What does exempt mean? Why it matters for your business

Many businesses need employees to work more than 40 hours in a given week from time to time. Generally, that means paying employees overtime for those extra hours. However, businesses don't have to pay overtime to exempt employees.

Here's what it means for an employee to be exempt and who qualifies.

What is an exempt employee?

An exempt employee is one to which the Fair Labor Standards Act (FSLA) does not apply. As such, businesses aren't required to pay exempt employees overtime pay. In some cases, you may not be required to pay them minimum wage, either.

However, a business can't simply classify all employees as exempt to avoid overtime and minimum wage laws. For an employee to qualify as exempt, they have to meet certain criteria.

The Department of Labor (DOL) has three tests for exempt status. An employee must pass all three tests for the business to classify them as exempt. Those tests are:

1. Salary level. The employee must be paid at least $684 per week ($35,568 per year).
2. Salary base. The employee must receive a predetermined amount of compensation each pay period. That predetermined amount can't be reduced because of variations in the employee's quantity or quality of work.
3. Duties. The employee must work in an executive, administrative, professional, computers/systems, or outside sales role. The employee's job title doesn't matter—their actual job duties are more important than the title.

Keep in mind that states may have their own criteria for determining who can be an exempt employee. For example, in California, exempt employees must spend more than 50% of their work time performing exempt duties, and the employee must earn a minimum monthly salary of at least two times the state's minimum wage for full-time employment. So be sure to check with your state's Department of Labor to ensure you're meeting state and federal requirements.

Exempt vs. non-exempt employees

Non-exempt employees are usually paid by the hour rather than on a salaried basis. If non-exempt employees work more than 40 hours per week, they're entitled to overtime at one-and-a-half times their regular pay rate for each additional hour worked.

By hiring exempt employees, you don't have to pay overtime no matter how many hours the employee works in a week. However, even if you don't pay them overtime, exempt employees may cost more than non-exempt employees because they're usually more experienced than non-exempt employees and may be tasked with more responsibility. Often, this means they can demand a higher rate of pay than non-exempt workers.

Consequences of misclassifying employees

Employers often mistake workers as exempt simply because they receive a salary rather than hourly wages. However, salary alone is not enough. The employee must meet all three tests.

Misclassifying employees as exempt can lead to fines from the Department of Labor, as well as owing back pay, overtime, payroll taxes, and retroactive benefits to employees.

To ensure you're classifying employees correctly (and ensure your classification can withstand DOL scrutiny):

• Create clear job descriptions for each role
• Review your payroll practices to ensure you're not improperly docking the pay of salaried employees
• If you're not sure how to classify an employee, get professional advice

Misclassifying employees as exempt is a costly mistake, and all it takes is one complaint by a disgruntled employee to find your business being audited by the DOL. If that happens, you want to be sure that your employees have been correctly classified, you've paid all wages due to them, and you have records to back it up.