Are You Misclassifying Employees? A Refresher on Non-Exempt vs. Exempt and Why You Need to Get it Right

In 2020, the government has been cracking down and creating more penalties for misclassifying employees.  It’s becoming more important than ever for employers to learn how to correctly classify workers as exempt and nonexempt.  Most recently, Pennsylvania passed the Minimum Wage Act (MWA), which takes effect on January 1^st, 2021.  This legislation will affect a few things, essentially making it harder than ever for an employer to classify workers as exempt.   While this law only affects Pennsylvania employers, it may be a sign of things to come for other states. 

On a federal and judicial level, there’s also been a push for employers to correctly classify their employees as non-exempt or exempt.  This year, the Department of Labor released Bulletin 2020-5.  This piece of legislation requires employers to be tracking their staff’s hours worked and compensable time.  It makes it clear that employers are responsible for paying non-exempt employees for all hours worked and compensable time, even if that time was not requested or authorized.  Bulletin 2020-5 was likely created to address all non-exempt employees who have been working remote since the start of the pandemic.  (If employers don’t already have a reasonable reporting procedure, they should consider creating one and using software like MP’s time tracking software to make sure all compensable hours are captured and paid.)  Bulletin 2020-5 makes it all the more urgent for employers to correctly identify their non-exempt workers, so they’re reporting, working, and getting paid for the appropriate amount of time and they’re not vulnerable to a situation in which they are liable for backpay, penalties, lawsuits, etc.  

It’s also worth noting that in California this year, there have been some major measures taken to reform the misclassification of “gig” workers.  The state passed legislation requiring that many staff of companies like Uber, Lyft, and Grubhub be correctly classified as full-time employees and paid per AB5, the state test for classifying exempt and non-exempt workers.  Though there has been some back and forth on this matter, it’s worth paying attention to as a potential signal of regulatory trends to come.  Many other states, including Illinois and New York are considering passing their own legislation to force employers to classify their staff correctly. 

Employers should re-examine all job descriptions to avoid misclassifying employees.  They should consult with their HR services providers, get reacquainted with the FLSA duties test, get caught up on relevant state laws, and get to work re-examining their classifications. 

Misclassifying Employees: The Consequences

Misclassifying employees can have serious repercussions for an employer.  With all the new and existing legislation and regulation, employers all over the country are exposed to risk.  Misclassified workers can sue under 29 U.S.C. § 216(b) and be awarded back pay for up to three years, as well as legal fees.  The court can add more penalties to the employer for liquidated damages in an amount equal to the owed unpaid wages, essentially doubling the amount owed to the employee.  For those employers who are found to have willfully and/or repeatedly misclassified workers as exempt, there are civil penalties of up to $1,000 for each violation.   These employers can also be criminally prosecuted and wind up with a fine of $10,000 and/or time in prison.    Beyond federal penalties, many states may have their own additional fees.  States are especially motivated to see employers correctly classify workers as non-exempt because they stand to gain more in taxes if employees are paid more for the overtime they work. 

Besides financial penalties, employers should not underestimate the pain of damage to their reputations.  When workplaces ignore things like the exempt duties test and incorrectly classify staff, they are denying them money.  They may also be denying their staff vacation time, and benefits if exemption status is a determination for eligibility.  Especially in the age of Glassdoor and the internet, employers should be ready for their staff to share anything they do—good and bad.  Misclassifying workers now can lead to a serious inability to attract and keep talent later. 

One example of all the ways an employer can rep consequences of misclassifying employees is Walmart.  Walmart misclassified 4,500 managers and coordinators as exempt, garnering them $5.3 million in penalties, damages, and back wages.  They also gained irreparable damage to their reputation as a desirable workplace or as a retailer that people feel good about giving their money to.

On the flipside, there are benefits of correctly using tools like the FLSA test to classify your employees as exempt and non-exempt.  First, it can help when you’re creating systems for reporting hours worked.  Especially in 2020, as many companies have gone remote for the first time, employers needed to set up new systems to assist employees in correctly reporting hours worked and requesting overtime.  Knowing what employees pass the exempt status test helps employers to know who should follow what protocol.

Another benefit of classifying employees as exempt or non-exempt is that when somebody unexpectedly leaves, and the role must be filled, knowing whether the role is exempt or non-exempt will be important information for the internal hiring process and the candidates who are applying.  This information can also be helpful as workplaces update their employee handbooks and are detailing out which roles can be eligible for things like remote and flexible work schedule policies, certain benefits like vacation time, PTO, etc.  

Misclassifying employees: how to avoid it

Here’s how employers can ensure they’re properly classifying their staff as exempt or non-exempt.  The first and most fool-proof way to handle this task is to work with HR services like MP’s.  With years of expertise, experience, and certification, they can advise employers on every role. 

