Exempt Employees vs Non Exempt Employees – The Ultimate Guide to Overtime Laws for 2017

Employee classification is when you determine whether you have an exempt employee or a non-exempt employee. It is usually done in the hiring process for a role and is even placed in the job posting and job description. However, misclassification happens all the time, which results in overtime penalties, and we are here to provide a guide for how you can classify your employees correctly.

Avoid overtime penalties by ensuring that you are accurately tracking your employees’ hours. By using a digital time-tracking system such as Homebase, you’ll get accurate reports that integrate directly with accounting programs such as Quickbooks, leaving less room for error and more time in your day. Homebase is free, so sign up today.

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Summary Table of Exempt vs Non Exempt Employees

The 3 General Exempt vs Non-Exempt Rules   

In general, to be considered exempt from overtime, an employee must pass what’s known as the “3 tests”. There are a few exceptions to these tests, and we will go over them in a section below. Let’s look at the 3 test rules (and remember, all 3 must apply for an employee to be exempt from overtime pay, unless they are an exclusion):

Test 1: Salary Test

The main boundary at time of publication is:

• Employees who are paid less than $23,600 per year ($455 per week) are non exempt (meaning you have to pay overtime).
• Employees who make more than this are considered exempt (meaning you do not have to pay overtime)

If you’ve been following the news, you might remember that the Obama administration was going to pass a sweeping law that was to start on December 1st, 2016, that raised the salary test to $47,476. The Trump administration and federal courts have put this on hold indefinitely. We will keep you posted if this changes!

Test 2: Salary Basis Test

• If any employee is paid consistently the same amount, or within a very small variance, then they would be considered exempt since this would make them salaried, or interpreted as salary by the government.
• If an employee is hourly with pay that varies widely based on schedule and the hours provided, they are considered non-exempt.

A big exception to the rule: This test does NOT apply to certain jobs, including doctors, lawyers and schoolteachers. They are still considered exempt even if the employees are paid hourly. More exceptions are covered in our section below.

Test 3: The Duties Test (aka White Collar Exemption)

• An employee who meets the salary level tests and also the salary basis tests is exempt only if they also perform exempt job duties.

Job titles or position descriptions are not part of the determination. It is the actual job tasks that matter. For example, if you give someone the job title Director of Operations, but they are functioning as the Janitor and cleaning floors, this rule would still make you non exempt. This test was put in place to prevent companies from circumventing overtime with job titles.
There are three typical categories of exempt job duties, called:

1. Executive 
   “Executive” duties means supervisory duties of 2+ full-time employees, management of employees is primary task of the job, and the job has input on other team members like hiring, firing, and promotions.
2. Professional 
   “Professional” duties include “learned” and “creative” professions like doctors, lawyers, graphic designers, actors, and engineers are generally exempt. Basically, those jobs that require an advanced degree past high school. However, we provide more details in our Exclusions section below.
3. Administrative
   “Administrative” duties are for jobs, like the Operations and Marketing team, whose job is to keep the business running. They are not the “line” team members who make widgets, but they are the office staff who provides support to the business. We provide more details in our Exclusions section, coming up next.

Let’s now look at those exclusions; we will then go over 5 examples of how to classify an employee so that this all starts to become clear.

Exclusions to Exempt vs Non-Exempt Employee Classification

Unlike most laws, with employment law, there are exceptions that the US government has recognized should exist. Exceptions are continually changing, most notably with the increase in technical roles in the United States. For example, many well-compensated technical positions also work long hours and do not have any management duties. Technical roles like IT support positions are continuing to be scrutinized for if they should be included in exceptions to these rules.

Current professions that are exempt regardless of the 3 tests are:

• Agricultural employees
• Movie theater employees
• Jobs which are governed by another labor law (i.e. unions)
• Railroad workers
• Any traditional “learned professions”. These include lawyers, doctors, dentists, teachers, architects, clergy, registered nurses (but not LPNs), accountants (but not bookkeepers), engineers (who have engineering degrees or the equivalent and perform work of the sort usually performed by licensed professional engineers), actuaries, scientists (but not technicians), and pharmacists.
• “Creative professional” job duties including actors, musicians, composers, writers, cartoonists, and many journalists.
• “Technical professionals” whose job duties include determining hardware, software or system requirements; designing, developing, documenting, analyzing, creating, testing or modifying computer systems or programs based on design specifications or machine operating systems.
• Commission based sales roles that work from home or away from the employer’s main place of business selling services (aka outside sales).

This might sound confusing to you, and don’t worry- it is! Employment law can have some grey areas, which is why we will go over 5 “grey” situations below.

Special Circumstances

There are some common industries that have special circumstances under the FLSA, and here are some resources to help you to sort them out.

• Commission Based Sales: If you have a retail store and your employees get commissions on sales, you will want to make sure that you are compliant with the FLSA and its unique rules around commissioned retail employees.
• Highly Compensated Employees: Employees who make over $100,000 year, regardless of job duties or tasks, are generally exempt by the FLSA.
• Computer Professionals: Computer systems analysts, computer programmers, software engineers, and other similar roles are usually exempt from overtime if they meet certain requirements including job duties and making $27.63/hour.
• Automobile Dealership Salesmen and Partsmen: These roles that are employed by automobile dealerships are exempt from the overtime pay provisions of the FLSA.
• Farm Workers: Most farm employees are covered by the FLSA if they are partaking in work for goods that will travel between states. However, there are a few complicated exceptions detailed here.
• Drivers, Loaders, and Mechanics: Motor carrier companies like bus companies also have some unique regulations under the FLSA regarding overtime.
• Seasonal and Recreational Employees: Establishments that are not open more than 7 months per year are generally exempt from the FLSA, like a football stadium. There are more details here.

