Learn the difference between exempt and nonexempt so you can properly classify your employees.
Exempt and nonexempt employees classify which type of employee is entitled to certain rights, like overtime pay, under the Fair Labor Standards Act (FLSA). Businesses need to classify employees based on certain qualifications like responsibilities held and payment structure. This distinction is important to understand as an employer, as it's crucial to understand the rights of different types of workers under the law.
According to federal regulations, employees fall under one of two categories: exempt or nonexempt. Employers cannot classify their employees based on personal preference; instead, they must follow preset federal guidelines that determine how employees are classified. It is important to be knowledgeable about both federal and state classifications. Misclassification can be very costly, and penalties can be assessed retroactively.
What is the difference between exempt and nonexempt employees?
To comply with labor laws and wage regulations, business owners must know how to properly classify employees. Lauren Blair, attorney and author at FreeAdvice.com, said the key differences between exempt and nonexempt status are based on an employee's job responsibilities, decision-making authority, and compensation.
"The factors that determine whether an employee can be classified as exempt or nonexempt are governed by the FLSA federal regulation, which is administered by the Wage and Hour Division of the Department of Labor," Blair told business.com. "The DOL will not just accept what the employer calls the employee. Rather, the regulations are designed to scrutinize the reality of someone's job."
Based on criteria in the FLSA, an employee is either ineligible for overtime pay (exempt) or eligible for overtime pay (nonexempt).
Exempt employees are typically salaried workers who are exempted from (i.e., not eligible for) overtime pay, regardless of how many hours they work per week.
A common misconception is that all salaried employees are exempt, when in fact, there are several guidelines that an employee must meet before they qualify as exempt.
According to the FLSA, an employee must pass each of the following tests to be considered exempt:
- Salary-level test: An employee must earn a minimum salary of at least $684 per week or $35,568 per year for a full-year worker. The DOL recently raised this threshold (effective January 1, 2020) from the previous requirement of $455 per week or $23,600 per year for a full-year worker.
- Salary-basis test: An employee must be paid a guaranteed salary for any week they perform "any" work.
- Duties test: An employee must perform exempt job duties which typically consist of executive, professional or administrative tasks.
"Under the duties test, there are a number of different categories of workers who are exempt from the overtime requirements, the most common of which are the executive exemption, the sales exemption, the professional exemption, the computer exemption and the highly compensated employee exemption," said Blair.
Although employees must meet all the aforementioned "tests" to be qualified as exempt, there are a few exceptions. For example, highly compensated employees are almost always considered exempt. These employees must make a minimum of $107,432 per year (previously $100,000 per year).
The new DOL ruling made additional threshold changes, allowing employers to use nondiscretionary bonuses and incentive payments to account for up to 10% of the standard salary level.
Types of exempt employees
The DOL outlines specific criteria for the salary and duties tests. While salary may be simpler to quantify, the duties test is important as well. Below are the main types of exempt employees and a summary of their responsibilities.
- Executive: This includes employees whose primary duties involve managing the enterprise or managing a subdivision within the enterprise.
- Administrative: According to the DOL, this includes "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."
- Professional: This includes employees whose work requires advanced knowledge, and whose work is intellectual in nature and requires a consistent exercise in judgment and discretion.
- Computer: This applies to workers employed as a computer analyst, programmer, software engineer or similar position.
- Outside sales: These employees conduct sales for the business. They may travel often on behalf of the company.
If an employee doesn't meet all three of the qualifying tests for exemption, they are nonexempt. Nonexempt employees are typically paid at an hourly rate (at least minimum wage) and tend to have more flexible schedules. (Salaried employees who don't meet the salary level or duties requirements may also be deemed nonexempt).
According to FLSA overtime rules, nonexempt employees are eligible to be paid overtime wages (generally time and a half) for every hour worked over 40 hours per week; however, check with your state to see what constitutes overtime pay – each state calculates this differently. For example, a nonexempt employee in California is entitled to overtime pay if they work more than 8 hours per day, more than 40 hours per week, or more than 6 days per week. They are also eligible for double-time overtime pay under qualifying circumstances (e.g., working more than 12 hours in a workday or more than 8 hours on the seventh day of the workweek).
