Employers sometimes operate under two mistaken beliefs when they classify their workers. The first is that by paying an employee a salary, the employee automatically becomes exempt from the obligation to pay overtime. The second is that workers are transformed into independent contractors by paying them on a 1099 basis. Neither of these beliefs is accurate.
Exempt vs. Non-Exempt Employees
The default under the Fair Labor Standards Act (FLSA), the federal law governing minimum wage and overtime rules, is that workers are non-exempt and must be paid overtime wages of 1½ times their regular rate of pay if they work more than 40 hours in a workweek. State wage and hour laws may designate different hourly overtime requirements. For example, in Colorado, non-exempt employees must be paid overtime for any work in excess of: (1) 40 hours per workweek; (2) 12 hours per workday; or (3) 12 consecutive hours without regard to the starting and ending time of the workday (excluding duty-free meal periods), whichever calculation results in the greater payment of wages.
For an employer to escape the obligation to pay a worker overtime, paying them a salary rather than an hourly wage is not enough. To be exempt, the worker must satisfy all three of the following tests:
The salary basis test requires that the employee be paid a fixed salary each pay period that does not vary based on the quantity or quality of their work. The current minimum federal salary level is $684 per week or $35,568 annually. The Colorado minimum salary level is $1,086.25 per week or $56,485 annually. Other states may have different minimum salary levels. Employers that misclassify employees as exempt typically meet these two requirements. However, they often fail to consider whether the position they are classifying as exempt adequately meets the requirements of one of the duties tests.
The most common duties tests are the executive, administrative, and professional tests, sometime referred to as the white-collar exemptions.
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To qualify for exemption as under the executive exemption, the employee must direct the work of at least two FTEs, and their primary duty must be the management of the enterprise or a department or subdivision thereof.
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To qualify for the administrative exemption, the employee must perform office or non-manual work directly related to management or general business operations and must be able to exercise discretion and independent judgment regarding matters of significance – this is not your typical administrative assistant.
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The learned professional must perform work requiring knowledge of an advanced type in a field of science or learning, and the creative professional must perform work requiring invention, imagination, originality, or talent in a recognized field of artistic or creative endeavor.
In addition to the white-collar exemptions, there are other categories of employees that qualify for exemption, including, but not limited to, highly compensated employees, computer professionals, and outside salespersons.
The consequences of misclassifying a non-exempt worker as exempt can be significant and can include requiring an employer to pay unpaid overtime going back two years (or three years if intentional), liquidated damages effectively doubling the amount of unpaid wages the employee is owed, civil penalties, and defending costly and time-consuming legal actions.
Employee vs. Independent Contractor
There are both federal and state tests that determine whether a worker can be classified as an independent contractor rather than an employee. Paying the worker on a 1099 basis or entering into an agreement that states the worker is an independent contractor is not enough. Under federal law, both the FLSA and the IRS have established tests to determine whether a worker is truly an independent contractor.
The FLSA applies an economic realities test and looks at the following factors:
As explained in a previous article, the FLSA test is under review, and the Department of Labor (DOL) under the new administration could revise or replace it. However, it remains in effect for private litigation. We will update you if the FLSA test is rescinded or modified.
The IRS test applies the following factors:
State tests may apply additional factors, including the following:
Employers Council offers whitepapers that provide an overview of state tests and sample independent contractor agreements.
It is not necessary for the worker to meet all of the factors under these tests to be deemed an independent contractor. Rather, the factors are weighed to determine whether the relationship between the employee and the worker is more like an employment relationship or an independent contractor relationship.
The consequences for misclassifying a worker as an independent contractor rather than an employee are also severe. They include wage law violations requiring the payment of back wages, including overtime; liquidated damages doubling the amount of unpaid wages; payment of unpaid state and federal payroll taxes; fines and penalties; and defending costly and time-consuming legal actions.
Because misclassification can be costly, time-consuming, and disruptive, it is important for employees to understand when an employee is properly classified as exempt and when a worker is truly an independent contractor and not an employee.
Of course, there are situations where the answer is relatively clear (e.g., your CEO is likely exempt, and your plumber is likely an independent contractor). But there are many situations where the answer is not obvious. In those situations, if you are a Consulting or Enterprise Member, it is helpful to consult an Employers Council staff attorney for guidance. You can contact us at info@employerscouncil.org. Learn more about how to avoid mistakes under the FLSA in this Employers Council training course.