Exempt or Non-Exempt? A Loaded (and Potentially Costly!) Question

Exempt/non-exempt status refers to an employee’s eligibility for overtime pay and certain other legal rights. This status is determined based on applicable law and such factors as the nature of the employee’s work, duties and responsibilities, and level and form of compensation.

Non-exempt employees are typically paid by the hour for each hour they work in a pay period and receive overtime pay in accordance with applicable overtime rules.

Exempt employees are generally paid a salary intended to compensate fully for all hours worked each week, are not compensated based on the number of hours worked, and do not receive overtime pay.

The High Costs of Misclassification

It can be extremely costly to mis-categorize an employee as exempt when he or she really should have been classified as non-exempt. And, that is true more so now than ever, as the federal government and many states are cracking down on employee misclassification like never before.

As two examples of just how costly misclassification can be, personal bankers for a large banking institution obtained a $22 million settlement after filing a lawsuit alleging that they had been misclassified as exempt, and insurance claims adjusters at a large insurance company were awarded more than $90 million in a misclassification lawsuit.

Part of the reason liability can be so great is that it can include liability for back wages, taxes, penalties, interest, and attorney’s fees. Plus, cases can reach back several years in most instances. With the stakes at such a high level, it behooves all employers to be extremely cautious when classifying employees.

Why Getting Exempt/Non-Exempt Status Right Is Not Always Easy

There are many different standards for determining an employee’s status as exempt vs. non-exempt. And, it is entirely up to employers to figure out which standards apply.

The federal Fair Labor Standards Act (FLSA) and related regulations set forth the federal standards, noting salary and duties tests for executive, administrative, and professional exemptions (as well as others), including the need for the exercise of discretion and independent judgment, and much more. Meanwhile, many states (e.g., California) have their own set of standards that are in some respects similar and in others very different.

The trick is that employers have to comply with whichever applicable standard is the strictest, and a variation of just one word from one standard to the next can make a huge difference. Consider, for example, the FLSA’s "primary duties" standard and California’s "primarily engaged in" standard. The two standards are entirely different, yet the words are almost the same.

The Standards Are Extremely Technical

Federal regulations fill pages and pages discussing the meaning of "discretion and independent judgment," and the "administrative/production worker dichotomy" (about which we will say more below), among other terms.

Since most people have not read the regulations, and since many who have read them don’t understand them, there are a number of common misconceptions, as discussed below.

