- Business owners need to properly classify their employees as exempt or nonexempt to avoid legal ramifications supported by the Fair Labor Standards Act (FLSA).
- Exempt employees must earn a minimum of $455 per week; be paid the same amount of money regardless of hours worked; and perform executive, professional, or administrative duties.
- Nonexempt employees have no limitations or requirements for the number of hours they can work each week, but they must receive overtime pay if they work more than 40 hours in one week.
- This article is for employers who are trying to make the determination between exempt and nonexempt employees.
It is an employer’s responsibility to accurately determine whether an employee should be classified as exempt or nonexempt. An employee’s classification as exempt or nonexempt is not a matter of preference or choice – the Fair Labor Standards Act (FLSA) has stipulations that determine and regulate each classification.
To avoid misconduct and legal ramifications, it is important to know which category each new hire falls under. Joshua Gerlick, a doctoral student of nonprofit management and a Fowler Fellow at Case Western Reserve University, said that business owners must carefully design job titles and descriptions that fall clearly into either the exempt or nonexempt category.
“Misclassification of employees is costly, and penalties can be retroactive – potentially back to the beginning of an employee’s date of hire,” Gerlick told Business News Daily.
Although some regulations vary by state, there are some basic rules you must follow when determining how to classify and compensate your employees.
What are exempt employees?
Exempt employees are those who are paid a regular salary, a predetermined amount of money distributed in regular intervals throughout the year. These employees do not qualify for minimum wage, nor do they receive overtime pay. “Exempt” means the employee is exempt from overtime pay. The FLSA regulates which employees are exempt and which are nonexempt.
Key takeaway: Exempt employees do not qualify for minimum wage, and they do not receive overtime pay.
What are nonexempt employees?
Nonexempt employees are those who are eligible for minimum wage and overtime pay calculated at 1.5 times their hourly rate of pay. They are often paid hourly for the precise amount of time worked in a pay period. Those who are nonexempt, and when they are eligible for overtime pay, is subject to federal and state standards.
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Overtime pay: Exempt vs. nonexempt employees
One of the main differences between exempt and nonexempt positions is compensation. Brian Cairns, CEO of ProStrategix Consulting, said that employees with exempt status must earn at least $455 per week but cannot receive payment for overtime. Nonexempt employees must earn at least minimum wage and are eligible for overtime pay.
“Overtime is paid at time and a half once a nonexempt employee works more than 40 hours a week or on specific holidays,” Cairns said. “This was the basis for the old classification of white-collar versus blue-collar workers.”
Overtime pay rules are set in the FLSA. The baseline is that overtime is paid at 1.5 times the rate of pay for every hour worked above 40 hours in a 168-hour consecutive workweek.
As of 2020, employers can pay bonuses to nonexempt employees on top of their regular pay. The full rules for overtime can be found on the U.S. Department of Labor’s website.
Key takeaway: Exempt employees are not eligible for overtime, while nonexempt employees are eligible for overtime pay. Specific guidance comes from the federal and state level, depending on where your business is located.
How to classify exempt vs. nonexempt employees
According to the FLSA, there are three basic tests you can perform to determine whether an employee should be classified as exempt or nonexempt:
- Salary level test: An employee earning more than $35,568 per year ($684 per week) qualifies (but is not guaranteed) as exempt.
- Salary basis test: An employee who receives a guaranteed minimum compensation, regardless of the time actually worked, qualifies (but is not guaranteed) as exempt.
- Duties test: An employee who meets the exemption requirements of tests one and two must also perform an exempt job duty, which can be one or more of the following:
- Exempt executive duties: The employee supervises two or more other employees as a regular part of their job.
- Exempt professional duties: The employee performs intellectual activities that require specialized education and the use of discretion and judgment.
- Exempt administrative duties: The employee performs support operations for significant matters that require the use of discretion and judgment.
- Exempt executive duties: The employee supervises two or more other employees as a regular part of their job.
“To be considered exempt, an employee must meet the requirements of all three tests,” said Gerlick. “However, the application of these tests is often complicated, and a business owner should consult with their legal advisor to determine specific applicability to a specific job function.”
There may be some exemptions to these rules, including by profession, industry, or pay structure. Visit the Department of Labor website, or consult a payroll professional for more information.
The U.S. Department of Labor (DOL) updated the federal overtime provisions of the FLSA in 2020. The new standards are as follows:
- Exemptions to white-collar salaries increased from $455 per week to $684 per week.
