Payroll and Taxes

One topic that can generate ongoing confusion for business owners is employee classification: what is an exempt employee, and what is a non-exempt employee? This can be compounded by the fact that failure to comply with the Fair Labor Standards Act (FLSA) and applicable state and local regulations related to employee classification may result in substantial costs to employers.

"As an HR consultant, I usually work on employee classification with new clients. The reason is actually very simple. The biggest misconception many employers have regarding exempt vs. non-exempt is that the method of compensation alone determines this classification," says Robert Sanders, Paychex client HR business partner.

Exempt vs. Non-Exempt: What Does It Mean?

What does it mean to be an exempt employee, and what does it mean to be a non-exempt employee? Before addressing some of the most common misconceptions, make sure you understand key differences between these employee classifications.

What Does It Mean To Be a Non-Exempt Employee?

As an employer, you should understand what the U.S. Department of Labor (DOL) regulations that apply to the FLSA require when an employee is non-exempt.

Why is this classification so important? The FLSA requires employers to pay all non-exempt employees at least the federal minimum wage for hours worked, plus overtime pay at one and one-half times the regular rate of pay for hours worked over 40 hours during a workweek.

What Are Some Examples of Positions Held by Non-Exempt Employees

Non-exempt employees are generally paid on an hourly basis. Often, non-exempt employees work in jobs where the main duties center around repetitive or routine tasks. Proper classification of non-exempt employees is essential because they are entitled to overtime pay and, depending on company policy or state or local law, may have rights in other areas, such as breaks. Some examples may include:

• Electricians, carpenters, and construction or maintenance workers in non-management positions
• Sales employees in a retail environment
• Clerical or secretarial employees with little autonomous decision-making, such as receptionists, accounting clerks, bookkeepers, and personnel clerks
• General inspectors or quality assurance workers following preset guidelines that need no specialized skills or knowledge to interpret
• Licensed practical nurses (LPNs)

What Does It Mean To Be an Exempt Employee?

The FLSA provides an exemption from both minimum wage and overtime pay for employees who meet three tests: a salary level test, a salary basis test, and a job duties test. To be exempt from FLSA provisions, an employee must earn a minimum base salary as provided in the regulations, and must also be paid on a salary basis, the same amount each week, regardless of quantity or quality or work.

Employees must also meet the DOL's job duties test to be classified as exempt from the overtime and minimum wage provisions of the FLSA. Exempt employees tend to work in roles that require little direct supervision and require special skill or knowledge. They may supervise other employees. Exempt employees also typically have the authority to make suggestions or recommendations about their work, although a higher level of management might make a final decision.

What Are Some Examples of Positions Held by Exempt Employees?

Exempt positions typically require the routine exercise of independent discretion and fit into a professional category defined by the DOL. Examples may include the following:

• Business executives
• Accountants, compliance, and marketing professionals
• Managers that supervise two or more full-time employees or the part-time equivalent
• Executive assistants given authority to make significant decisions on behalf of business owners or senior executives
• Doctors
• Lawyers
• Teachers

The following professions may also be considered exempt, depending on compensation and job duties:

• Outside salesperson
• Certain computer employees
• Registered nurses may be classified as exempt in some states

What Is the Difference Between Exempt and Non-Exempt Employees?

The difference between exempt and non-exempt employees depends on their primary duties, how they are paid, and possibly how much they're paid. To ensure proper classification, employers should fully understand what skills are required to perform a job and ensure that each employee is paid in accordance with the FLSA and applicable state laws.

Exempt vs. Non-Exempt Compensation

One of the chief differences between exempt vs. non-exempt workers is how they are compensated. Exempt employees are generally "exempt" from the FLSA regulations governing minimum wage and overtime pay.

Exempt employees are paid on a salary or fee basis which means that they typically must receive their predetermined salary each workweek regardless of the quality or quantity of work performed. Subject to limited exceptions (e.g., first and last week of work, unpaid FMLA leave, etc.) an exempt employee must receive their full salary for any week in which they perform any work regardless of the number of hours or days worked.

Alternatively, non-exempt employees may be paid on an hourly, piece, salary, commission, or other basis provided the employee is paid at least the federal minimum wage for each hour worked and for overtime at a rate not less than time and one-half the employee’s regular rate of pay.

