Classification Conundrum
Avoiding Potentially Costly Exempt Vs. Non-Exempt Errors
by Melanie Lockwood Herman
The publication of the U.S. Department of Labor's new wage and hour regulations on April 21, 2004, received a mixed greeting. Some groups claim that the new regulations will result in substantial numbers of workers losing overtime benefits. Others, including the Bush Administration, claim that large numbers of Americans will now be eligible for overtime pay. The regulations go into effect on August 23, 2004.
The reaction in the nonprofit sector was also mixed, but in a different way. Some nonprofit HR directors and CEOs greeted the announcement by simply vowing to review the regulations carefully in order to make certain their organizations are in compliance. Most, however, failed to notice the change.
U.S. Secretary of Labor Elaine L. Chao testified before Congress on April 28, telling legislators that the new regulations would mean guaranteed
overtime protection for 1.3 million salaried workers who earn $455 a week or less.
Whether you've been keeping up with the public debate and wondering which "side" is telling the truth, or ignoring the matter like a dreaded household chore, it's time to take a look at the regulations and determine what actions are necessary.
Wage and hour violations are a lurking risk in many nonprofits. Unlike risks that pose obvious threats to an organization's well-being, itis 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. Yet undetected compensation errors are commonplace in the nonprofit world.
Common Wage and Hour Mistakes
Wage and hour investigations by the Department of Labor often claim that an employer failed to pay overtime because of misclassifying and treating 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:
- 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
The new regulations provide an updated approach to the three tests that should be used in classifying white collar employees: the salary test, the salary basis test, and 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 (Can you explain them in lay-person's terms to someone else?), 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: Make plans today to conduct a careful review of all staff positions in order to determine which classification is correct under the updated rules. 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 some suggested steps for reviewing the positions in your nonprofit.
Step 1: Does the Position Meet the Salary Test?
Salary Test — The regulations provide that positions that are paid more than $455 per week may be exempt from overtime, but only if the positions meet the second and third tests. This means that an employee whose annual earnings are $23,660 or less must be classified as non-exempt. If a position pays more than $455 per week proceed 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 test.
Step 2: Does the Position Meet the Salary Basis Test?
Salary Basis Test — The salary basis test answers the question of whether the employee is paid on a salary basis or a fee basis. 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. 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 the employer makes deductions from an employee's predetermined salary, i.e., because of the operating requirements of the business, that employee is not paid on a 'salary basis.' If the employee is ready, willing and able to work, deductions may not be made for time when 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, available at www.dol.gov. The term "Fee basis" is defined in 29 CFR 541.605.
Step 3: Does the Position Meet the Duties Test? Which Exemption Category Applies?
Duties Test — The duties test is the most complicated of the three tests. It provides that a position that is eligible for exempt status because it meets the salary and salary basis tests 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 DOL Web site for insight into the additional exemption categories.
Executive Exemption
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 nonmanual 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.
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;
- The advanced knowledge required for the position is acquired through a "prolonged course of specialized intellectual instruction."
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.
The U.S. Department of Labor Web site (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.