Business Owners Explore Exemptions, Exceptions & Consequences Surrounding Fair Labor Standards Act

Before putting front-line workers on salary, make sure you’re following the law.

It’s not an uncommon belief: If you put your employees on salary, you won’t have to pay overtime. Like a lot of seemingly simple solutions, it’s wrong. That doesn’t keep it from being widespread, however.

“Many employers, even sophisticated employers, make the mistake that simply paying people on a salaried basis exempts them from overtime,” says Wisconsin labor and employment lawyer Sean Scullen.

There may be good reasons for switching someone from an hourly wage to an annual salary, but there are also serious pitfalls that could put your business at risk. So if you want to make the change just to save money, think again – and read on.

EXEMPT, OR NOT?

The real difference in how employees are categorized isn’t between “hourly” and “salaried,” says Scullen, the National Chair of the Labor & Employment Practice Group of the law firm of Quarles & Brady, headquartered in Milwaukee with offices in Florida, Arizona and Washington, D.C.

“Anyone can be paid on a salaried basis,” Scullen says. “The real question is whether employees are exempt from overtime requirements under federal or state law.”

The federal Fair Labor Standards Act requires employees to be paid 1½ times their “regular rate” (generally determined by dividing all compensation earned by an employee in a work week by the total number of hours worked) for every additional hour they work in one week over 40 hours – in other words, time and a half.

To be exempt from that requirement, an employee must be paid on a salary of not less than $455 per week. But that alone doesn’t pass the test, Scullen points out. The FLSA also requires that an exempt employee’s duties fall within one of a limited group of exemptions. The most common are the so-called “white collar” exemptions involving “executive,” “administrative” or “professional” duties.

“They’ll save money in the short term, but all it takes is an employee or two to complain to the Department of Labor,” says Bruce Elliott, manager of compensation and benefits at the Society for Human Resources Management in Arlington, Va.

COSTLY MISTAKE

Suppose you classify a particular employee as salaried, and a federal administrative law judge rules your decision was wrong. Further, let’s say the judge finds that your wrongly classified employee should have been paid for 100 hours of overtime work in the last year. You could owe the worker the equivalent of 150 times his or her regular rate.

But it doesn’t stop there. You may be required to pay the employee’s attorney fees (as well as your own legal fees, of course). And the federal law also provides for an additional damage award of up to 100 percent of the unpaid wages – in this instance, another 150 times the employee’s regular rate.

And don’t think that because your business is very small it isn’t governed by federal labor laws. Where the FLSA is concerned, very few businesses are immune, Scullen says.

It can get even worse. “There are robust timekeeping regulations around hourly paid employees,” Elliott notes. Even if just one or two employees complain, that could trigger a full-blown audit of your entire operation by the labor department. If your timekeeping records aren’t in order to show you’ve paid hourly employees appropriately, including overtime when it has been worked, you could face additional penalties.

That also doesn’t take into account the cost of compiling the data you need to respond to an audit request. “And if the organization hasn’t kept timekeeping records, the burden of proof is on the employer to prove that the employees didn’t work overtime when they claim they have.”

EXCEPTIONS TO THE RULES

It is possible to put workers on a salary, but still keep the records so that they earn and are paid overtime when their workweek exceeds 40 hours. Elliott sees little point in that sort of arrangement, however, especially considering that even for those employees, you’ll need to keep accurate time records so that they’re paid overtime when they qualify for it.

“It’s easier to categorize them as hourly-paid so you can reconcile hours worked to compensation,” Elliott says.              

But it bears repeating: To be truly exempt and therefore not eligible for overtime pay, a salaried worker must have duties that fall within one of the legal exemptions. Those include responsibilities for managing workers, performing administrative work as the exemption defines it, or performing professional duties: work that requires specialized knowledge typically acquired in a prolonged course of study, such as accounting or engineering.

BONUSES AND COMMISSIONS

Hourly or not, Elliott says bonuses and commissions can be a useful tool for motivating front-line workers, especially those whose jobs offer opportunities to sell an additional service or product to the customer.

Straight sales commissions can be easier to figure in this way, he points out. Annual profit-sharing or other forms of bonuses are another alternative.

One caution, however, Scullen warns: Employers who fail to take nondiscretionary bonuses or commissions into account when calculating overtime do so at their peril. While outside salespeople may be exempt from overtime requirements, other nonexempt employees who are paid commissions or nondiscretionary bonuses must have such payments included in their overtime calculation. That typically requires a difficult retroactive calculation, he says.

One way to avoid that recalculation on a year-end bonus is to pay the bonus as a percentage of the employee’s total annual compensation (including overtime).

Elliott says the FLSA requires that when nondiscretionary bonuses for hourly workers are calculated in terms of annual gross pay, overtime hours must be included, not just the straight time wages over the year.

PREVENTING DISASTER

So how do you avoid problems from overtime violations, or any other violation of the Fair Labor Standards Act?

Scullen recommends a proactive strategy for employers: Conduct your own audit of wage-and-hour compliance to identify and correct potential concerns before a lawsuit is filed or the Department of Labor knocks on your door.

A knowledgeable labor and employment lawyer can help you review compensation plans and employee classifications and guide you in their proper implementation. At the same time, working with legal counsel can help ensure that your internal audit is protected from easy discovery by a plaintiff’s attorney – because it will then be covered under the attorney-client or attorney work-product privileges, Scullen explains.

The U.S. Department of Labor has numerous fact sheets and guidelines in the FLSA requirements, including a series of online tests you can run through to get a quick assessment of whether a worker’s circumstances or assignment qualifies that person as exempt under the federal law. You can find fact sheets at www.dol.gov/whd/fact-sheets-index.htm and one of those online tests at www.dol.gov/elaws/esa/flsa/scope/screen9.asp, along with links to other specialized tests.

And most of all, do your homework before trying to save money through a specious strategy.

“While you may save money on the short term,” Elliott says, “if it catches up to you, you’re going to pay through the nose on the back end.”

And that’s the kind of nosebleed you’ll never want.



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