Misclassification of Employees is a Money Maker for Everyone But the Employer

A financial planning firm has 5 employees (excluding the 2 financial planners/business owners).

The employees are:

• Associate (Junior) Financial Planner (in training)
• Paraplanner
• Portfolio/Investment Specialist
• Client Service Specialist/Executive Assistant
• Administrative Assistant

When a complaint was received and investigated regarding employees working more than 40 hours per week and not getting paid overtime, it was determined:

• There were inadequate job descriptions for the portfolio/investment specialist and paraplanner.
• The portfolio/investment specialist and paraplanner were expected to record every hour they worked and were docked pay for hours not worked (hours or partial days).
• The client service specialist/executive assistant was receiving a salary and was regularly recording 40+ hours per week.
  • There was no overtime paid.
  • There was an inadequate job description.
• Further investigation revealed that over 2 years ago, there were employees working as paraplanner and client service specialist/executive assistant working over 40 hours per week.
  • There were no job descriptions.
  • Time cards revealed that the employees had to record every hour worked and employees were docked pay for hours not worked (hours and partial days).
• The audit went back 3 years for the current employees and another 2 to 3 years for past employees (who are currently working elsewhere).

The business owners were required to pay:

• Back pay to current and past employees (including time-off, retirement contributions and corresponding employment taxes – federal, state, social security & medicare) was over $147,000
• Punitive Damages equal to 1.5 times the back pay (over $220,000) paid.
• Attorneys fees in excess of $50,000
• The total over $367,000 was paid out to everyone but the business owners.

These amounts involved people working on average 1 or 2 hours above 8 hours each day.

How did this happen?

There was a feeling, substantiated through the audit that employees were owed overtime. Improper or insufficient documentation did not support the employer’s treatment of employee’s pay. In this example, it was determined that the employer intentionally required some employees to work over 40 hours per week and did not pay overtime. Some employees were misclassified as exempt from overtime and some employees were no longer exempt (losing the exemption status).

Complaints and claims are on the rise and the greater use of these actions is the result of (1):

• Almost double damages to successful plaintiffs plus attorney’s fees
• Workers and their advocates more informed about their rights
• Competitive forces where employers needs to increase production and lower costs
• Uncertainty on the part of employers about the proper classification of employees for overtime exemption

What is misclassification?

There are some confusing terms and definitions that should be covered first.

Salaried employees

Employees who are paid a certain dollar amount of base compensation per week or less frequently that does not vary. So you can’t reduce the pay regardless of the number of hours worked, the quality of work or quantity of work.

Salaried employees are not automatically “exempt” from overtime just because they are paid a salary.

Hourly wage employees

Employees paid by an hourly wage rate and obviously, the wage for the pay period will depend on the number of hours worked.

The FLSA generally requires employers to pay all covered nonexempt employees at least the minimum wage and overtime pay. FLSA requires overtime pay of at least 1.5 times the employee’s regular rates of pay for hours worked in excess of 40 hours in a workweek. The overtime rate could be more depending on state and other regulations.

Usually nonexempt employees are paid an hourly wage.

Exempt employees

Exempt employees are those employees who meet the “exemption” from overtime based on meeting various criteria (federal and state criteria which may or may not be the same). So you could interpret this as “your employees are nonexempt (and eligible for overtime) UNLESS the employee meets the exemption criteria.”

Exempt employees are usually paid a salary. If you choose to pay an exempt employee on “piecemeal” , hourly or commission basis, that may leave the exempt status subject to challenge. You need to consider the “exemptions” from overtime that may allow compensation other than salary. We will discuss some of these exemptions later in this article.

Misclassification occurs when employees are classified “exempt from overtime” incorrectly.

What rules should I be aware of?

Overtime rules and regulations are part of the U.S Government Fair Labor Standards Act (FLSA). FLSA also provides the standards for minimum wage, recordkeeping, child labor – as examples.

