Hiring your first employee or adding a new employee to your team marks another milestone in the growth of your small business.
The hiring process requires careful consideration to ensure you remain compliant with federal, state, and local employment laws.
Employee classification—identifying employees as exempt or non-exempt from certain requirements under the Fair Labor Standards Act (FLSA), as well as state and local laws—marks one of the more confounding aspects of the hiring process. From a payroll perspective, you'll need to understand both types of employee classifications.
Read on to learn more about:
- Difference between exempt and non-exempt employees.
- How do you determine if a position should be exempt or non-exempt.
- The implications of each classification.
- How to determine the right classification for your employees.
- An overview of the FLSA and the risks of failing to properly classify employees.
Exempt vs Non-Exempt Employees
According to the U.S. Department of Labor, the FLSA “establishes Federal minimum wage, overtime pay, recordkeeping, and youth employment standards affecting employees in the private sector and in Federal, State, and local governments.” 1
FLSA guidance requires that employers pay employees “at least the federal minimum wage for all hours worked and overtime pay at not less than time and one-half the regular rate of pay for all hours worked over 40 hours in a workweek.” 2
Under the FLSA, employees may qualify for one or more of the “white-collar exemptions”—executive, administrative, computer-related professionals, outside sales, and professionals—which would allow their employers to be exempt from the FLSA’s minimum wage and overtime.
Failure to comply with FLSA and applicable state and local regulations related to employee classification may result in substantial costs to employers.
What is an Exempt Employee?
Generally speaking, an exempt employee is paid a fixed amount each workweek, which meets or exceeds the applicable threshold, on a salary or fee basis, and whose primary job duties meet one or more of the available exemptions under the FLSA and any applicable state or local laws.
What is a Non Exempt Employee?
Typically any employees who do not qualify as exempt are considered to be non-exempt employees who are entitled to receive at least the minimum wage for all hours worked and the appropriate amount of overtime pay.
Is non exempt hourly? Not necessarily.
Though frequently paid on an hourly basis, some non-exempt employees may be paid a salary or on another basis provided they are paid the appropriate amount of overtime pay for any hours worked in excess of 40 in the workweek.
The FLSA does not limit daily or weekly working hours for non-exempt employees, ditto for potential hours of overtime.
The Key Differences Between Exempt and Nonexempt Employees
The primary criteria when classifying employees generally come down to assessing primary duties, whether they’re paid hourly or salary, and how much they’re paid. The key difference is whether the employee is eligible for minimum wage and overtime protections.
Overtime Eligibility
Exempt
An exempt employee is not eligible for overtime pay.
Non-Exempt
Under the FLSA, a non exempt employee is eligible for overtime pay for hours worked over 40 per workweek. State and local law may establish additional overtime requirements.
Job Duties and Responsibilities
Exempt
Exempt employees tend to work in roles that require independent judgment and little direct supervision. The role may also demand special skills or knowledge, or involve the supervision of other employees. Exempt employees include doctors, lawyers, accountants, business executives, and teachers.
Non-Exempt
Non-exempt employees tend to hold positions where the core responsibility centers on a repetitive or routine task. Roles include skilled trades, certain retail employees, and office-based employees with limited decision-making authority.
How to Determine If an Employee is Exempt or Non-Exempt
Accurate classification is crucial for compliance with employment laws and for ensuring employees are compensated accurately. Employers must consider various factors to make informed compliance decisions.
But how do you determine if an employee should be classified as exempt or non-exempt?
The Department of Labor offers a three-step test to help employers determine whether to classify an employee as exempt or non-exempt.
The salary basis test verifies that the employer pays the employee a fixed amount per week regardless of hours worked. This differs from the salary level test, which ensures that the employer pays the employee at least $684 per week. The job duties test specifies that an employee performs job duties consistent with a professional, executive, and administrative role.
When it comes to full-time or part-time status, an employee's part-time status does not affect their classification. According to the FLSA, the salary threshold for exemption applies regardless of an employee’s status as full-time or part-time.
What about independent contractors? Independent contractors are not considered employees and do not fall under the FLSA guidance on this topic. If you’re unsure how this guidance applies to you, it’s always best to check in with a trusted professional.
Pros and Cons of Exempt and Non-Exempt Status
Understanding some of the advantages and disadvantages of each classification helps employers make informed decisions.
When deciding whether an employee should be classified as exempt or non-exempt, consider the following:
- Job Duties. Review the actual responsibilities and duties of the employee. Ensure they align with the criteria for exempt status, focusing on the nature and level of responsibility required.
- Salary Level. Ensure the salary meets the minimum threshold under federal and state law for exempt status. Regularly review compensation structures to stay compliant with any changes in labor laws.
While there are pros and cons of exempt vs non-exempt status, classification should only be based on set criteria, such as salary basis, salary level, and job duties.
