Overtime? But, I pay them a salary!
The Connecticut Law Tribune
October 28, 2015
The Fair Labor Standards Act (“FLSA”) was enacted in 1938 and establishes minimum wage, overtime pay, recordkeeping and youth employment standards. Despite having been in effect for over seventy years, employers continue to struggle with compliance and mistakes prove costly. For instance, in fiscal year 2014, the federal Wage & Hour Division (the “Division”) of the Department of Labor, the governmental agency that enforces the FLSA, collected approximately $240 million in back wages for workers. This is approximately a 30% increase from fiscal year 2010 when the Division collected $176 million. The increase is, in part, a result of a strategic effort by the Division to target investigations where violations are most common. Two of the most common violations for employers are (1) misclassifying employees as exempt rather than non-exempt and (2) misclassifying workers as independent contractors rather than employees. Both of these mistakes expose employers to significant liability. This article will identify these mistakes and offer solutions for correcting them with the least disruption possible.
Exempt versus Non-Exempt
The FLSA requires that in addition to paying at least the minimum wage employers also must pay overtime after 40 hours in a given workweek, unless the employee meets one of five general exemptions. The exemptions are where the rub lies. The exemption where the most employer mistakes exist is where the Division placed its new focus – the Administrative exemption.
The FLSA provides an administrative exemption for those employees (1) who earn a salary of at least $455 per week or $23,600 annually (which will soon increase to $970 per week, or $50,440 per year), (2) whose primary duty is the performance of office or non-manual work directly related to the management policies or general business operations of the employer or its customers and (3) whose primary duty includes the exercise of discretion and independent judgment with respect to matters of significance.
Although the administrative exemption seems self-explanatory, i.e. it applies to support staff or administrative staff, this is often not the case. Most companies have a secretary, an admin, or an office manager, and often times that employee keeps the business going day to day and is paid a salary. Unfortunately, more times than not, this type of position does not fall under the administrative exemption. But remember, this problem only exists if the employee works over 40 hours per week. If they work no more than 40 hours, no overtime is earned and this misclassification becomes a very minor issue. (For the analysis below, we assume the work week exceeds 40 hours.)
For instance, a typical office manager exerts extremely diverse duties: he/she answers the phone, interacts with customers, and effectively keeps the office running. The company would literally be lost without him or her. Despite this fact, this position often times fails to meet the test for the administrative exemption because the position does not exercise independent judgment and discretion with respect to matters of significance.
Technically, under the FLSA, discretion and independent judgment entails the comparison and evaluation of possible courses of conduct, and acting or making a decision after the various possibilities have been considered. Some indicators that an employee possesses these powers are the employee has the authority to bind the company, the employee provides expert advice to management, and the employee represents the organization in handling disputes, among others. These factors are both very difficult to satisfy for the typical office manager, secretary, admin, etc. and more than most owners are willing to grant to such employees. The truth is many small businesses succeed because the owner micro-manages the business. But this means few if any employees are given this power. And without such power, the employee will not be exempt. As a result, most administrative employees in an office setting are not appropriately exempt under the administrative exemption and should not be paid a salary unless they also receive overtime after 40 hours.
A Solution – Convert from Salaried to Hourly
Once an employer discovers it has inappropriately been paying its administrative employee a salary, it must delicately transition the employee from salaried to hourly. This more times than not creates a morale problem because most employees view being classified as exempt as a status symbol. Clocking in and out also can be perceived as a hassle by the employee and demeaning. It also forces the employee to watch the clock rather than just work until the job is done – something both the employee and employer may resent. Despite the angst or inconvenience this may cause the company or displeasure on the part of the employee, it simply must be done to comply with the FLSA.
One way to make this conversation more palatable is to estimate total hours normally worked and find a wage that produces the compensation level everyone seeks. To do this, start with the yearly compensation desired and work backward. Assume for instance the company wants to pay the office manager $55,000 a year and knows that he or she will regularly work 45 hours a week. This means the employee will gross $1,057.69 per week. The employer can then determine the hourly rate to achieve this compensation. This can be done using a simple calculation: 40(x) + 5(1.5x) = 1,057.69. This equates to $ 22.27 per hour of straight time and $33.41 per overtime hour. To ensure the employee actually receives this compensation, the company should schedule the employee for 45 hours a week regardless of business demand unless the hours need to vary based on the work load. In this case, the employer may use this formula but check through the year to see if the hours average out to what was expected. If not, adjustments may be needed. The employer must also be prepared to pay overtime for any additional hours worked in excess of forty-five that are not foreseen.
But what if you have a worker who works a very irregular schedule. One week he or she works 50 hours and the next he or she works 20 hours due to changes in business demand. How do you create a compensation structure that is beneficial to the company and retains the employee? Clearly, such an erratic schedule without a guarantee of hours is not going to work from most employee’s perspective. In this scenario, the “half-time measure” or fluctuating workweek method may be worth exploring. This method allows employers to pay non-exempt employees a fixed salary, if the employee’s hours fluctuate week to week.
