What You Need to Know About Overtime Pay for 'White-Collar Employees'

The Fair Labor Standards Act (FLSA) exempts certain categories of “white-collar employees” from the overtime pay provisions of that statute. Unfortunately for employers, the correct application of those exemptions is difficult and often misunderstood. Even more unfortunate is that the consequences of even innocent mistakes can be extremely costly for employers.

That situation has prompted demands for fundamental revisions of the regulations that the United States Department of Labor (DOL) promulgated decades ago to provide criteria for exempting white-collar employees from mandatory overtime pay. Regrettably, that sorely-needed reform appears to be hopelessly ensnarled in politics as the parties position themselves for next year's national election. This article will examine both the proposed changes to these regulations and what employers can do to help protect themselves until change is effectuated.

The White Collar Exemptions

As enacted in 1938, the FLSA exempted salaried Executive, Administrative, and Professional Employees from the requirement that an employee who works more than 40 hours during a week be paid overtime at the rate of 1.5 times the employee's regular hourly wage. See 29 U.S.C. '213. In 1940, the DOL issued regulations that established the criteria used to qualify employees for those exemptions. See 29 C.F.R. ”541.1, 541.2, and 541.3.

The criteria under the so called “short test” that applies to employees who earn a weekly salary of at least $250 are as follows:

• Executive Employee: The employee's primary duty must be managing the enterprise or a recognized department or subdivision of the company and customarily and regularly directing the work of at least two employees.
• Administrative Employee: The employee's primary duty must be performing non-manual work that is directly related to management policies or general business operations and that includes the exercise of discretion and independent judgment.
• Professional Employee: The employee's primary duty must be performing tasks that: 1) require the knowledge of an advanced type in a field of science or learning customarily acquired by a prolonged course of specialized intellectual instruction and study; or 2) are original and creative in a recognized field of artistic endeavor and the result depends on the employee's invention, imagination, or talent.

Needless to say, those criteria are very vague and subjective and leave ample room for disagreement with respect to the proper classification of employees.

The “long test” has become essentially irrelevant because that standard applies only to white-collar employees who earn weekly salaries ranging between $155 and $250. Few, if any, employers exempt employees earning that little.

Common Mistakes

Many employers make similar mistakes in classifying employees as exempt. For example, the exemption criteria for Administrative Employees are especially difficult to interpret and apply. As a consequence, employers frequently exempt personnel who perform what are commonly considered “administrative” tasks, such as payroll, human resources, employee benefits, billing, procurement and accounts payable and receivable functions. The mere fact that an employee performs such non-manual tasks does not qualify the worker for exemption unless the job also involves the formulation or implementation of “management policies” or “general business operations” and requires the exercise of “discretion” and “independent judgment” – whatever those terms mean. (The FLSA and DOL's regulations fail to provide clear definitions of those terms and leave much room for subjectivity in their application.)

In addition, only “salaried” employees qualify for exemption as Executive or Administrative Employees. To be compensated on a salary basis, an employee must be paid a set amount per week regardless of whether the employer has enough work to keep the employee fully occupied. Employers often destroy that compensation arrangement by docking employees' pay for partial days taken off to handle personal affairs or for disciplinary suspensions lasting less than a week. By doing so, the employer effectively transforms the employee into a non-exempt hourly-paid worker eligible for overtime pay regardless of the nature of the duties performed.

Plaintiffs' Attorneys Have Preyed Upon Employers

In recent years, plaintiffs' attorneys have targeted employers who inadvertently misclassified workers as exempt white-collar employees. That strategy has been facilitated by the fact that the FLSA provides jury trials for employees' claims for unpaid overtime and employers generally have not kept time records for workers who were treated as exempt and not required to clock in and out. Thus, employers generally lack the documentation needed to effectively rebut the records assiduously kept by a disgruntled employee who suddenly decides to challenge his exempt status after having resigned or been terminated.

Indeed, plaintiffs' lawyers lured by the prospect of such easy pickings have filed class actions against companies that had exempted employees because they were paid salaries and were genuinely thought to perform Executive, Administrative, or Professional Employee functions. Indeed, Starbucks paid $18 million, Taco Bell $9 million, Radio Shack $29.9 million, and Pizza Hut $10 million to store managers who claimed that they were not exempt because they spent most of their time serving customers. In addition, Bank of America paid $4.1 million to client managers and a jury returned a verdict against Farmers Insurance for $90 million in a suit filed by claims adjusters. To add insult to injury, the employers who lost those cases were required to pay the employees' attorneys' fees ' an amount than often totals millions of dollars.