Although many nonexempt employees can qualify for work benefits like health insurance, paid time off and retirement contributions, this is not always the case. Seasonal and part-time employees are often disqualified from receiving benefits, but this can vary by company.
Types of nonexempt employees
In general, nonexempt employees are those who cannot meet exempt status. They receive a set wage (usually minimum wage) and overtime pay if they work over 40 hours in a workweek.
Overtime pay rules and exceptions
The only major exception to overtime pay is if your workers are exempt employees. If they meet the criteria, both with salary and duty, and can be classified as exempt employees, you are not required to pay them for overtime work.
If your employees are nonexempt, there are no major exceptions: If they work over 40 hours per week, you must pay them overtime. According to the DOL, nonexempt workers protected under the FLSA who work more than 40 hours per week are entitled to their hourly wage plus half that wage at a minimum for every additional hour worked. This is the major rule connected with overtime pay. If a nonexempt employee works overtime, he or she must receive at least time and a half under the provisions of the law.
While the act does not require overtime pay on weekends and holidays, it does apply if a worker has already met their 40 hours for that week and are being asked to work more. The act also applies on a workweek basis, which must be defined by the employer.
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Which type of employee is better for a small business?
There are benefits and drawbacks with each classification (exempt and nonexempt), and the best type for your business depends on your unique situation.
Do you need employees with more expertise (exempt) or flexibility (nonexempt)? Leslie Tarnacki, senior vice president of human resources and general manager at WorkForce Software, provided a scenario for determining when you would classify a worker as exempt or nonexempt.
"If my small business was a small engineering architecture firm, most employees would be exempt based on a professional categorization," said Tarnacki. "However, if I ran a small boutique or retail shop, those employees would most likely be nonexempt. It depends on what type of small business you're talking about."
Generally speaking, if you are looking for long-term employees with a high level of knowledge, experience and responsibility, those workers would fall under the exempt status. (Again, though, an employee must meet all three FLSA tests discussed above to truly be considered exempt.) Nonexempt status is typically conferred to employees who partake in short-term seasonal work, work part time, and whose jobs involve a low level of expertise and responsibility.
Common employee classification mistakes to avoid
Misclassifying employees can be detrimental to your business. When an employer misclassifies an employee, they face financial repercussions; for example, retroactive benefits and pay. Tarnacki said that two of the most common employee classification mistakes that employers make involve the employee's job title and salary pay.
"Giving someone a fancy title, like manager or assistant manager, doesn't mean they're automatically exempt; it's the duty, not the title, that matter in the classification," said Tarnacki. "When businesses simply pay someone a salary as opposed to an hourly rate, they often assume that the employee is exempt, but it doesn't necessarily translate because it's the duties that count."
An employee must meet all three tests (salary level, salary basis and duties) to qualify as exempt. If you change someone's job title or wage type, ensure that you are reconsidering every aspect of their position before reclassifying them. Employers sometimes make mistakes when reclassifying an employee's status from nonexempt to exempt.
Blair said that upgrading titles and restructuring pay from hourly to salary may not be sufficient when, in reality, the duties and the responsibilities of the position don't meet the criteria of any of the exempt categories listed in the regulations.
"Some [employers] view overtime payments as a financial burden, and they try to cut corners by giving hourly jobs fancy titles and paying hourly wages on a salary basis, which can land them in serious legal trouble," said Blair. "The most important thing for employers of any size is to never classify an employee as exempt simply to avoid overtime pay."
There are a few industries that can be especially tricky when classifying employees, such as retail sales (e.g., trucks, cars or farm equipment) and office workers (e.g., paralegals and secretaries). Tarnacki said that the transportation industry (e.g., drivers, airlines, trains and cruise lines) can be especially tricky because sometimes employees can be paid per drive/trip and have a set rate that may or may not qualify them as exempt. If you have any questions about how you should classify your employees, it is always best to speak with an expert in your industry.
"Don't ignore classification issues because it can be costly to correct misclassification," said Tarnacki. "If a business discovers that they had an employee classified incorrectly, there's more risk in hoping that the issue goes away … you could be facing damages, back pay, costs related to litigation and attorneys that cost much more in the end if the issue is identified."
Max Freedman also contributed to the writing in this article. Some source interviews were conducted for a previous version of this article.