1. Salaried employees are not all exempt While most exempt employees are required to receive a salary, all salaried workers are not necessarily exempt. This is because in addition to meeting the "salary" and "salary basis" tests, an exempt employee must meet the "duties" test as well. Most employees must meet all three "tests" to be exempt, and for the duties test, the actual job tasks must be evaluated, along with the way the particular job tasks "fit" into the employer's overall operations. Exempt executive job duties, for example, include tasks such as supervising two or more employees, hiring, firing, or promoting employees, or making job assignments for others. Job titles or position descriptions are not much use here.
2. The most commonly misused exemption: "Administrative Exemption"
   The "administrative exemption" is the most commonly misunderstood exemption. One of several keys to determining the applicability of this exemption is determining whether or not the employee’s "primary duty is 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."¹ (Emphasis added.) It is easy to misinterpret this language, and so the exemption is often misapplied. An example of an exempt administrator could be a buyer for a department store. This employee performs office or non-manual work and is not engaged in production or sales. The job involves work which is necessary to the overall operation of the store — selecting merchandize to be ordered as inventory. It is important work, because having the right inventory (and the right amount of inventory) is crucial to the overall success of the store's business. The job involves the exercise of a good deal of important judgment and discretion, because it is up to the buyer to select items which will sell in sufficient quantity and at sufficient margins to be profitable. Some examples of administrative functions include labor relations and personnel (human resources employees), payroll and finance (including budgeting and benefits management), records maintenance, accounting and tax, marketing and advertising (as differentiated from direct sales), quality control, public relations (including shareholder or investment relations and government relations), legal and regulatory compliance, and some computer-related jobs (such as network, internet and database administration). Whether anyone engaged in such functions is an exempt administrator, however, will depend on whether they meet the applicable compensation and duties tests. To make things even more confusing, because the administrative exemption is designed for relatively high-level employees whose main job is to "keep the business running," a useful rule of thumb is to distinguish administrative employees from "operational" or "production" employees. Production workers — employees who make what the business sells — are not administrative employees. They are "staff" rather than "line" employees. This distinction, however, can be very difficult to make where high-level employees are involved and where it is not clear whether their work is administrative or production work.
3. College graduates are not necessarily or even likely to be exempt under the"Professional Exemption" Under the FLSA, education beyond a 4-year college degree is usually required to qualify under the professional exemption under the FLSA. Moreover, under the FLSA, an employee’s primary duty must be the performance of work requiring advanced knowledge, or in other words, work which is predominantly intellectual in character, requiring the consistent exercise of discretion and judgment. Here, the advanced knowledge must be in a field of science or learning and customarily acquired by a prolonged course of specialized intellectual instruction. Typical professions covered under the professional exemption include medicine, theology, accounting, actuarial computation, engineering, architecture, teaching, various types of physical, chemical and biological sciences, pharmacy, and other occupations that have a recognized professional status and are distinguishable from the mechanical arts or skilled trades where the knowledge could be of a fairly advanced type, but is not in a field of science or learning. In California, however, not only is advanced education usually required, but so is a professional license. Thus, in California, exempt status as a professional is generally reserved for those who are licensed or certified by the State of California and "primarily engaged" in the practice of law, medicine, dentistry, optometry, architecture, engineering, teaching, or accounting — provided the salary test is met.
4. Many highly paid computer professionals may not be exempt
   To qualify for the computer employee exemption under the FLSA, the following tests must be met: (a) The employee must be compensated either on a salary or fee basis at a rate not less than $455 per week or, if compensated on an hourly basis, at a rate not less than $27.63 an hour; (b) The employee must be employed as a computer systems analyst, computer programmer, software engineer, or other similarly skilled worker in the computer field performing the duties described below; and (c) The employee’s primary duty must consist of:

• The application of systems analysis techniques and procedures, including consulting with users, to determine hardware, software or system functional specifications;
• The design, development, documentation, analysis, creation, testing, or modification of computer systems or programs, including prototypes, based on and related to user or system design specifications;
• The design, documentation, testing, creation, or modification of computer programs related to machine operating systems; or
• A combination of the aforementioned duties, the performance of which requires the same level of skills.

In California, employees falling within the computer professionals exemption must be paid at least $39.90 per hour, which translates to a monthly salary of $6,927.75 and an annual salary of $83,132.93 (these figures typically increase every year). In addition, similar to the federal law, California computer professionals must meet stringent duties requirements, including being highly skilled and proficient in the theoretical and practical application of highly specialized information to computer systems analysis, programming, and software engineering. Both federal and California law expressly exclude from the computer professionals exemption employees who are engaged in the manufacture, repair, or maintenance of computer hardware and related equipment. California law also excludes trainees, employees in computer-related occupations who have not attained the level of skill and expertise to work independently and without close supervision, and technical writers who prepare setup or installation instructions.

Take Employee Classification Seriously

The major takeaway here is to treat employee classification seriously. Employers who maintain a cavalier attitude about exempt/non-exempt classification could find themselves saddled with liability for years of unpaid wages, plus interest, statutory penalties, and attorney fees.

Considering that misclassification is one of the most common reasons for lawsuits against employers, it’s not surprising that many big-name employers (as well as small and medium-sized ones) have had to pay large amounts of money for misclassifying employees.

We recommend that you seek legal counsel should you have any specific questions about classification of employees.

Disclaimer

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