- Up to 10% of the standard salary level can comprise bonuses, incentive pay, and/or commissions.
- The new compensation requirement for what’s classified as highly compensated employees increased to $107,432 from $100,000.
Key takeaway: According to the FLSA, you can determine if an employee is exempt or nonexempt by salary level, salary basis, and job duties.
Pros and cons of exempt employees
Although the employee classification of “exempt” may seem ideal for some employers, that is not the case for everyone. There are many benefits and drawbacks to hiring (and working as) an exempt employee.
For the employer
Since exempt employees cannot earn overtime pay, Gerlick said that the primary benefit of hiring an exempt employee is the ability to demand a certain level of performance or output while maintaining a fixed budget. However, Gerlick warned that exempt employees typically cost more than their nonexempt counterparts, largely due to the expectation that they will use discretion and judgment in executing their duties.
For the employee
Cairns said the primary benefits of exempt employees include paycheck stability, eligibility for benefits, and standard business hours. However, employees with exempt status generally have less-flexible work schedules than nonexempt employees, and they can’t be paid overtime, even if they work more than 40 hours a week.
Key takeaway: Exempt employees are not owed overtime pay, which helps employers stay within their budget. Exempt employees are also eligible for benefits. However, they have less flexibility in their schedules, and they may work more than 40 hours a week without additional compensation.
Pros and cons of nonexempt employees
Hiring nonexempt employees comes with its own set of benefits and drawbacks for employers and employees alike.
For the employer
Hiring a nonexempt employee offers flexibility for employers, since there is no minimum requirement for how many hours they should work each week. You can pay a nonexempt employee an hourly rate (minimum wage or higher) and schedule them based on your company’s needs.
There are a few drawbacks to hiring nonexempt employees, the primary one being overtime pay for employees who work more than 40 hours a week. You will need to accurately monitor and track employee hours to ensure that they are being accurately compensated for their time. [Read related article: What You Need to Know About the Federal Overtime Rules]
For the employee
Although the most obvious benefit for nonexempt employees is the ability to work overtime and receive proper compensation for every hour worked, Cairns said there are drawbacks that nonexempt employees should know about. Since hours can vary week to week, nonexempt employees may not have a stable or consistent paycheck, their work hours may not adhere to standard business hours, and, in some states, they may not be eligible for paid vacation or sick time.
Key takeaway: Nonexempt employees offer employers flexibility for hours worked, but those who work more than 40 hours a week are owed overtime. Employees receive accurate pay for actual hours worked, but their paychecks may fluctuate as hours worked can vary from week to week.
When to hire exempt or nonexempt employees
When creating job titles and descriptions for your employees, consider which category (exempt or nonexempt) will benefit your company the most. Review what duties you will need to be completed and what type of payment you would like to pay (salary or hourly).
Cairns said that some types of jobs are legally required to be exempt and can only be hired as such. However, for positions that can be modified to fit one category or the other, Gerlick said business owners must decide which is more important: flexibility or expertise.
“Hiring an hourly-wage employee whose duties are nonexempt gives owners the option to adjust working hours according to demand – perhaps scheduling 15 hours for one week and 35 hours the week thereafter,” said Gerlick. “Despite the added cost, hiring a salaried employee whose duties are exempt fixes the labor cost regardless of the required time for the employee to accomplish a given objective.”
As a rule of thumb, nonexempt employees are better suited to hourly, temporary, or seasonal work, whereas exempt employees are more suited to long-term positions with executive, administrative, or professional duties. It is important to differentiate these positions based on the actual duties and then hold your employees accountable to the set guidelines.
Gerlick said a common mistake for business owners is designing a job that qualifies as exempt, but then not allowing that employee to exercise the judgment and discretion commensurate with the job description. This mistake can be very costly to your business: If that employee decides to take legal action, they can use the FLSA to support their claims against you.
“If employers are unfamiliar with the particulars of the FLSA, they should retain competent human resources counsel to review job descriptions and occasionally audit job duties to ensure the applicability of existing classifications,” said Gerlick. “Proactivity is crucial. Issues don’t typically arise until an unhappy employee files a lawsuit.”
Key takeaway: When determining whether to hire an exempt or nonexempt employee, consider the job description, length of the job (temporary, short-term, or permanent), whether the position is part time or full time, and the type of candidate you want to hire.