These cases graphically illustrate the potential for substantial liability and the problems that companies of all sizes and in all industries face trying to comply with the white-collar exemptions. In fact, experienced employment lawyers have expressed the opinion that 90% of employers in the United States are not complying fully with some aspect of the FLSA.

Proposed Reforms

The DOL regulations are complex and have become obsolete as a result of changes in workplace that have occurred since those rules were first promulgated several decades ago. For instance, the minimum weekly salary level of $250 set by the regulations for application of the short test f or exemption as a white-collar employee was set in 1975.

That amount was intended to help employers classify employees who were relatively highly compensated and, thus, were likely to hold jobs with significant management, administrative, or professional responsibilities. The figure, however, provides no guidance in 2003 when the minimum wage has climbed to $6.15, which means that a non-exempt employee paid that rate earns just a few dollars less than $250 for a 40-hour workweek.

Moreover, the FLSA and DOL regulations became effective when the overwhelming majority of employees worked in blue-collar jobs on production lines. Over the past 60 years, many workers have moved into “light blue-collar” positions that require the use of technology and decision-making unlike the relatively mindless, repetitive tasks associated with production line jobs. That evolution and the inherent difficulty of applying the exemption criteria have prompted a demand for modification of the DOL regulations to bring those rules into line with the realities of the modern workplace.

In March 2003, DOL issued proposed regulations that drew considerable criticism, including Congress's passage of two bills prohibiting the expenditure of funds to implement the new rules and regulatory changes exempting additional categories employees from overtime pay. See Federal Register, Vol. 68, No. 61, pp. 15560-15597; H.R. 2660, 108th Congress, 1st Session, Sec. 106; Senate Bill 1485, 108th Congress, 1st Session In the Senate of the United States. That legislative reaction was prompted by the concerted efforts by unions and other interest groups to distort the actual substance of the proposed revisions.

For instance, the media reported that, under those changes, no employees earning more than $22,000 per year would qualify for premium overtime pay under the FLSA regardless of the nature of their duties. That statement grossly mischaracterized what the new regulations provide.

The proposed regulations actually included the following provisions:

• Salary Level. Employees must earn a weekly salary of at least $425 in order to qualify for exemption.
• Duties Tests. A single and simpler duties test for each white-collar exemption category would be used to determine an employee status.
• Salary Basis Test. This test would be more lenient on employers and allow deduction from salaried employee's pay for disciplinary suspensions of a full day or more for violations of workplace conduct rules. Moreover, an employee would lose an exemption only if the employer engages in a pattern or practice of improper salary deductions.

Anticipated Effect of The Proposed Regulations

The proposed regulations preserved many of the provisions of the current rules and did not constitute a radical departure from the existing regulatory scheme. Indeed, DOL predicted that the proposed regulations would: 1) would automatically guarantee overtime pay for 1.3 million more workers who earn less than $425 per week; 2) would make entitlement to overtime more certain for 10.7 million employees under the simplified duties test; and 3) enable employers to better understand their obligations under the FLSA.

The proposed regulations, however, failed to address the trap created by the state wage and hour laws in jurisdictions, such as California, that set exemption criteria that differ significantly from the standards used under the FLSA. That situation will continue to vex employers unless the Congress takes steps to preempt those state laws ' a measure unlikely to occur any time soon.

Conclusion

The white-collar exemptions under the FLSA will continue posing problems for employers ' both large and small ' until the Congress allows implementation of a simpler scheme that reflects today's workplace realities. As soon as Congress makes a move in that direction, however, powerful interest groups will exert tremendous pressure on the legislative and executive branches unless a broad consensus is first reached on the proper parameters of reform. The prospects for such a consensus are dim at best. the salary level.

In the meantime, employers can reduce their exposure to overtime claims by taking the following relatively simple steps:

• Prepare and update written job descriptions for all positions in consultation with employees and their supervisors.
• Determine whether other employers treat comparable jobs as exempt or non-exempt.
• Require employees who are treated as exempt to review their job descriptions and acknowledge in writing that they agree with the substance of those descriptions.
• Conduct periodic audits of salaried employees' payroll records to ensure that improper pay deductions are not being made.

