How to Classify Employees as Exempt or Nonexempt

When hiring employees, a company should ensure it is complying with applicable federal, state, and local laws regarding employee minimum wages, withholdings, and other applicable requirements. To ensure compliance, employers must first determine whether an employee is “exempt” or “nonexempt.” Nonexempt employees are entitled, among other things, to certain minimum wages and overtime under the Fair Labor Standards Act (FLSA) and applicable state and local laws.

The FLSA is a federal law that addresses the minimum wage and overtime requirements for most nonexempt employees. States and local jurisdictions also have their own wage and hour laws, and employers must apply the most protective and favorable standards to their employees. Because of the overlap between the FLSA and other state and local laws, employers should work with experienced counsel to ensure compliance with the applicable jurisdiction’s requirements and to ensure proper employee classification. Failure to properly classify employees can result in damages and penalties under federal, state, and local laws, state and federal audits, and lawsuits on an individual or even collective/class basis.

The Practical Difference between Exempt vs. Nonexempt

Nonexempt employees benefit from the protection of applicable wage and overtime laws, while exempt employees are exempt from those requirements. More specifically, the FLSA requires that nonexempt employees be paid at least the minimum wage (currently $7.25 under federal law) and overtime pay for hours worked over 40 in a workweek at a rate not less than time and one-half their “regular rates of pay.” Note that the regular rate of pay is a term of art under the FLSA (and some state laws) and employers should consult experienced counsel to advise them on how to ensure that the regular rate of pay is calculated properly. State and local jurisdictions also have different minimum wages, including but not limited to California, New York, Arizona, Illinois, Oregon, Alaska, and Washington. Some states have different minimum wages depending on the industry in which the employee works.

Many state and local laws provide for overtime in additional situations, meal and/or rest breaks, and other protections for nonexempt employees. For example, in addition to the minimum FLSA requirements, California requires employers to pay overtime for hours worked over 8 hours in any workday and double pay for hours worked over 12 hours in any workday, as well as meal/rest break requirements.

Nonexempt employees are usually paid an hourly wage. In contrast, exempt employees often receive salary pay, though that is not the exclusive means of pay. An employee’s wage type alone does not determine exempt classification. To qualify as exempt, employees must meet the applicable federal and/or state tests for exempt employees. To qualify as FLSA-exempt, an employee generally must:

1. be paid a salary above a specific level of at least $684 per week or $35,568 per year under the FLSA or a higher amount based on applicable state law (for example, $66,560 for the year for certain exempt employees in California as of 2024); and
2. perform administrative, professional, executive, or computer-related work (which each has its unique test that must be met to qualify for the exemption).

Outside sales and retail sales employees are subject to different tests and applications. There is also a “highly compensated” exemption under the FLSA (those paid total annual compensation of at least $107,432). The highly compensated exemption does not apply in all states, including California.

Because neither a job title nor pay alone determines whether an employee is exempt or nonexempt, employers must analyze each position to determine the appropriate classification.

Takeaway:

The risk of litigation due to alleged employee overtime misclassification is substantial should an employer fail to ensure compliance with FLSA, state, and local requirements. Employers are strongly encouraged to work with trusted counsel to assess their employees’ compensation structure for compliance.

*Last updated April 15, 2024