Tools from the HR Desk: Exempt vs. Nonexempt

Many line managers mistakenly believe that wage and hour regulations are solely an HR issue. Think again: It is a manager’s decision that affects whether his employees should be classified as exempt or nonexempt and whether or not they qualify for overtime pay. Managers decide their employees’ work loads and duties—both of which determine exempt status. Too often, department heads promote a nonexempt secretary to an exempt-level coordinator to justify a higher salary, for instance, even though the employee may be handling the same nonexempt duties as before. And many times, HR is not aware of this.

In addition, managers’ budgets are on the line any time a wage and hour audit challenges the way they have classified employees in their departments. Imagine being audited by the U.S. Department of Labor (DOL) and getting penalized for misclassifying one of your employees, resulting in years of back overtime pay. That unexpected charge could put a serious dent in your budget.

What’s more, many employers believe that random wage and hour audits by the DOL create the only exposure to potential penalties. However, more audits come as a result of a disgruntled employee, something the manager is responsible for.

Here’s how it works: When plaintiff attorneys interview a potential client—an ex-employee of yours who may be looking to sue for wrongful termination, for example—they may ask, “Have you ever worked through your lunches or breaks? Have you ever worked overtime without getting paid time-and-a-half? Have you ever taken lunch at your desk and answered the phone? Have your co-workers ever done the same things, and how many of them are there?” Potential clients often respond, “Sure. That kind of stuff happened all the time.” All of a sudden, you have the making of a class action wage and hour suit.

If plaintiff attorneys prove successful in establishing that an employer has violated the wage and hour provisions of the Fair Labor Standards Act (FLSA), then they will have the right, in tandem with the DOL, to audit two years of payroll records—three if the employer acted willfully, which is an easy threshold to meet. Although punitive damages are not involved, civil penalties could be assessed for repeated or willful overtime violations to the tune of $1,000 per transgression plus liquidated damages for unpaid wages.

The Mechanics of Overtime

How can line managers protect their companies? Understanding the mechanics of overtime and how it impacts payroll administration for their nonexempt employees is the first place to start. An exempt employee is “exempt from the overtime provisions” of the FLSA. That means there are no overtime rules that govern an exempt worker’s employment. Managers, outside sales people and recognized professionals, such as doctors and lawyers, are typically exempt and receive no premium pay for working long hours and weekends.

Nonexempt employees, on the other hand, are protected by the FLSA. They should receive preferential treatment in terms of their working conditions, and many states recognize this treatment in the form of regular breaks and lunch periods as well as premium pay for overtime.

States differ in terms of how rest periods and lunch breaks should be administered to nonexempt workers. In California, for example, nonexempt employees are entitled to two, 10-minute paid rest periods or “breaks” for every four hours worked. Wage and hour law dictates that those breaks should occur as near as possible to the middle of the work period. In addition, nonexempt workers are entitled to a half-hour meal period for every five hours worked.

So, if a nonexempt employee in California works from 8 a.m. to 5 p.m., the first 10-minute break must occur by noon. In addition, the lunch break has to occur no later than the beginning of the sixth hour of the shift, or, in this case, no later than 2 p.m. And a second 10-minute break must occur within four hours after the lunch period, or, in this case, by 5 p.m.

Managers should set the actual times for the breaks and lunch as close to the middle of each work period as possible. Therefore, they might choose to make the first break at 10 a.m., lunch at 12:30 p.m. and the second break at 3 p.m.

Here’s where the law gets tricky: No court would deny that nonexempt employees sometimes need to take lunch at their desks or skip breaks. What could land you in hot water, however, is if your employees report to the DOL or to a plaintiff attorney that this happens on an ongoing basis. In other words, if your culture dictates that nonexempt employees work through breaks, skip lunches or clock out at night and then return to do more work “off the clock,” then you will have acted “willfully” in the eyes of the law.

To combat potential challenges, managers should review the company’s policies and practices. Document in the employee handbook that management expects nonexempt workers to strictly adhere to their break and lunch schedules, have any overtime approved in advance and avoid taking work home. Employees should sign a document that acknowledges their agreement to these terms of employment. And on a day-to-day basis, managers should encourage employees to get away from their desks while on breaks or lunch.

Most importantly, managers need to avoid any expectation of unlimited time commitments from nonexempt staff members. This is where line managers’ responsibility for upholding wage and hour regulations is most apparent. Remember, more audits are triggered by dissatisfied employees’ formal complaints than by random government audits.

