Classification Conundrum

Avoiding Potentially Costly Exempt Vs. Non-Exempt Errors

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by Melanie Lockwood Herman

If you’re uncertain whether you have properly classified staff member as either “exempt” or “non-exempt” workers, you’re not alone. Across the country nonprofit leaders often struggle with proper classification.

Wage and hour violations continue to be a lurking risk in many nonprofits. Unlike risks that pose obvious threats to an organization's well-being, it is very difficult for even a well-intentioned CEO to spot compensation errors that could jeopardize the fiscal health of the nonprofit. As long as the nonprofit meets its payroll obligation every pay period and employees voice few or no complaints about their pay stubs, wage and hour violations go unnoticed.

Common Wage and Hour Mistakes

Wage and hour investigations by the Department of Labor indicate that employers fail to pay required overtime when they misclassify employees who were really "non-exempt," as if they were "exempt." The true danger in this practice lies in the fact that if the government's position is correct, the nonprofit will not only owe back overtime wages and withholding taxes, but also penalties — often money that the nonprofit had not budgeted and is generally not available out of the operating budget. Other common but risky practices include:

Wage and Hour Q & A

  • Q. Can a part-time employee be paid on a salary basis and qualify for exempt status?
  • A. YES, as long as the position pays more than $23,660 annually and meets the duties test.
  • Q. Can we dock the pay of an exempt employee who only worked a partial day last week but has exhausted their accrued leave?
  • A. NO. Disciplinary action may be taken against a salaried, exempt employee who fails to meet your performance requirements, but you may not dock their pay on any day where they performed any work.
  • Q. We no longer employ secretaries. All of our secretaries are now called Administrative Assistants. Doesn't this mean the administrative exemption applies and they are no longer eligible for overtime pay?
  • A. NOT NECESSARILY. The position description must be scrutinized carefully to determine whether the position of administrative assistant is eligible for the administrative exemption. In most cases AAs should be classified as non-exempt.
  • Q. We cannot afford to pay overtime, so we ask incoming employees to voluntarily agree to "exempt" status. As long as they agree to be “exempt,” is this ok?
  • A. NO. An employee may not opt out of the wage and hour laws. According to DOL, “The overtime requirement may not be waived by agreement between the employer and employees. An agreement that only 8 hours a day or only 40 hours a week will be counted as working time also fails the test of FLSA compliance. An announcement by the employer that no overtime work will be permitted, or that overtime work will not be paid for unless authorized in advance, also will not impair the employee's right to compensation for compensable overtime hours that are worked.”
  • Q. Where can I find additional information on the wage and hour laws and the new regulations?
  • A. The Department of Labor's Wage and Hour Division's Web site is available at www.wagehour.dol.gov. You may also call the Division's toll-free help line, available from 8 a.m. to 5 p.m. in your time zone, at 1-866-4US-WAGE (1-866-487-9243). Keep in mind that when state laws differ from the federal Fair Labor Standards Act, your nonprofit must comply with the standard most protective of employees. Links to state labor departments can be found at www.dol.gov.
  • disciplining exempt employees by docking pay in periods of less than a full day, which results in the conclusion that the employer was paying the employee by the hour, rather than on a salary basis, thus creating liability for overtime;
  • failing to treat mandatory work-related meetings and training sessions as hours worked;
  • not providing "duty free" lunches for non-exempt staff — keep in mind that if you're requiring an employee to answer phones or perform any task during lunch you have not provided a true lunch break;
  • not requiring non-exempt employees to clock in and out for lunch — some employers automatically deduct one hour or one-half hour from an hourly employee's workday, regardless of whether the employee actually takes a lunch break;
  • not paying work preparation time or travel time that is legitimately part of the job;
  • not reimbursing employees for employment-related expenses (e.g., mileage or required extra insurance premium for auto coverage the employer requires that exceeds the state's minimum limits);
  • not providing all wages due at termination. Most states have "final paycheck" laws that require prompt payment of a departing employee's final check that may include payments for accrued vacation time; and
  • erroneously classifying employees as independent contractors.

An employer that commits any of the violations just described may be liable for unpaid wages, statutory penalties, interest, and attorneys' fees for all affected employees. To avoid exposure to financial penalties and an enormous headache, every employer should conduct a thorough review of wage and hour practices and eliminate any non-compliant practices.

Step by Step

In the section that follows we’ve simplified the exempt versus non-exempt classification process into two steps: (1) the salary and salary basis test, and (2) the duties test. If you're responsible for developing job descriptions and/or classifying employees in your agency but you don't fully understand these tests, there's a good chance your nonprofit has made some potentially costly missteps in classifying employees.

It is never appropriate to classify employees based solely on their salary, rank, background, or the nonprofit's desire to avoid overtime pay. Act wisely: conduct a careful review of all staff positions in order to determine which classification is correct under DOL regulations. If a position has been classified incorrectly, consult with legal counsel about the process for changing the classification and reducing the exposure facing your agency. Here are two steps for reviewing the positions in your nonprofit.

STEP 1: DOES THE POSITION MEET THE SALARY / SALARY BASIS TEST?

Salary / Salary Basis Test — The regulations provide that a position for which you pay more than $455 per week may be exempt from overtime, but only if the position is paid on a salary basis. An employee whose annual earnings are $23,660 or less—regardless of whether they are paid on a fixed, salary basis—must be classified as non-exempt. If a position pays more than $455 per week ($23,660 annually), make certain the employee is paid on a “salary basis” before proceeding to Step 2. Remember, the title, position, authority or role of the employee are of no consequence in determining whether a position meets the salary / salary basis test. (Note: exempt computer employees may be paid at least $455 on a salary basis or on an hourly rate of not less than $27.63 per hour.)