View more details about overtime rules & regulations »

State laws can also regulate overtime and also supersede federal requirements.

FLSA was enacted in 1938. While provisions have changed over the years, some people argue that the overtime regulations are not relevant considering the nature of jobs. It could be argued that some provisions for “exempting” people from overtime pay are confusing and outdated.

Regardless of your opinion regarding these regulations, they are in effect and they present a ready source of cash for everyone EXCEPT the business owner. Ignorance of the law does not grant relief from the penalties.

State and Local Laws can require different exemption criteria. So while the employee may meet a federal Department of Labor FLSA exemption, the employee may still be paid overtime according to state laws. Employers should comply with the law (federal or state) that is the most generous to the employee on any particular wage and hour issue.

The review of individual state laws regarding overtime regulations and exemptions is not the scope of this article, but employers should review the individual state laws. Employers should also consider under which state law their out-of state employees may fall under.

Generally state laws on exemptions are modeled on those contained in the FLSA. There are at least 2 tests that must be met to qualify for one of the exemptions below.

Salary Basis Test

Shared by all exemptions except for Outside Sales. The employee must be compensated on a salary basis of at least $455 per week. Only the computer exemption also allows a person to meet the test if paid on an hourly basis of at least $27.63 per hour.

Duties Test

In order to qualify for an exemption, the employee’s primary or main duties must meet certain criteria per the exemption. The focus is on duties and responsibilities and job titles do not guarantee the exemption.

The term “primary duty” means the principal, main, major or most important duty that the employee performs. The determination of an employee’s primary duty must be based on all the facts in a particular case, with the major emphasis on the character of the job as a whole. The amount of time spent on the duty can be a useful guide; but time alone is not the sole test.

Each of the exemptions has other individual tests that may need to be met. See the link for each exemption for details on terminology.

Executive

• Meet salary basis test
• Primary duty must be managing the business or managing a customarily recognized department or subdivision.
• Also:
  • Must customarily and regularly direct work of at least 2 or more full time employees (or equivalent – such as using part time people).
  • Must have authority to hire or fire employees or his/her suggestions or recommendations for hiring, firing, promotions and other status changes must be given weight.
• A business owner who has a bona-fide minimum 20% equity stake in the business and is actively involved in the management of the business is considered to have the executive exemption.

Learn more about the Executive classification »

Administrative

The administrative exemption is one of the exemptions most misunderstood and inappropriately used.

• Meet salary basis test
• Primary duty – performance of office or non-manual work directly related to management or general business operations of the employer or employer’s customers.
  • Work must be related to the running or servicing of the business.
  • Performance of work directly related to management or general business operations of the employer’s customers — acting as advisors or consultants to their employer’s clients or customers.
• Primary duty must include the exercise of discretion and independent judgment with respect to matters of significance.
  • Independently compare and evaluate possible courses of conduct and make a decision
  • Have the authority to form , interpret or implement management policies or major operating practices. Have authority to deviate from or waive established procedures,
• Commit company on significant matters. Perform work that affects business operations to a substantial degree. The affect or commitment does not arise simply from bad judgment or poor performance which creates financial liability.

Exercise of discretion & independent judgment, significant matters and affecting the business “to a substantial degree” criteria has to be carefully evaluated.

Learn more about the Administrative classification »

Professional

This exemption is generally used in academia and the sciences – so consult an expert in interpreting the use of this exemption.