To take advantage of this method, 1) the company must pay a fixed salary each week that does not vary based on the number of hours worked; 2) the company must share a “clear mutual understanding” with the employee that the company will pay this fixed salary regardless of the number of hours worked; 3) the fixed salary must be sufficiently large to provide compensation that at least equals the minimum wage for all hours worked; and 4) the employee’s hours must fluctuate from week to week both above and below 40 hours.
This method of calculating overtime can be quite attractive. However, it has to work in the employee’s favor some weeks. Thus, there must be weeks the employee works significantly less than 40 for this arrangement to comply with the FLSA. Also, this method does not work if the employees receive premium rates for work done on nights, weekends, holidays and other undesirable shifts. For example, if the company uses this method for calculating overtime and generously provides a holiday bonus at the end of the year, the company’s makes itself ineligible for this method. Furthermore, to ensure that the company has a clear understanding with the employee regarding this method of calculating overtime, the company should have a written agreement setting forth the terms of the arrangement. Some states like California, however, prohibit this type of overtime calculation so check your state law before proceeding.
Independent Contractor versus Employee
In addition to misclassifying non-exempt employees, employers routinely misclassify employees as independent contractors. In fact, according to the DOL, 10 to 30 percent of employers misclassify their employees as independent contractors. This is such a common mistake because both employers and employees like it; employees may fail to declare all their income and employers pay no workers’ compensation tax, no unemployment insurance, and no 7.5% tax for wages to cover FICA and FUTA. Unfortunately, the headache and cost that arises from failure to properly classify workers is much greater and more costly than most employers expect. In April of this year for instance, a plumbing and heating company based out of Long Island paid 300 employees $1.4 million in back wages, in part, for misclassifying employees as independent contractors and other overtime violations.
Under the FLSA, independent contractors are workers with economic independence who are in business for themselves. Employees, on the other hand, are economically dependent on the business of the employer, regardless of skill level. To determine whether a worker really is an independent contractor, the employer must analyze a series of factors: 1) the extent to which the work performed is an integral part of the employer’s business, 2) whether the worker’s managerial skill affects his or her opportunity for profit and loss, 3) the relative investments in facilities and equipment by the worker and the employer 4) the worker’s skill and initiative, 5) the permanency of the work’s relationship with the employer, and the nature and degree of control by the employer. For example, the work of a carpenter is integral to a construction company whereas a worker hired to fix the construction company’s fax machine is not. Thus, the latter is likely an independent contractor.
In an effort to circumvent this potential landmine, companies often enter into consulting agreements or other types of written contracts specifying that the worker is an independent contractor, and not an employee. These agreements, however, will not save the day if in fact the worker is more appropriately classified as an employee. And, as a word of caution according to an interpretative memorandum issued by the DOL on July 15, 2015 “most workers [classified as independent contractors] are employees under the FLSA’s broad definitions.” Therefore, employers must exercise great caution when classifying workers as independent contractors as the DOL will highly scrutinize this classification.
Potential Liability for Misclassified Independent Contractors
Failure to classify employees correctly can be quite an expensive mistake. Under the FLSA, the statute of limitations is two or three years depending on whether the violation is found to be willful. However, state law may extend that time period. For instance, in New York the statute of limitations is extended to six years. This means the company may owe six years of back wages for all the uncompensated overtime if the independent contractor is really an employee. Additionally, under the FLSA the employee is also sometimes entitled to liquidated damages – which doubles the backpay award, and is always entitled to recover attorneys’ fees. State law also has additional penalties. Thus, the amount owed can quickly become significant depending on the number of employees at issue and the number of violations found.
Moreover, in misclassification cases, it is often true that the employer has little to no records at all detailing the number of hours the employees worked since it believed the workers were exempt. The law, however, places the burden on the employer to keep accurate time records. Thus, it becomes a classic “he said she said” case with the thumb of the scale weighing exponentially on the side of the employee. Thus, if the employee claims to have worked 60 hours per week, that claim is normally accepted as true. Only in rare cases will a court not accept the word of the employee when calculating hours worked. For instance, if the employer can prove that it was impossible for the employee to have worked the hours alleged the court will likely reduce the back pay award. For instance, if the employee alleges that he or she worked 65 hours for an entire month when the employer can show the employee was on vacation or out of the country for two of the weeks the award should be reduced. However, absent extraordinary facts, the court will side with the employee in calculating the number of hours worked.
Ultimately, classifying workers as exempt versus non-exempt or employees versus independent contracts in conformity with the FLSA can prove to be complicated. Both analyses require a series of considerations and failure to make the right decision can significantly impact the company’s bottom line. Thus, it is typically a best practice for employers to err on the side of caution and presume non-exempt employee unless you are ready for a fight.
Robert G. Brody is the founder of Brody and Associates, LLC. Katherine M. Bogard is an associate at the firm. Brody and Associates represents management in employment and labor law matters and has offices in Westport and New York City.