According to the Department of Labor, "Being paid on a 'salary basis' means an employee regularly receives a predetermined amount of compensation each pay period on a weekly, or less frequent, basis. A sometimes confusing issue for employers is that the predetermined amount cannot be reduced because of variations in the quality or quantity of the employee's work. Subject to exceptions listed below, an exempt employee must receive the full salary for any week in which the employee performs any work, regardless of the number of days or hours worked. Exempt employees do not need to be paid for any workweek in which they perform no work.

If your nonprofit makes deductions from an employee's predetermined salary due to variances in work load, that employee is not being paid on a 'salary basis.' If the employee is ready, willing and able to work, you may not make deductions from their pre-determined pay simply because work is not available. For information on the circumstances under which a salaried employee may receive less than his or her full salary for any week in which the employee performs any work, see DOL Factsheet #17G. The term "Fee basis" is defined in 29 CFR 541.605.

STEP 2: DOES THE POSITION MEET THE DUTIES TEST? WHICH EXEMPTION CATEGORY APPLIES?

Duties Test — The duties test is more complicated than the salary / salary basis test. It provides that a position that is eligible for exempt status because it meets the salary and salary basis test can only be classified as exempt if the position's duties meet the parameters of an allowed exemption category. The most common exemption categories are executive, administrative and professional. These are discussed in the next section. Keep in mind that other exemption categories, such as technical and creative, exist as well. Consult the Wage and Hour Division website for information about other exemptions.

Executive Exemption

Fact Sheet #17B offers information on the exemption for executive employees under the FLSA. Eligibility for the executive employee exemption is limited to positions:

  • Whose primary duty is managing an enterprise, or managing a customarily recognized department or subdivision of the enterprise;
  • Whose customary duties include supervising the work of at least two or more other full-time employees; and
  • Whose authority includes the ability to hire or fire other employees, or whose recommendations as to the change of status of other employees are given weight.

Classification Tip: Some nonprofit managers believe that anyone who supervises two or more employees is automatically "exempt." As the section above indicates, this is a misconception about the regulations.

Administrative Exemption

Eligibility for the administrative employee exemption is limited to positions:

  • Whose 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"; and
  • Whose primary duty includes the exercise of discretion and independent judgment with respect to matters of significance.

Classification Tip: A key to properly applying the Administrative Exemption is understanding the phrase "discretion and independent judgment with respect to matters of significance." Some nonprofits misstep by claiming that all (or most!) employees use discretion and judgment. A closer look reveals that the opposite is generally true: a minority of employees at the typical nonprofit use discretion and judgment. When an employee performs work that involves following techniques or procedures, they are applying skill to the task. When an employee is expected to depart from or change procedures without supervisory intervention they are probably using discretion and judgment.

Professional Exemption

Positions that may be exempt under the professional exemption category include those where:

  • The primary duty is work requiring advanced knowledge, defined by DOL as "work which is predominantly intellectual in character and which includes work requiring the consistent exercise of discretion and judgment";
  • The advanced knowledge required for the position is in a field of science or learning; and
  • The advanced knowledge required for the position is acquired through a "prolonged course of specialized intellectual instruction."

Some employees may qualify for the “creative professional employee exemption.” This exemption applies to positions that meet the salary/salary basis test AND where the position’s “primary duty” is the “performance of work requiring invention, imagination, originality or talent in a recognized field of artistic or creative endeavor.”

Classification Tip: Some nonprofit leaders regard all of their staff as "professionals" and therefore believe the professional exemption applies to all positions. This is rarely, if ever true. The requirements listed above should make it clear that the professional exemption applies in only rare instances. While it may be good for morale to refer to staff members as "professionals," remember that this term is interpreted narrowly in wage and hour regulations and a staff member who is regarded as a professional may be non-exempt and therefore eligible for overtime pay.

Helpful DOL Fact Sheets

See Fact Sheet #23 on “Overtime Pay Requirements of the FLSA” for general information about the overtime pay provisions of the Fair Labor Standards Act.

See Fact Sheet #17A for an overview of the executive, administrative and professional exemptions described above.

For more information on the executive, administrative and professional exemptions, see the Handy Guide to the FLSA published by the Department of Labor and available at: www.dol.gov or visit the Wage and Hour Division site at www.wagehour.dol.gov.

It is important to realize that to be exempt from overtime, an employee must not only meet the federal test for exempt status, but must also meet any state requirements that may be more stringent than the federal exemptions. Review the wage and hour provisions in your state by visiting your state department of labor Web site. A complete listing of state labor departments is found at www.dol.gov. Before proceeding with changing the classification of any positions in your nonprofit, consult an experienced employment attorney licensed in your state who can advise your nonprofit about the best way to proceed.

Minimum Wage Laws and Your State

DOL offers a clickable may of the Minimum Wage Laws in the States as well as a table showing state minimum wage rates and daily/weekly thresholds for premium pay. To learn more about the minimum wage laws in your state, visit: www.dol.gov/whd/minwage/america.htm and click on your state. Keep in mind that where Federal and state laws have different minimum wage rates, the higher rate applies. As you’ll see on the map, six states/territories have NO minimum wage law, but 18 states have minimum wage rates that are HIGHER than the Federal rate.

To get RISK HELP on classification and other HR issues throughout the year, join the Center as an AFFILIATE Member.

Purchase the Center’s eBook on HR risk for access to best practices in HR risk management.