Pros of Exempt Status
- Stable Income. Salaried exempt employees typically receive the same pay each workweek, helping to provide financial consistency. This consistency is attractive to employees seeking predictability in their financial planning.
- Work Hour Flexibility. Exempt employees may have more flexibility in their work hours, focusing on results rather than time spent. This can lead to increased job satisfaction and productivity, as employees tailor their schedules to individual work-life balance.
- Simplified Payroll. Employers typically do not need to track hours worked by exempt employees, simplifying payroll processes. This reduces administrative burdens and potential errors in tracking and reporting hours worked.
Cons of Exempt Status
- No Overtime Pay. Exempt employees are not eligible for overtime pay, which can be a disadvantage if they frequently work long hours. This can lead to dissatisfaction if employees feel their extra efforts are not recognized financially.
- Salary Requirements. Employers must ensure the salary meets the minimum threshold, which can be a financial commitment. This requirement may necessitate careful budgeting and forecasting to maintain compliance.
Pros of Non-Exempt Status
- Overtime Compensation. Non-exempt employees are compensated for overtime work, providing additional income opportunities. This can be particularly appealing in industries with seasonal demands or fluctuating workloads.
- Defined Work Hours. Non-exempt employees may have fluctuating work hours set by their employer. This can make it easier for some to balance work and personal life. This structure can enhance job satisfaction by providing clear boundaries between work and leisure.
Cons of Non-Exempt Status
- Income Variability. Pay for nonexempt employees can vary based on the number of hours worked each workweek. This can lead to uncertainty in financial planning, especially if hours fluctuate significantly.
- Overtime Tracking Requirements. Employers must carefully track hours worked to ensure compliance with applicable minimum wage and overtime requirements and other employment laws. This can increase administrative tasks and require more robust tracking systems to prevent errors and disputes.
- Holiday Pay. Under the FLSA, employers need only pay non-exempt employees for actual time worked. The FLSA does not require employers to pay non-exempt employees a different pay rate for holidays or pay non-exempt employees who do not work a holiday, although some employers may choose to do so. It’s important to note that state or local laws or the employment contract may dictate a different paid holiday policy.
Consequences of Exempt vs. Nonexempt Misclassification
Misclassifying employees can lead to serious legal and financial consequences.
An employer who misclassifies an employee as exempt may be held liable for all unpaid wages, including overtime, owed to that employee for two years prior to the date of the claim. State law may be more stringent.
The court may also penalize an employer in an amount equal to wages owed the employee. These liquidated damages effectively double the unpaid wages a misclassified employee could collect.
The financial implications get worse for employers who willfully and / or repeatedly misclassify employees as exempt. Those employers could be liable for up to three years of unpaid overtime and incur up to $1,000 in civil penalties for each violation. The employer could also face criminal prosecution, exposing them to a fine of up to $10,000, and possibly incarceration.
It's crucial to understand the distinctions and ensure compliance with applicable employment laws. Employers should conduct regular audits of employee classifications and seek legal advice if uncertain about compliance issues.
3 Common Misconceptions About Exempt and Non-Exempt Employees
Misunderstandings about employee classifications can lead to compliance issues and employee dissatisfaction. It's important to address these misconceptions when classifying employees.
Myth #1: All Salaried Employees Are Exempt
Not all salaried employees qualify as exempt. They must meet the salary, salary level, and duties test requirements to be classified as exempt. Employers should not assume salary basis alone determines exemption status and should evaluate salary level and job duties thoroughly.
Myth #2: Exempt Employees Can Never Receive Additional Pay for Overtime Worked
Exempt employees may be paid for recognized with incentives for working extra hours if an employer chooses to offer it, but it is not required by law. This is not the same as paying an exempt employee overtime.
Myth #3: Non-Exempt Status Is Inferior to Exempt Status
Some employees and employers ask, is it better to claim exempt or non-exempt? Non-exempt status is not inherently inferior; it allows for different forms of compensation and provides greater protections by requiring employees to be compensated at least minimum wage for all hours worked and one and one-half times the regular rate for hours worked over 40 in the workweek. It can be advantageous in roles where overtime is common, enhancing total earnings.
Conclusion
Understanding the difference between exempt and non-exempt classifications is vital for managing your workforce compliance effectively. By considering job duties, salary levels, and basis of pay, you can determine the appropriate classification for your employees. This helps to ensure your business operates in compliance with applicable wage and hour laws
Accurate classification not only helps you ensure compliance with labor laws but also helps you manage payroll and benefits more efficiently, ultimately supporting your business's growth and success. By fostering a clear understanding of these classifications, employers can build a more transparent workplace, benefiting both the organization and its employees.
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1 Wages and the Fair Labor Standards Act | U.S. Department of Labor