The Fair Labor Standards Act (FLSA) exempts certain categories of “white-collar employees” from the overtime pay provisions of that statute. Unfortunately for employers, the correct application of those exemptions is difficult and often misunderstood. Even more unfortunate is that the consequences of even innocent mistakes can be extremely costly for employers.

That situation has prompted demands for fundamental revisions of the regulations that the United States Department of Labor (DOL) promulgated decades ago to provide criteria for exempting white-collar employees from mandatory overtime pay. Regrettably, that sorely-needed reform appears to be hopelessly ensnarled in politics as the parties position themselves for next year's national election. This article will examine both the proposed changes to these regulations and what employers can do to help protect themselves until change is effectuated.

The White Collar Exemptions

As enacted in 1938, the FLSA exempted salaried Executive, Administrative, and Professional Employees from the requirement that an employee who works more than 40 hours during a week be paid overtime at the rate of 1.5 times the employee's regular hourly wage. See 29 U.S.C. '213. In 1940, the DOL issued regulations that established the criteria used to qualify employees for those exemptions. See 29 C.F.R. ”541.1, 541.2, and 541.3.

The criteria under the so called “short test” that applies to employees who earn a weekly salary of at least $250 are as follows:

• Executive Employee: The employee's primary duty must be managing the enterprise or a recognized department or subdivision of the company and customarily and regularly directing the work of at least two employees.
• Administrative Employee: The employee's primary duty must be performing non-manual work that is directly related to management policies or general business operations and that includes the exercise of discretion and independent judgment.
• Professional Employee: The employee's primary duty must be performing tasks that: 1) require the knowledge of an advanced type in a field of science or learning customarily acquired by a prolonged course of specialized intellectual instruction and study; or 2) are original and creative in a recognized field of artistic endeavor and the result depends on the employee's invention, imagination, or talent.

Needless to say, those criteria are very vague and subjective and leave ample room for disagreement with respect to the proper classification of employees.

The “long test” has become essentially irrelevant because that standard applies only to white-collar employees who earn weekly salaries ranging between $155 and $250. Few, if any, employers exempt employees earning that little.

Common Mistakes

Many employers make similar mistakes in classifying employees as exempt. For example, the exemption criteria for Administrative Employees are especially difficult to interpret and apply. As a consequence, employers frequently exempt personnel who perform what are commonly considered “administrative” tasks, such as payroll, human resources, employee benefits, billing, procurement and accounts payable and receivable functions. The mere fact that an employee performs such non-manual tasks does not qualify the worker for exemption unless the job also involves the formulation or implementation of “management policies” or “general business operations” and requires the exercise of “discretion” and “independent judgment” – whatever those terms mean. (The FLSA and DOL's regulations fail to provide clear definitions of those terms and leave much room for subjectivity in their application.)

In addition, only “salaried” employees qualify for exemption as Executive or Administrative Employees. To be compensated on a salary basis, an employee must be paid a set amount per week regardless of whether the employer has enough work to keep the employee fully occupied. Employers often destroy that compensation arrangement by docking employees' pay for partial days taken off to handle personal affairs or for disciplinary suspensions lasting less than a week. By doing so, the employer effectively transforms the employee into a non-exempt hourly-paid worker eligible for overtime pay regardless of the nature of the duties performed.

Plaintiffs' Attorneys Have Preyed Upon Employers

In recent years, plaintiffs' attorneys have targeted employers who inadvertently misclassified workers as exempt white-collar employees. That strategy has been facilitated by the fact that the FLSA provides jury trials for employees' claims for unpaid overtime and employers generally have not kept time records for workers who were treated as exempt and not required to clock in and out. Thus, employers generally lack the documentation needed to effectively rebut the records assiduously kept by a disgruntled employee who suddenly decides to challenge his exempt status after having resigned or been terminated.

Indeed, plaintiffs' lawyers lured by the prospect of such easy pickings have filed class actions against companies that had exempted employees because they were paid salaries and were genuinely thought to perform Executive, Administrative, or Professional Employee functions. Indeed, Starbucks paid $18 million, Taco Bell $9 million, Radio Shack $29.9 million, and Pizza Hut $10 million to store managers who claimed that they were not exempt because they spent most of their time serving customers. In addition, Bank of America paid $4.1 million to client managers and a jury returned a verdict against Farmers Insurance for $90 million in a suit filed by claims adjusters. To add insult to injury, the employers who lost those cases were required to pay the employees' attorneys' fees ' an amount than often totals millions of dollars.