The second thing to know is that any employee can be classified as non-exempt.  An employer can always choose to classify an employee this way, thus making them entitled to overtime pay and at least minimum wage for all hours worked.  Some employers will also tie exempt and non-exempt status to the ability to receive PTO, vacation, and benefits.  (It’s important to note that ACA requirements apply in this circumstance, too.  The ACA requires employers with 50 or more employees to offer affordable group health insurance to employees who put in “30 or more hours of service” each week.)  Many employers choose not to make non-exempt employees entitled to these forms of compensation.   

Unlike the non-exempt designation, not every employee can pass the FLSA exempt test.  In addition to often being considered eligible for benefits, vacation time, paid holidays, and sick time, exempt employees are also paid in a particular way.  They must be paid the same amount every week, regardless of the number of hours they have worked or the quality or quantity of their work.  There are also rules about the pay you can and cannot deduct from exempt workers.  HR consulting providers can help clarify these rules for you.  

To classify employees as exempt, they must pass the FLSA duties test that are relevant to their specific roles.  The first test is the salary basis test.  For many employees, this means they must be paid at least $35,568 yearly or $684 a week.  (These numbers are a significant step up from 2019, when workers had to be paid $23,660 a year or $455 a week to be classified as exempt.  Thus, it is notably harder to classify employees as exempt in 2020 and beyond.)  The salary basis test is different for employees who perform “outside sales” functions or for employees who fall into the “highly compensated worker” category.  Outside sales employees have no minimum amount for the salary basis test, while “highly compensated workers” must make a minimum of $107,432 a year in total annual compensation. 

Duties Tests: 7 Employment Categories

• Executive employees pass the exempt duties test if their primary duties are managing the organization or a department within the organization.  This includes managing two or more employees.  They must also be part of the hiring and termination process.
  
• Administrative employees pass the exempt duties test if their responsibilities are “directly related to the management or general business operations” and they must exercise “discretion and independent judgement” for “matters of significance.” 
  
• Learned professionals’ primary duties must be work that requires and advanced knowledge and is predominantly intellectual in character.  They must also consistently need to exercise “discretion and independent judgement.”  Lastly, they need to have advanced knowledge in a field of science or learning, and have advanced knowledge that has been obtained through a “prolonged course of specialized intellectual instruction.”  Note that the salary basis test does not apply to teachers, lawyers, and doctors.

• Creative professionals must primarily perform work that requires “invention, imagination, originality, or talent in a recognized field of artistic endeavor.”  For the salary test, they may be paid on a “fee basis,” but must still make at least $684 a week if the money was stretched across a 40-hour weekly basis.

• Computer professionals must make $684 a week or $27.63 an hour to pass the salary basis test.  To be considered exempt, they need to have the title Computer Systems Analyst, Computer Programmer, Software Engineer, or hold a role requiring similar skills with one or a combination of the following duties:

• “Application of systems analysis techniques and procedures, including consulting with users to determine hardware, software, or system function applications
  • Design, development, documentation, analysis creation, testing, or modification of computer systems or programs, including prototypes, based on and related to user system design specifications
  • Design, documentation, testing, creation, or modification or computer programs related to machine operating systems.”

• Outside sales employees pass the exempt duties test if their “primary duty” is “making sales,” or “obtaining orders or contracts for services or for use of facilities for which a consideration will be paid by the client or customer.”  They must perform most of their duties away from the workplace.    
  
• Highly compensated employees’ primary duties must include performing office and non-manual work.  The must also regularly complete at least one of the duties of an exempt executive, administrative, or professional employee.

Misclassifying Employees: 4 Exemptions to Note

In addition to the above employment categories, these exemptions should also be considered.

Business Owners: An employee who possesses at least a 20 percent equity interest in the business or organization in which they’re employed and is actively engaged in its management is considered an exempt executive.

Teachers: A teacher can be considered exempt if his or her primary job responsibility is “teaching, tutoring, instructing, or lecturing in the activity of imparting knowledge.”  The must also be employed by “an educational establishment.”  Some examples of exempt teachers are: conventional academic teachers, kindergarten and nursery schoolteachers, teachers for gifted or differently abled children, teachers for skilled and semi-skilled trades and vocations, teachers for automobile driving, instructors for flying aircrafts, vocal and instrument teachers, and home economics teachers.  The salary basis test does not apply to teachers.

Law and Medicine: A worker who holds a valid license or certificate for practicing law or medicine can be counted as exempt if one of these is their primary duty.  Employees who hold the academic degree for the general practice of medicine is also exempt if working an internship or resident program for medical practitioners.  The salary basis test doesn’t apply to those who practice law or medicine.

Retail Commission Sales: Employees in retail or service establishments who are paid more than half their total compensation on a commission basis can be considered exempt if all three of these conditions are met, the exception doesn’t apply, and premium pay for overtime must be paid for every hour worked in a 40 hour workweek at 1 or 1.5 times the regular rate of pay.  The requirements are:     

• The employee works at a retail or service establishment.
• More than half their total earnings in a representative period represent commissions on goods or services.
• Their total compensation divided by the number of hours worked exceeds one and one-half the minimum wage.