Professional, Executive and Administrative Exemptions

In addition to failing to pay appropriate overtime to nonexempt workers, employers also mistakenly misclassify employees as exempt who, in reality, should be nonexempt. Employees may be exempt from the FLSA’s overtime provisions if they are employed in professional, executive or administrative capacities, or if they are outside salespersons. A full discussion of the intricacies of exemption rules goes well beyond the scope of this article. What is critical to remember, though, is that employees who are eligible for exemption status under federal law will still need to meet the tests of state exemption criteria. Therefore, speak with a qualified compensation consultant or labor attorney to determine who should be classified as exempt.

The professional exemption is probably the most straightforward and easy to understand. Employees whose primary duty involves work requiring specialized, advanced knowledge in a field of science or learning are considered exempt from the protections of the FLSA. Practicing doctors, lawyers and certified professional accountants fall under this category.

The executive exemption applies to those who are in charge of a unit, department or subdivision, and who customarily and regularly direct the work of two or more employees. To qualify, executive employees’ work duties must be of an exempt nature more than half the time. Many states also determine a minimum monthly remuneration/salary threshold for executive employees to obtain their exempt status. Exempt duties include interviewing, directing work, evaluating employees’ performance and initiating progressive disciplinary actions. In contrast, routine clerical duties, such as cashiering, billing, filing and bookkeeping, do not count toward exempt duties.

A special note about working managers and low-level supervisors: As a subset of general management, “working managers” who work front desks, cook, pump gas and work the sales floor may not be exempt because they do not customarily and regularly direct the work of others. Instead, they may typically spend more than half their time performing the same duties as their co-workers do. As a result, those exempt “managers” on your staff may indeed be nonexempt and eligible for overtime pay.

The important lesson here is that management titles alone are unreliable in determining exemption status. Instead, the primary duty must be examined to properly establish a position’s exemption status.

The administrative exemption is the most vague and the most commonly misapplied exemption category. An exempt administrative employee:

• Customarily and regularly exercises discretion and independent judgment.
• Performs specialized or technical work requiring special training, experience or knowledge.
• Must devote the majority of his time to such activities.
• Earns at least $250 a week on a salary basis. Keep in mind that states may have their own minimum remuneration or salary requirements.

The discretion and independent judgment exercised must be directly related to management policies or general business operations. In addition, the decisions must involve “matters of consequence” that are of real and substantial significance to the employer’s business or customers. Therefore, a department head who has no functional subordinates may be exempt under the administrative exemption if the above referenced criteria are satisfied.

So, why the confusion? Executive assistants and coordinator-level employees potentially fall under this category and could be classified as either exempt or nonexempt. As a result, they are the most misclassified. How much discretion and independent judgment they exercise is often open to interpretation.

For example, executive assistants in larger companies are sometimes designated as exempt because their supervisors may delegate part of their discretionary powers to them. Whether executive secretaries indeed have enough authority to qualify for the administrative exemption, however, can be challenged. Therefore, if your department has a tier of secretaries classified as exempt, it is worth your time to perform an exemption analysis. Retain the documented analysis should you later be challenged in an audit.

Although consultants may provide sophisticated analysis tools, the concept of an audit is simple: First, detail the position’s exempt and nonexempt duties. Then estimate the hours spent weekly handling all the tasks that are listed. If the total weekly hours spent handling exempt duties total 50 percent or more of the position’s activities and the salary is at least $250 a week, then the position has reached the exemption threshold.

If you inadvertently designate employees as exempt and the DOL redesignates them as nonexempt, your company will be subject to up to three years of back pay for overtime for those employees plus attorneys’ fees, if applicable. Some state laws also may stipulate that your company pay a penalty for having underpaid its nonexempt employees. Periodically questioning an employee’s exemption status is well worth the time and effort.

If time and money are scarce, at least review those employee classifications that fall under the ambiguous administrative exemption category. Especially examine the exemption status of low-level supervisory employees, such as working supervisors, and of high-level clerical employees, such as exempt administrative assistants. That’s where the auditors will probably focus their efforts and where many employee claims originate.

Exemption classification is not one of the sexier topics of business management. However, learning this issue the hard way can be expensive. If plaintiff attorneys’ civil actions and government audits don’t scare you enough, keep in mind that paying overtime individually when it is due is much easier on your departmental budget than three-year, class action, lump-sum back pay penalties plus attorneys’ fees and costs.

Paul Falcone is director of employment and development at Paramount Pictures in Hollywood, Calif. He is the author of three books published by the American Management Association, including 101 Sample Write-Ups to Document Employee Performance Problems: A Guide to Progressive Discipline and Termination (1999) and 96 Great Interview Questions to Ask Before You Hire (1997). This article represents the views of the author solely as an individual and not in any other capacity.