These cases graphically illustrate the potential for substantial liability and the problems that companies of all sizes and in all industries face trying to comply with the white-collar exemptions. In fact, experienced employment lawyers have expressed the opinion that 90% of employers in the United States are not complying fully with some aspect of the FLSA.

Proposed Reforms

The DOL regulations are complex and have become obsolete as a result of changes in workplace that have occurred since those rules were first promulgated several decades ago. For instance, the minimum weekly salary level of $250 set by the regulations for application of the short test f or exemption as a white-collar employee was set in 1975.

That amount was intended to help employers classify employees who were relatively highly compensated and, thus, were likely to hold jobs with significant management, administrative, or professional responsibilities. The figure, however, provides no guidance in 2003 when the minimum wage has climbed to $6.15, which means that a non-exempt employee paid that rate earns just a few dollars less than $250 for a 40-hour workweek.

Moreover, the FLSA and DOL regulations became effective when the overwhelming majority of employees worked in blue-collar jobs on production lines. Over the past 60 years, many workers have moved into “light blue-collar” positions that require the use of technology and decision-making unlike the relatively mindless, repetitive tasks associated with production line jobs. That evolution and the inherent difficulty of applying the exemption criteria have prompted a demand for modification of the DOL regulations to bring those rules into line with the realities of the modern workplace.

In March 2003, DOL issued proposed regulations that drew considerable criticism, including Congress's passage of two bills prohibiting the expenditure of funds to implement the new rules and regulatory changes exempting additional categories employees from overtime pay. See Federal Register, Vol. 68, No. 61, pp. 15560-15597; H.R. 2660, 108th Congress, 1st Session, Sec. 106; Senate Bill 1485, 108th Congress, 1st Session In the Senate of the United States. That legislative reaction was prompted by the concerted efforts by unions and other interest groups to distort the actual substance of the proposed revisions.

For instance, the media reported that, under those changes, no employees earning more than $22,000 per year would qualify for premium overtime pay under the FLSA regardless of the nature of their duties. That statement grossly mischaracterized what the new regulations provide.

The proposed regulations actually included the following provisions:

• Salary Level. Employees must earn a weekly salary of at least $425 in order to qualify for exemption.
• Duties Tests. A single and simpler duties test for each white-collar exemption category would be used to determine an employee status.
• Salary Basis Test. This test would be more lenient on employers and allow deduction from salaried employee's pay for disciplinary suspensions of a full day or more for violations of workplace conduct rules. Moreover, an employee would lose an exemption only if the employer engages in a pattern or practice of improper salary deductions.

Anticipated Effect of The Proposed Regulations

The proposed regulations preserved many of the provisions of the current rules and did not constitute a radical departure from the existing regulatory scheme. Indeed, DOL predicted that the proposed regulations would: 1) would automatically guarantee overtime pay for 1.3 million more workers who earn less than $425 per week; 2) would make entitlement to overtime more certain for 10.7 million employees under the simplified duties test; and 3) enable employers to better understand their obligations under the FLSA.

The proposed regulations, however, failed to address the trap created by the state wage and hour laws in jurisdictions, such as California, that set exemption criteria that differ significantly from the standards used under the FLSA. That situation will continue to vex employers unless the Congress takes steps to preempt those state laws ' a measure unlikely to occur any time soon.

Conclusion

The white-collar exemptions under the FLSA will continue posing problems for employers ' both large and small ' until the Congress allows implementation of a simpler scheme that reflects today's workplace realities. As soon as Congress makes a move in that direction, however, powerful interest groups will exert tremendous pressure on the legislative and executive branches unless a broad consensus is first reached on the proper parameters of reform. The prospects for such a consensus are dim at best. the salary level.

In the meantime, employers can reduce their exposure to overtime claims by taking the following relatively simple steps:

• Prepare and update written job descriptions for all positions in consultation with employees and their supervisors.
• Determine whether other employers treat comparable jobs as exempt or non-exempt.
• Require employees who are treated as exempt to review their job descriptions and acknowledge in writing that they agree with the substance of those descriptions.
• Conduct periodic audits of salaried employees' payroll records to ensure that improper pay deductions are not being made.