• Meet the salary basis test
• Primary duty: performance of work requiring advanced knowledge.
  • Predominately intellectual in nature to distinguish this from routine mental work. The professional uses advanced knowledge to analyze, interpret or make deductions.
  • Advanced knowledge must be in field of science or learning. Fields such as law, medicine, accounting, engineering, sciences (biology, chemistry, etc.).
  • Must be acquired through prolonged course of specialized intellectual instruction. This is where specialized academic training is the standard pre-requisite for entrance into the profession. Employees can gain some knowledge through experience but not all.
    • Specialized academic training cover a longer period of time than 2 or 4 year college degree and short apprenticeship program. On its own, the CFP® certification program and testing probably won’t meet the criteria for professional exemption.
• Primary Duty: Consistent exercise of discretion and independent judgment

Learn more about the Professional »

Computer

See the link below for more information:

Learn more about the Computer Worker »

Highly Compensated Workers and the Part-541 Exemptions

• Meets salary basis test and Earns total annual compensation of $100,000 or more.
• Compensation above $455 per week can be commissions, nondiscretionary bonuses, etc.
• There are some exceptions noted in the document accessed by the above link.

Primary Duty: Perform office or non-manual work

AND “customarily and regularly performs at least one of the exempt duties or responsibilities of an exempt executive, administrative or professional employee.”

So if an individual makes at least $100,000 total annual compensation and can make recommendations for hiring, firing, promotions, changes to employees (one of primary duties of executive exemption) – then the employee may be exempt from overtime.

Learn more about Highly Compensated Workers »

Financial Services Industry Employees and the Part 541 Exemptions

Within the Administrative Exemption, is exemption for financial services employees.

• Meet the salary basis test
• Primary duties: office or non-manual work directly related to the general business or management operations of the employer or employer’s customers.
  • Work such as collecting and analyzing clients’ documents regarding financial status, assets, etc.; determining which financial products best meet clients’ needs and goals; advising customer on the advantages and disadvantages of financial products; marketing, servicing or promoting employer’s financial products.
  • The employee’s activities could be aimed at the end user (client) or intermediary (financial advisor).
• HOWEVER – there needs to be consistent and regular exercise of discretion and independent judgment.
• Employees whose primary duty is selling financial products would not qualify for this administrative exemption.

Learn more about Financial Services Industry Employees »

Outside Sales

Primary Duty – making sales AND the employee must be customarily and regularly engaged outside the employer’s place(s) of business.

• “Inside Sales” ( inside the employer’s place(s) of business) does not qualify for this exemption.
• Any fixed site (home or office) used as salesperson’s headquarters would be considered as the employer’s place of business.
• Sales by phone, mail or internet does not qualify as outside sales.

Learn more about the Outside Sales »

Calculating Overtime

A covered, non-exempt employee’s pay may be determined on a piece-rate, salary, commission, hourly or some other basis, but the calculations for determining overtime pay must be computed using the employee’s regular rate of pay. (2)

There is additional compensation that may need to be included in calculating the regular rate of pay for overtime. Some examples are: bonuses (nondiscretionary, expected by employee), commissions, deferred compensation, retroactive pay, hourly or lump sum for additional work.

• One federal government resource showing how to determine regular rate of pay for overtime calculations.

Learn more about calculating overtime »

How to Evaluate Positions for Proper Classification

Start with the Job Description

If you are audited, the job description will be reviewed to determine overtime eligibility. If you have inadequate job descriptions (outdated, vague with regard to addressing the exemption criteria or not followed in practice), then your employee’s exemption is at risk.

Review your job descriptions on a periodic basis. Address an employee’s performance through the coach, counsel and discipline process. Don’t change the job duties “because it’s easier to do it myself”, than give it to the employee to do.

Have an expert in human resources or employment law review your job descriptions for proper language and content. Make certain that your employee actually follows the responsibilities and standards in the job description

What Does the Employee Think He/She Does?

During an audit, your employees will be interviewed alone. If your employee feels that he/she is paid according to the hours actually worked, that he/she can’t exercise discretion or independent judgment , etc. —- the exemption will be at risk.

So make certain that your employees understand that their work and responsibilities match the exemption criteria. Periodic self-evaluation by the employee helps.

What are the deductions from the employee’s pay?

