This is the first article in a series provided by HR Limited, a human resource and training consulting firm.
The Fair Labor Standards Act is the federal law that governs employees' pay.
It is the FLSA that requires overtime pay for certain employees and exempts others from overtime pay altogether. Employers who ignore the FLSA's requirements will find themselves subjected to heavy penalties, including paying overtime to the wronged employees for up to the past three years.
To avoid the stiff penalties imposed under the FLSA, employers need to be mindful of the FLSA's classifications of employees who are exempt and non-exempt from the overtime laws.
Under the FLSA, employees who must receive overtime pay are classified as "non-exempt," signifying that they are entitled to time and a half pay after they have worked forty hours in a single week. Only non-exempt employees are required to keep track of their time. Employees who are exempt from the overtime pay requirements are classified as "exempt" and accordingly do not need to be paid overtime and do not need to keep track of their time at all.
Generally speaking, in order to be exempt, an employee must be paid on a salary basis and meet one of the following employment categories: executive, administrative, or professional. Each of these terms must be analyzed to fully understand the law's intent.
The Salary Basis Test
Under the salary basis test, the employee must earn at least $455 per week or $23,600 per year and his/her pay may not be subject to deductions because of variations in the quantity or quality of work performed. This means that even where an exempt employee only works partial days, he/she is nevertheless entitled to full pay. Although deductions are permitted, they are limited to the following circumstances: no work performed in an entire week; violation of a major safety rule; a full day absence for personal reasons; a full day sick or disability absence in excess of the sick or disability pay policy; and discipline for workplace conduct rules published in a written policy uniformly applied to all. The only time a partial day absence can be deducted from the pay of an exempt employee is in the event of an absence under the FMLA.
If the salary basis test is met, then the next analysis is to consider whether or not the employee can be classified as an executive, administrative or professional employee. Each of these classifications has lengthy definitions and many examples appear in the regulations.
The Executive Exemption
The executive exemption exists where the employee's primary duty is management of a customarily recognized department or subdivision thereof; where he/she customarily and regularly directs the work of two or more employees; and has the authority to hire or fire other employees or whose suggestions and recommendations as to the hiring, firing, advancement, promotion or any other change of status of other employees is given particular weight. Under this exemption, the "primary duty" requirement means that the employee must actually perform his/her management duties at least 50 percent or more of the time.
The Administrative Exemption
The administrative exemption requires that 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 its customers and that he/she exercises discretion and independence with respect to matters of significance. This exemption is typically known as the "white collar" exemption.
To meet the requirement that one's work be directly related to the management or general business operations of the employer, the employee must perform work directly related to assisting with the running or servicing of the business. The regulations cite work in areas such as tax, finance, accounting, budgeting, quality control, purchasing, human resources and public relations as fitting this requirement.
To fit the requirement that the employee exercise discretion and independent judgment, the employee must compare and evaluate possible courses of conduct and act or make a decision after the various possibilities have been considered. Factors to consider in determining whether the employee exercises discretion and independent judgment with respect to matters of significance include: whether he/she has the authority to formulate, affect, interpret or implement management policies or operating practices; whether he/she carries out major assignments in conducting operations of the business; whether his/her work affects business operations to a substantial degree; and whether he/she can commit the business in matters that have significant financial impact, etc.
The regulations further provide examples of employees who will meet the administrative exemption. Included among these examples are: employees in the financial services industry if their duties include work such as collecting and analyzing information regarding the business' income, assets, investments or debts; an employee who leads a team of other employees assigned to complete major projects for the employer; executive assistants to the owner or a senior executive; and human resource managers.
The Professional Exemption
The professional exemption applies to those employees whose primary duty is the performance of work requiring advanced knowledge in a field of science or learning customarily acquired by a prolonged course of specialized intellectual instruction. This primary duty test includes the following three elements:
(1) The employee must perform work requiring advanced knowledge beyond the high school level and the work must be predominantly intellectual in character and require the consistent exercise of discretion and judgment.
(2) The advanced knowledge must be in a field of science or learning that includes traditional professions of law, medicine, engineering, architecture, various types of physical, chemical and biological science, and other similar occupations that have a recognized professional status.
(3) The advanced knowledge must be customarily acquired by a prolonged course of specialized intellectual instruction where specialized academic training is a standard prerequisite for entrance into the profession or where an employee has attained the advanced knowledge through a combination of work experience and intellectual instruction.
In 2004, the regulations interpreting the FLSA were amended. The new regulations created a new exemption called the "highly compensated employee" exemption. This applies where an employee is paid at least $100,000 per year and customarily and regularly performs one or more exempt duties that are non-manual or office in nature.
The new regulations also created, for the first time, a complete prohibition against any exemption for blue collar employees. "Blue collar employees" are defined as employees whose primary duties are performing work involving repetitive operations with their hands, physical skill and energy. Therefore, even if a blue collar employee is earning over $100,000 per year, overtime must be paid so long as that employee is performing work that is repetitive in nature.
Finally, the new regulations recognize a new "business owner rule" which, if applicable, will permit the business owner to be exempt even if the salary basis test is not met. To meet this new rule, the owner must own at least a bona fide 20 percent equity interest of the business and be actively engaged in management of the business.
Pitfalls of Non-Compliance
The pitfalls of not complying with the FLSA's regulations are serious. The worst scenarios appear where an employer has misclassified an employee as exempt and that employee has worked many overtime hours but has failed to keep track of his time. In an audit and/or lawsuit, the employer is at once charged with failure to maintain the proper records for a non-exempt employee and is ordered to pay a mandatory fine. At the same time, the employee fills out an affidavit in which he estimates all of the overtime hours he worked in the past two or three years. The employer is prohibited from contesting this affidavit unless there are some records, which do not typically exist because the employee was misclassified as exempt. The result is typically a massive amount of overtime claimed to be worked which is accepted at face value.
Another pitfall exists where an employee, who is clearly non-exempt, volunteers to work overtime and not be paid for the overtime hours. Many employers fall into this landmine and believe that the fact that the employee volunteered to forego overtime will protect them. However, every court that has been confronted with these facts finds against the employer and holds that it is the employer's duty to be cognizant of the FLSA's requirements and know that an employee cannot voluntarily exempt himself from the overtime laws. The result is that the employer is subjected to heavy fines, plus he must pay the employee for all the overtime worked over the past three years.
If your business requires employees to work overtime, the best practice is to closely scrutinize those employees who you believe should be exempt. Only those employees who you are sure meet one of the exemptions explained above should be classified as exempt. Keep in mind that serious questions arise where there is more than one exempt employee in any one department, especially where the exemption is under the administrative or executive exemption.
When it comes to the FLSA, all businesses must be aware that failure to comply results in very serious economical ramifications. The safest bet to make is to invest the time and resources in learning about the exemptions and how to comply with them and to establish these formally and proactively in writing and practice. If you are unsure, it's best to talk with an experienced human resources professional and/or employment attorney.
Construction Business Owner, February 2007