Paying A Salary Does Not Make Someone Exempt

A common misconception is paying an employee a salary makes them “exempt” from payment of overtime.  I bet at least half of you reading this are saying, “what, you mean that’s not the case?”

That’s right, it’s not.  While paying a salary is required, there is also a duties test (and other requirements) that has to be met for each of the three primary exemptions: executive, administrative, and professional.

The details of what duties meet each exemption varies.  And under California wage and hour law there is both a qualitative and quantitative aspect to the duties test.  Not only must the duties meet those required by the exemption (qualitative), the employee must perform exempt duties at least 50% of the time (quantitative).  And when there are no time records – as is nearly always the case for exempt employees – figuring out that 50% is a bit challenging.

What Kinds Of Duties Meet The Exemptions?

Those that require “discretion and independent judgment.” Discretion and independent judgment means evaluating various courses of action/outcomes based on various factors and making decisions on matters of significance to the business.

A closer look demonstrates how squishy this is.  A receptionist has to make decisions all day long about who to put on hold, whether to track down their boss, take a message or put the caller to voicemail, etc. And it seems to me this sounds like exercising discretion and independent judgment (receptionist making decisions, incorrect decision clearly can be significant, including loss of client/customer, etc.).  Yet, these are not the kind of duties that make someone exempt.

Really what is required is decision making at a fairly high level and performing duties, the nature of which meet the exemption.

For example, an executive exempt employee directs/supervises at least two subordinates and engages in management type duties (over simplifying executive exempt duties) at least 50% of their time.  A professional exempt employee is someone like a lawyer making decisions on client advice or a doctor making decisions on patient treatment.  The administrative exemption is the most misunderstood and misapplied of the exemptions and merits close evaluation before being relied upon.

Especially in a small/medium business, figuring out who is exempt can be difficult.  The challenge is we don’t get to make the final decision and we can be second guessed.  The exempt duties test is very fact specific, vague and ambiguous, and subject to interpretation.  Thus, on a degree of risk scale of 0-100, 0 being “guaranty” non-exempt and 100 being “guaranty” exempt, anything below the 80th percentile is a very risky proposition (not that 80-99 carries no risk).  And the fact of the matter is very few positions are exempt in the small/medium business.

Misclassification Consequences

“Misclassification” (as though it were intentional) is the word your friendly neighborhood administrative watchdog uses to label treatment of exempt status later determined by them to be erroneous.

But hey, we don’t get to make the rules and we don’t get to decide.  The administrative body, jury or judge decides.  And if it turns out they disagree with our classification of exempt and re-classify the employee as non-exempt, then we have problems.

Those problems include:

• No detailed time records to rebut the amount of hours (usually overtime hours) the employee is claiming; therefore the sky is the limit on the wage/overtime claim
• Payment of overtime wages, and since we paid the misclassified employee a salary, the overtime is significant at 1.5 the regular rate (annual salary/2080 hours per year) for all overtime hours
• Labor Code section 203 penalty (up to 30 days’ wages)
• Inaccurate itemized statements (aka paystubs) penalty (up to $4,000) because we didn’t list the overtime hours or wages and the overtime rate
• Potential rest and/or meal period violations/penalties, most notably the latter because we don’t have any clock outs for meal periods

All of the above can add up to significant dollars even for just one “misclassified” exempt employee.  And if we have many employees in the same exempt position then we can have a wage and hour class action where the numbers are magnified by the number of employees in the class.

Reduce Your Risk

It’s much safer to classify employees as non-exempt.  Simply keep track of their time, pay them an hourly rate, pay them overtime, and provide them rest and meal periods.  Then there’s no possibility they can claim they were misclassified.

And when they tell you they are insulted because you are making them punch a clock, tell them to write their legislative representatives.