Recording Time

Review payroll records and time cards to determine if inappropriate deductions are made. Common examples of inappropriate deductions are for hours not worked during the day and subsequent deduction in pay. Also make certain there are different mechanisms for recording work. The nonexempt employee’s time card should show actual hours worked and time-off (whether paid or not). The exempt employee’s recording of work should be tailored to projects or tasks per customer, etc.

What if an Employee is Improperly Classified

Consult Your Attorney First

preserve attorney client privilege. This article is not giving legal advice and gives a general overview. Attorney – client privilege can offer the employer an opportunity to have the situation investigated without the resulting documents accessed by courts. So if an employer goes to court regarding the situation, the documents and investigation would be privileged information. You need to be careful to set the attorney – client privilege properly. Working with in-house or outside counsel should be focused on the particular issue with properly worded engagement letter and other documents. Get counsel involved right away if you suspect potential issues.

Communication and Back pay – should be handled properly

Your legal and human resource experts will guide you on how to communicate issues regarding misclassification and potential back pay. An employer should not act alone.

How can you lose the exemption?

Deviating from the exemption requirements

If you change the primary duties (consciously or not) and change salary (below minimum) – you could potentially lose the exemption. A common example is when managers or executives decide to direct or control the work of the exempt employee as a result of poor performance. The exempt employee loses the ability to exercise discretion and independent judgment. This is more than having work reviewed by supervisors or managers. This is being told what to do – either verbally or through strictly adhered-to processes and systems. The employee’s performance should be addressed through a system of coaching, counseling or discipline.

Paying Exempt Employee that Conflicts with the Exemption Criteria

Frequently adjusting an exempt employee’s salary to match the expected hours of work.

An exempt employee’s salary is based on knowledge and experience a person uses to perform projects, tasks and work. As soon as you are changing an employee’s salary because of hours, volume of work and quality of work – you are treating the exempt employee in the same manner as a nonexempt (eligible for overtime) employee. You can change the salary based on a reduction in hours in the normal scheduled work week. There has to be a bona fide reason and can’t bring the salary below the applicable minimum salary of $455 per week. You can’t determine the length of the workweek on a week-to-week basis.

Reducing Exempt Employee pay for hours not worked

You can not reduce the exempt employee’s salary regardless of the how long the employee works during the day or the week. There are some exceptions whereby you can deduct from an exempt employee’s pay. You need to consult the federal and state laws and you need to exercise caution.

Department of Labor guidelines »

What this means for employers of exempt personnel?

You need to check your language and provisions on time-off policies for exempt personnel. Saying that an exempt employee can take time-off in minimum hour increments is not acceptable. It suggests that the employee would realize a reduction in pay if the employee did not have the time-off benefit available. When an exempt employee is absent for a day or more, the employer can record this as time-off but there is no reduction in the employee’s pay. What if the exempt employee does not have time-off benefits or has exhausted the time-off given? The employer won’t be able to deduct the exempt employee’s pay. Again, consult your experts and the federal and state laws carefully before reducing the pay.

You can require the exempt employee to come to work during designated business hours. If the employee deviates from these hours, then you need to address this as a performance issue – not docking pay.

Footnotes:

1. “Wage and Hour Collective and Class Actions Are on the Rise”; SHRM (Society for Human Resource Management); 5/25/2010; Joanne Deschenaux.
2. United States Department of Labor (US DOL) elaws® – FLSA Overtime Calculator Advisor;

This is just an overview. This article is for informative purposes only and is not to be construed as legal advice. You need to consult your experts, such as human resource consultant, attorney, to be aware of federal, local and state regulations and exceptions.

Mary Dunlap, CFP®, of Mary Dunlap Consulting, helps financial planning firms attract, develop and retain the best people for their teams. She is a member of the Society for Human Resource Management. You can reach her at mary@marydunlapconsulting.com.

Mary Dunlap

My team and I are dedicated professionals who through honesty, caring and desire, provide our clients the tools and processes for sensible, appropriate human resource management, for recruiting the right person for the right job, for coaching people to do better and to direct energies for increased business and personal results.