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Salary vs. Hourly: What's Better for Your Business?

image for baranq / Shutterstock
baranq / Shutterstock
  • Salaried and hourly employees vary in how they are paid and whether they are eligible for overtime.
  • Salaried workers earn a preset sum each pay period that isn't determined by how many or few hours they work each week.
  • Hourly workers get paid a per-hour rate, so their paychecks are based specifically on the number of hours they work.
  • This article is for new business owners trying to determine whether they should have hourly or salaried employees.

When hiring an employee, you must ask and answer many questions. One of the most important is whether you will offer them a salaried or hourly position.

Salaried employees are usually not paid based on the hours they work; instead, they are paid the same amount each pay period, based on their total salary. An hourly worker, on the other hand, earns a set payment for each hour they work. For example, if they earn $20 an hour and work eight hours in a day, they would earn $160 for that day.

There are pros and cons to both options. Knowing the differences between them and what laws are in place for them will help you make this decision.

A salaried employee gets paid a set amount based on an annual salary they agreed upon with the employer. The employee's pay is based on a 40-hour workweek; however, they may work more or less than 40 hours in a given week and still earn the same. For this reason, salaried workers not eligible for overtime pay. You may have a weekly, biweekly, semimonthly or monthly pay schedule for them.

Since salaried workers are paid a flat rate, if they work more than 40 hours in a week, you will not need to pay them overtime. When employees are not paid for overtime work, you can offer them more flexible work hours, which is a draw to many workers. Hiring salaried employees will also make your payroll easier to process, as there is not much fluctuation in pay.

Since salaried workers have a fixed income, there is a chance they'll work less than 40 hours in some weeks. In addition, since they aren't clocking in and out each day, they could come in late or leave early. However, salaried workers are often high-level employees who understand the expectations for them and wouldn't abuse the flexibility their salary affords. You should also consider the amount and quality of work that high-level employees accomplish in the time they give your company, rather than just the number of hours they technically spend in their seat.

Key takeaway: Salaried employees are paid a fixed amount each pay period. In other words, these workers aren't bound to a 40-hour workweek; they are paid the same whether they work more or less than 40 hours.

An hourly employee is paid a certain rate per hour of work. Depending on the state you operate in, hourly employees are typically required to be paid time and a half for any time they work beyond 40 hours in a week. You can pay hourly workers at the same frequency you pay salaried workers, but their paychecks will fluctuate based on the exact number of hours they work.

You are not required to make an hourly worker a full-time employee, which can offset the costs of benefits such as healthcare, paid time off and retirement savings plans. If you do not need a worker consistently, you have more flexibility in setting their hours, which can guarantee that you will have coverage when you need it.

If an hourly worker does work over 40 hours in a week, you are required to pay them overtime wages, which can become costly if the position requires a lot of overtime. You are also required to track their hours, which can be difficult if their hours are not consistent or you aren't using the correct digital tools, like a time and attendance system.

Key takeaway: An hourly worker gets paid a set amount for each hour they work. As the employer, you must record how many hours those employees work in order to pay them each pay period. Hourly workers are also eligible for overtime pay, typically time and half, for each hour they work over 40 hours.

Before determining if you should have salaried or hourly employees, you must determine whether the positions have federally exempt or nonexempt status.

On a federal level, exempt employees are those who are not eligible to get paid overtime for any time worked over 40 hours. An exempt employee meets these criteria:

  • They make at least $23,660 a year ($455 a week).
  • They are a salaried worker.
  • They meet the exemption job duty requirements under the Fair Labor Standards Act (FLSA).

If an employee does not meet all three of these requirements, they must be nonexempt.

You must pay nonexempt employees the federal or state minimum wage and overtime pay (time and a half) for any time worked over 40 hours in a week. Any job that earns a minimum wage, is eligible for overtime pay and does not meet the criteria for exempt employees is considered nonexempt. These workers include contractors, freelancers, interns and servers, to name a few.

These requirements are based on federal law, and some states have additional laws for exempt vs. nonexempt employees. Make sure to check your state labor laws before classifying your employees. [Read related article: Exempt vs. Nonexempt: What Is the Difference?]

Many small businesses get into trouble when they misclassify employees, so accuracy in employee classification is critical. This can result in a business being required to pay back wages when they classify someone who is actually nonexempt as exempt. Additionally, some state laws mandate that the back wages be paid within a certain timeframe. Failure to do so can result in additional daily fines until the wage is paid in full.

Classifying an exempt employee as nonexempt usually does not result in any fines or penalties. It can even be beneficial for the employee, since they will receive overtime pay and other benefits they would not get when classified as exempt.

Key takeaway: An exempt employee is not eligible for overtime pay, while a nonexempt worker must be paid extra for each hour over 40 that they work each week. You may face fines if you don't properly classify your employees.

While you can make an exempt employee hourly, can you make them salaried after they have begun working for you? Can you make a salaried hire into an hourly one? The answer is yes, but it depends on what you have written in their job description and how they fit in your organization.

You can convert an hourly employee to a salaried position as long as the worker meets FLSA and state laws that qualify them to be exempt. You can decide to do so if they are going to be taking on a new position or if you are reorganizing your team.

While this is less common, if you reorganize your company or have less work for your employee than you thought you would, you may want to consider making them hourly. You would need to make sure there is nothing in their contract to prevent you from doing this.

In addition, you may need to alter their job description. If their original job required them to work until a project is finished regardless of how long it takes, you would need to rework it to comply with a 40-hour workweek or state that they will now receive overtime if they do work more.

When you change a salaried employee to an hourly position, you will need to determine a new hourly wage, which may be lower than their old salary if they will work more overtime. If this is the case, tread lightly and treat this matter with the utmost sensitivity. Switching an employee to hourly from salaried is not recommended unless you have no other option.

Most importantly, educate your employees on the wage and hour laws so they know what they are agreeing to. This will help keep morale and productivity up.

Key takeaway: Employees can be switched from hourly to salaried and vice versa. However, when switching a worker from salaried to hourly, you need to determine their new hourly pay rate. Before making any changes, check the job contract they signed to ensure you are not bound to keep them at their original classification.

There is no right or wrong answer when determining whether your employees should be salaried or hourly. The main difference is that you'll offer salaried workers an annual pay that will be consistently paid throughout the year. Conversely, an hourly worker is only paid for the hours they work. To make your decision, ask yourself the following questions.

The biggest factor is if the position is exempt or nonexempt. If they are defined as nonexempt under FLSA, they must be hourly, which takes care of the decision for you. However, you may still want to consider making an exempt employee hourly if there is not enough consistent work for them to be salaried. On the other hand, if the employee is going to be working more than 40 hours a week regularly, it might be more cost-efficient to pay them a salary.

Even if employees are exempt on a federal level, there may be state laws that classify them as nonexempt. For this reason, it is important to be familiar with the laws and regulations in your region. For example, in California, for a worker to be exempt, they must make twice the state minimum wage, which is higher than the federal law's required amount.

While you can offer benefits to hourly employees, it is much easier to track the benefits of a salaried employee. This does not need to be a deciding factor in whether you make someone hourly or salaried, but it is something to consider.

There is no set answer to whether your workforce should be salaried or hourly. While you must follow federal and state laws, there is still room for you to make decisions based on what would be best for your company. In the end, what counts most is that you and your employees are happy with the situation and your business runs smoothly.

Key takeaway: The decision of whether to make an employee salaried or hourly should be based on a number of factors, including whether they are exempt or nonexempt, your state's laws, and whether you plan to offer certain benefit packages.