As all employers know, employees classified as “exempt” under the federal Fair Labor Standards Act (“FLSA”) or any of the various similar state statutes need not be compensated for what would otherwise be considered overtime.  These employees are paid a fixed salary and it does not matter whether they work 30 hours per week or 60.  Their salary is their compensation.  But for their classification, these employees would be entitled to time and one-half for all hours worked in a week over 40.  Thus, the savings for a company can be substantial.  Consequently, companies often are “very generous” in who they classify as “exempt”.  But, misclassifying someone as exempt can be costly!

To be exempt under the FLSA (and likely under various state laws), employees must fall into one of the following categories: executive, administrative, professional, outside sales or computer professional.  Each of these categories has its own criteria which must be satisfied.  For example, the criteria for the executive exemption:

1. Weekly salary of at least $455
2. Primary duty is managing the enterprise or a department or subdivision of the enterprise
3. Customarily directs the work of at least 2 full-time employees or their equivalent
4. Has the authority to hire and fire, or at least his recommendations carry significant weight

Items 1 and 3 are essentially self-explanatory.  It is in the application of the other two criteria where employer often run afoul of the US or State Department of Labor.  Often employers assume that, so long as they pay someone a substantial salary and give him an appropriate job title, they can classify that employee as exempt.  As anyone who has been through a DOL investigation knows, it is not quite that simple. The government will dig deeply into the actual job functions in question.

For improperly classified employees, back pay liability can be substantial.  Take, for example, an employee being paid an annual salary of $40,000 per year, the equivalent of approximately $20/hour, if paid on an hourly basis.  If the employee works, on average, 10 hours of uncompensated overtime per week, that would come to about 500 hours per year.  If paid hourly, the employee’s overtime rate would be $30/hour (1-1/2 x $20).  Those 500 hours could represent an additional $15,000 in annual compensation if the employee is found to be “non-exempt”.  The FLSA statute of limitations would allow at least 2 years of back pay – 3 years if willfulness can be established, and the burden is quite low to establish that.  So, in this example, that could be $45,000 in back pay.  The FLSA also allows for liquidated damages, which are the equivalent of the back pay – thus, this is commonly referred to as “double back pay.”  So, again considering our example, the employer could be liable for $90,000 – for a single $40,000/year employee improperly classified.  Multiply that by the number of employees possibly improperly classified and the numbers can rapidly add up.

And, we haven’t even discussed employers classifying employees as “independent contractors"...

Prudent employers will conduct an objective audit of their exempt/non-exempt classification of the workforce.  The time and effort expended now will be paid back in dividends when the DOL comes knocking!  If you have any questions about this subject or would like some assistance in conducting a self-audit, please contact Philip S. Mortensen.