Have You Properly Classified Your Employees?

Employers must classify all employees as either exempt or nonexempt. Exempt employees are exempt from many wage and hour requirements — most notably, the overtime requirement.  On the other hand, non-exempt employees are usually hourly-paid, non-managerial employees, who must be paid overtime if they work more than 40 hours in a workweek or more than eight hours in one day.

Classifying an Employee as Exempt or Nonexempt

Exempt employees must meet certain narrow requirements (discussed below). Therefore, it is wise to always assume employees are nonexempt unless they clearly meet the job duties and salary requirements of an exempt position.

In general, exempt employees fall into one of three exemptions: executive, professional, or administrative. However, other specific industry exemptions also exist such as the computer professional and artist exemptions. For the most part, the executive exemption applies to most managers, the professional exemption applies to licensed professionals such as lawyers, doctors, or architects, and the administrative exemption applies to employees with broad administrative powers within an organization who operate independently with little supervision.

To properly classify an employee as exempt under the executive, professional or administrative exemptions, the employee must satisfy a two-prong test: the compensation prong and the duties prong. The employee cannot qualify for exempt status unless the employee meets both prongs of the test.

1. Compensation Prong

For the compensation prong, employers should know about two tests: the current, California test and proposed federal test that could take effect in the near future.

Since state and federal overtime laws apply, employers must follow whichever law provides more protection for employees. Until this year, California’s law governed whether an employee qualified for exempt status because California’s test for these exemptions was more rigorous than the federal test.

But that could change soon. In 2016, new proposed rules outlined a federal salary requirement that would have been higher than California’s test. This federal rule was supposed  to take effect on December 1, 2016, but a federal judge put the brakes on the new overtime rule on November 22, 2016, when the judge issued a preliminary injunction, temporarily halting the implementation of the new rule. The new rule pretty much went nowhere, but as of March 2019, a new new federal rule has been proposed.

Just in case, we’ve outlined all three of these laws below.

Current California Test: To meet the salary basis test for exempt status, an employee must earn a monthly salary no less than two times the state minimum wage for full-time employment, which is defined as 40 hours per week. As of 2019, California’s minimum wage is $11 per hour for employers with 25 or fewer employees. This works out to a monthly salary minimum of approximately $3,813.33 ($22 per hour x 40 hours per week x 52 weeks per year, divided by 12 months per year = a monthly salary of $3,466.67) or $45,760 annually. For employers with 26 or more employees, the minimum wage is $12 per hour as of January 1, 2019. Thus, larger employers must pay exempt employees $49,920 per year. Read our article on the minimum wage requirements here.

Federal Overtime Rules: Under the ill-fated 2016 proposed rules, to satisfy the salary basis test an employee must earn a weekly salary of $913, which amounts to $47,476 annually (up from the former federal requirement of $23,660 annually). The new federal rule also provided for automatic increases to the salary test every three years, starting January 1, 2020.

However, the most recently proposed 2019 rule falls somewhere in the middle of the old federal requirement and the 2016 proposal, with a requirement of $679 per week, equivalent to $35,308 per year. And with these rules, there would be no automatic increases. Instead, the Department of Labor would review the minimum salary threshold every 4 years. It’s unclear when there will be a final determination on the 2019 rule.

Regardless of which set of rules employers follow, in order to satisfy the compensation prong, an exempt employee’s required salary may not be prorated if he or she works less than full time. In other words, as a general rule the salary, once set, cannot be modified based on the quantity or quality of the work performed, including how many hours worked or how well the salaried employee performs. Exempt employees are paid based on the general value of the services performed, rather than the amount of time spent performing the work. With limited exceptions, employees who perform any work during the workweek should be paid their entire salary.

2. Duties Prong

In California, to be properly classified as exempt, an employee must be “primarily engaged” in exempt duties. In general, the employee must spend more than 50 percent of his/her weekly work time performing exempt duties. Although exempt duties will differ based on the specific exemption that applies, under California law most exemptions require the employee to customarily and regularly exercise discretion and independent judgment. Discretion and independent judgment involves comparing and evaluating possible courses of conduct and acting or making a decision after considering various possibilities. An employee with discretion and independent judgment must either:

  • Have the power to make independent choices pertaining to significant matters, and free from immediate supervision; or
  • Have the ability to make a recommendation for action that is subject to a superior’s final authority. The employee must possess sufficient authority for the recommendations to affect matters of consequence to the business or its customers.

To “customarily and regularly” exercise discretion and independent judgment is to use discretion and independent judgment frequently in the course of day-to-day activities. The phrase “customarily and regularly” signifies a frequency that is more than occasional but may be less than constant.

These types of activities do not involve exercising discretion and independent judgment:

  • Applying knowledge to follow prescribed procedures
  • Determining which procedures to follow
  • Determining if specified standards are met
  • Determining if an object falls into one or another grade or class

Also, employees in training for an exempt position are not exempt employees because they do not exercise discretion and independent judgment during the training process.

Salesperson Exemptions

Additionally, two exemptions may apply to salespersons (1) the outside salesperson exemption and (2) the commissioned salesperson exemption. The difference between the two primarily hinges on whether the salesperson regularly works away from the company’s place of business. A salesperson may qualify for both exemptions. Here are the requirements and exemption details of both:

1. Outside salesperson

Requirements to qualify for the exemption:

  • A person must regularly work more than 50 percent of his/her working time away from your place of business; and
  • This time must be spent selling tangible or intangible items or obtaining orders or contracts for products, services or use of facilities.
2. Commissioned salesperson

Requirements to qualify for the exemption:

  • Business is a retail or service establishment;
  • The employee earns more than 1.5 times the minimum wage for each pay period worked;
  • More than half of the employee’s compensation represents commission earnings; and
  • Commissions are determined as a percentage of the price of the product or service that the employee sells.

Additional Tips

  • The job title alone does not make the position exempt:
    Just because an employer classifies someone as a manager does not mean that he or she is exempt from overtime requirements. It is necessary to analyze an employee’s duties and level of responsibility to determine whether or not a position is exempt.
  • Salaried positions are not automatically exempt:
    A position’s exempt status depends on (1) the duties associated with it, and (2) being paid on a salary basis that meets minimum salary requirements. In addition, under very limited circumstances, certain doctors, high-level computer professionals and commissioned sales persons may be paid an hourly wage and still be exempt from overtime.
  • No “Hybrid Activities:”
    When an employee engages in concurrently performing both exempt and nonexempt duties this time will likely be classified as nonexempt. A California court recently ruled that a manager who performed various nonexempt duties while simultaneously supervising staff was not primarily engaged in the performance of exempt work and therefore was entitled to overtime pay.

Best Practices

Here are some best practices we recommend for classifying employees as exempt versus nonexempt:

  • Create Employee Job Descriptions. For tips and best practices, check out our resource on the topic: Why Every Employer Should Use Employee Job Descriptions
  • Consider Self-Auditing your employees sporadically for a week to get a better idea of the types of activities they perform, and whether or not they perform exempt activities 50% of the time.
  • When in doubt classify an employee as nonexempt and contact an attorney to advise you on employee classification because an employer that misclassifies an employee can face significant legal liabilities such as potential fines and awards of back overtime pay for misclassified employees.
Updated by: Olivia Phillips – 7/1/19

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Photo Credit:  Phillip Harder