Understanding Overtime: A Guide for Small Business

The Fair Labor Standards Act (“FLSA”) requires that virtually all employees be paid at least the federal minimum wage for hours worked, plus overtime (at time and a half the employee’s base pay) for any hours over 40 in any given work week. It is critical for small businesses to know which employees are considered “exempt” from the overtime rules and which are “non-exempt,” meaning they must be paid overtime.
 
Many small businesses and non-profits assume that if they pay an employee a salary, then they don’t have to worry about the overtime rules. After all, paying overtime is expensive. However, the penalties for misclassifying employees and refusing to pay overtime can be steep. And while happy employees generally don’t complain, disgruntled employees (and former employees) will suddenly demand their unpaid overtime no matter what “understanding” you thought you all had.
 
Before adopting a policy of simply not paying overtime (or making everyone a salaried employee), small businesses and non-profits should ask three questions:

1. What is the employee’s salary level?
2. What is the employee’s salary based on? In other words, how do you determine the employee’s paycheck each pay period?
3. What are the employees duties?

Salary Level Test

For most employees, the minimum salary they must earn to be considered exempt from the overtime rules is $455 per week (or an annual salary of $23,660). Like most areas of the law, there are, of course, exceptions:

• Outside sales employees do not have a minimum salary level.
• Blue collar workers must always be paid overtime, no matter what their salary level might be.
• Computer employees can be compensated hourly if they are paid at least $27.63 per hour.
• Highly compensated employees (a special catch-all category discussed below) must be paid at least $100,000 per year.

Salary Basis Test

Next, the employee’s salary must be fixed on a weekly or less frequent basis, predetermined, and not subject to reduction because of variations in the quality or quantity of work performed. (Remember, this test does not apply to outside sales employees or computer employees who are paid hourly.) Generally, the employee must be paid their full salary for the entire week if the employee performs any work that week, regardless of the number of days or hours worked. Again, there are a number of exceptions when the employee does not have to be paid their full weekly salary, some of which include:

• An absence of 1+ full days for personal reasons other than sickness or disability
• An absence of 1+ full days for sickness or disability in accordance with a bona fide paid leave policy
• Absences due to disciplinary suspensions for violations of workplace rules
• The first or last week of employment, if the employee only worked a partial week
• While an employee is out on unpaid family and medical leave 

Duties Test

Finally, the employee’s job duties, regardless of job title, must fit into one of the following categories:

Executive: An executive employee’s primary duty must be managing the business (or at least a “customarily recognized department or subdivision”). They must also be responsible for supervising at least two full-time employees (or full-time equivalents). And they must have the authority to hire or fire other employees (or at least have their recommendations given “particular weight”). In other words, is it part of the executive’s job to make recommendations regarding the employees that executive regularly supervises?

A common question I get from small businesses is whether the business can give someone an ownership interest in the business as a way to avoid paying employees. Business owners are exempt from the overtime rules provided that they have at least a 20% equity interest in the business and are actively involved in its management. For example, ABC, LLC wants John Smith to serve as Director of Marketing. But ABC is a start-up and can’t afford to pay John Smith a salary. So Eddie Entrepreneur offers John a 5% stake in ABC in exchange for his services. While Eddie and John might be perfectly happy with this arrangement today, it is technically a violation of the FLSA and is therefore illegal. (No, John can’t agree to set aside the requirements of the FLSA no matter what agreement John signs to the contrary.) If Eddie and John later have a disagreement and John leaves ABC, John could claim that he was an employee of ABC who wasn’t paid wages and overtime.

Administrative: An administrative employee must be primarily engaged in office or non-manual work that is directly related to management or general business operations. This might include areas such as accounting, advertising and marketing, research, human resources, etc. They must also be allowed to exercise discretion and independent judgment in significant matters (which rules out your typical administrative assistant).

Learned Professional: These employees perform work that requires advanced knowledge (i.e., work that is predominantly intellectual and consistently requires the exercise of discretion and judgment). In addition, their advanced knowledge was acquired by a prolonged course of specialized instruction in a field of science or learning. (In other words, they typically have an advanced degree of some sort that confers a professional status and not just a skilled trade.)

Creative Professional: Creative employees’ work requires invention, imagination, originality or talent in a field of artistic or creative endeavor. Typically, this will include musicians, writers, actors, graphic designers, etc.

Computer Employee: To be considered a computer employee, the individual must be a computer systems analyst, computer programmer, software engineer, or other similarly skilled worker in the computer field. Such employees primary duties must include: determining hardware, software, or system specifications; designing, developing, documenting, analyzing, creating, testing or modifying computer systems or programs; or some combination of these duties.

Outside Sales: Sales employees must be primarily responsible for making sales or obtaining orders that a client or customer will pay for. In addition, sales employees do most of their work away from the employer’s place of business. Interestingly, the law views any fixed site for sales calls or internet sales as part of the employer’s place of business, including a salesperson’s home office. In order for a position to truly be considered an outside sales position, the salesperson should be spending most of their time visiting customer’s at their place of business; merely working from home does not make a person an outside sales employee.
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Highly Compensated Employees: Aside from the significantly higher compensation requirements, highly compensated employees are a bit of a catch-all. Their duties must include at least one of the duties of an executive, administrative, or professional employee. For example, a highly compensated employee who is responsible for supervising others but isn’t responsible for an entire department or managing the entire business won’t meet all of the professional employee requirements, but because of their high compensation, would still be exempt from overtime. 

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