A great resource on all FLSA exclusions can be found here from the Department of Labor.

3 Examples of Employee Classification

Let’s now look at some relatable examples for our FSB readers.

Example 1: Suzie is an Operations Coordinator.

Suzie is part-time, and her employment agreement puts her at 20 hours per week at $14/hour. Suzie’s Operations Coordinator role is at a company that makes TV mounts (it is considered a manufacturing company). Suzie’s job mainly deals with clients, vendors, and helping the accounting team. Suzie works in the corporate office. Some weeks, Suzie works 20 hours, and others she works more or less. It depends on the work load and is unpredictable.

Exempt or Non Exempt? Suzie is non-exempt because of the inconsistency of her paycheck (test 1). If Suzie works more than 40 hours in a workweek, she is entitled to overtime. However, her employer can choose to pay her either salary or hourly.

Example 2: John is a Business Development Rep.

His main function is Inside Sales, which is commission based and only has a salary of $20,000/year. John works full time and works about 37 hours per week from home. He sells software for a large software company and averages about $120,000/year in compensation over the past 4 years. This means 84% of his compensation is from commissions.

Sounds exempt, right?

Inside sales is a unique position within the exempt versus non-exempt debate. For the most part, “inside” salespersons are non-exempt employees who sell to people over the phone (they do not travel or “carry a bag” and meet clients face to face). Now, if John was in outside sales, there is a different set of rules. For the most part, outside sales are exempt. There is no minimum pay for outside sales roles. Employees in these positions often work primarily for commissions and are contractors.

Exempt or Non Exempt? John is exempt because he works from home and makes a significant living (he is highly compensated over $100,000) as an INSIDE sales rep.

Example 3: David is a Head Waiter.

David works for a steakhouse and is supposed to work full time at 40 hours per week or 5 full shifts, sometimes he picks up a 6th or even 7th shift is he has time and they are available. Some weeks, the restaurant is slow and he only works 25 hours in a week. His income is unpredictable. He is also the Head Waiter, which means he hires and fires new staff members and sets the restaurant’s staffing needs. He makes the minimum tipped wage per his state, and then reports his cash tips at the end of each shift. He also gets a $1000 bonus each month for his head waiter duties. He makes about $60,000/year on average over the 8 years he’s worked there.

Exempt or Non-Exempt? David is non-exempt because of the wide variety in the hours worked, and how inconsistent his pay is. On weeks he works more than 40 hours, he is owed overtime on his hourly wage. He too can be paid salary or hourly.

Let’s also address independent contractors since they are commonly used at small businesses these days.

Classification and Independent Contractors

Independent contractors are not employees, so they’re automatically exempt from overtime pay. That said, if your contractors are incorrectly classified, and/or you don’t have the right paperwork in place, they could actually be considered employees by the IRS, and thus be potentially eligible for overtime pay.

Here’s what you need to do to make sure there are no classification issues with your independent contractors:

1. Get a contractual agreement in place 
   Make it clear that the contract is not for employment and that your business is not taking on the risk of this person, or their agency, as an employee. Make the agreement between the 2 businesses. If you are working with a solo freelancer, be wary if they haven’t even set up and LLC or S-Corp. If they were a serious freelancer, they would have done this.
2. Get a 1099 from them
   Make sure you have it on file that they are a 1099 contractor with your business. Keep the files current each year.
3. Keep tabs on their hours
   If you have a contractor, especially if they are a solo-preneur or freelancer, watch their hours. If they begin to work 30 hours/week for your business for more than 3 months, the IRS may interpret them as your employee (especially if you are their only client). If you reach this juncture, ask yourself if you should bring them on as an employee or reaffirm your contractor agreement with them.

If you need help time-tracking, we recommend Harvest and have some great time-tracking software options in this article.

Now, let’s talk about the ugly part of this topic- you may have realized you made a mistake in your past compensation of employees. Let’s talk it out.

What If I Found Past Mistakes?

Don’t panic: for small business owners who did not intentionally not pay overtime, you can easily rectify it with what’s called retro pay or backpay by the Department of Labor. An employee has up to 2 years to claim back wages; which means, if you know you have backpay owed over the past 2 years, you need to rectify it. We advise you to consult with your accountant to go over these issues and figure out how to best rectify them. Depending on the amount, you may also want to consult your attorney.

One client I worked with discovered a retro pay error that they did not know was there. An employee brought it to their attention 3 months after it happened and nearly 8 employees were owed overtime and even double overtime for the hours they worked. They made an official statement to every employee owed, and gave them each a print out of what they owed and why, and when those payments were going to come. They paid it out over 3 pay periods, and guess what? It was OK. The IRS did not get involved, the employees were thrilled, and the business owners sighed in relief. We made sure the accountant and attorney were informed, and we moved forward. Mistakes happen, you just have to fix them.

How to Calculate Overtime

If your gears are now turning to figure out time and overtime for your employees, we highly recommend getting time tracking software, payroll software, or using our time card article to help you calculate these accurately. Gusto, our recommended payroll provider, has great customer service and ways to help make sure you are compliant. You could also check out scheduling software if your business suffers from employees logging overtime from people who drop shifts or call in sick.

The Bottom Line

Employee classification isn’t a “fun” topic, but it is an important one. Making sure you have air-tight job descriptions and job titles in place, and are keeping an eye on everybody’s roles, hours, and job duties, especially as they change over time,  is important. Feel free to ask us questions if you need help by posting a comment below.

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