also help you determine if your state has its own version of these exemptions, which might include additional restrictions.