States differ in regard to overtime laws, but federal regulations use a 40-hour workweek as the threshold. An employer is not obligated to pay overtime wages when an exempt employee works more than 40 hours in a workweek. For employers, this classification removes their obligation to pay overtime and certain recordkeeping requirements under the FLSA.

Exempt vs. Non-Exempt Job Function

Keep in mind that simply relying on job titles is not a proper method of determining exempt status. An employee may have an executive, professional, or administrative title; however, that does not necessarily mean that the employee is automatically eligible for an exempt classification. Rather, a salary level, salary basis and primary duties analysis should be performed. An employee's classification as exempt or non-exempt may also affect how their compensable time is measured for certain job-related activities such as travel, being on-call, or work-related training.

"FLSA status is driven by what you do in terms of job function, not how you are compensated," Sanders explains. "Although it does follow that most of the time, non-exempt employees will be paid on an hourly basis and exempt employees will be paid a salary, it's not always the case ... The key is understanding that status is not determined only by the method of compensation."

Consequences of Exempt vs. Non-Exempt Misclassification

Incorrectly classifying an employee can result in fines and penalties, which may include payment for back wages. Make sure you adhere to the following best practices to avoid the expensive consequences of misclassification:

1. Review and understand the rules and regulations outlined by the FLSA regarding exempt vs. non-exempt classifications.
2. Next, turn your attention to your state, as several states have their own regulations around this subject.
3. Consistently review, update, and use job descriptions to ensure employees performing similar duties are classified consistently. "The key functions and responsibilities of a given employee will dictate whether that position can qualify for one of the limited 'white-collar' exemptions that would allow an employer to exempt the employee from overtime," Sanders says.
4. Don't leave best practices to chance. Avoid missing key actions by having a process in place for correctly classifying your employees.

Classifying employees correctly and adhering to the applicable federal, state, and local laws and regulations can feel overwhelming and frustrating. But employee misclassification can be a common mistake that many business owners make. Putting the right process in place may help you avoid time-consuming and costly penalties.

Exempt vs. Non-Exempt Employee FAQs

What Is the Minimum Salary for Exempt Employees?

The U.S. DOL has set a $684 minimum salary per week for exempt employees. Individual states may have different thresholds.

What Are the White Collar Exemptions?

Generally, exempt employees fit into one of the following categories:

• Administrative: Employees performing office, or other non-manual work, with primary work responsibilities related to the administration of management or general business operations of the employer or employer's customers; employees primary duties involve the exercise of discretion and independent judgment to make decisions of significance.
• Executive: Employees with the primary duty to manage a company or one of its departments, or divisions. They must also regularly direct the work of, and have the authority to hire and fire or recommend such action for, two or more full-time employees or their equivalent (e.g. 2 part-time employees working 20 hours each equals one full-time employee).
• Learned professionals: Employees with primary duties that require advanced knowledge in a field of science or learning typically evidenced by the appropriate academic degree. Some examples are doctors, registered nurses, executive chefs, teachers.
• Creative professionals: Employees with primary duties involving invention, imagination, creativity, or talent in a recognized area for creative endeavors such as music, journalism, or writing.
• Outside sales: Employees working customarily and regularly away from the company location with a primary focus of making sales, as defined by the FLSA.
• Computer: Skilled workers in the computer field such as programmers or engineers with responsibilities to design or analyze systems; may be compensated on a salary basis of at least $684 per week or an hourly basis or not less than $27.63 per hour.
• Highly compensated: Employees making at least $107,432 on an annual basis, including at least $684 per week on a salary or fee basis, who regularly perform at least one of the stipulated duties of an exempt professional, administrative, or executive employee.

Can Non-Exempt Employees Be Salaried?

Although non-exempt employees are generally paid on an hourly basis, they may be paid on a salary, commission, or piece rate basis. However, regardless of basis of pay, all non-exempt employees must be paid the appropriate overtime rate for hours worked over 40 in a workweek. Thus, the non-exempt employee's hours must still be tracked each week to determine when they are eligible for overtime payments.

What Makes an Employee Exempt vs. Non-Exempt?

Classification of an employee is generally determined by pay amount, how an employee is paid for work, and the individual's primary job duties. Exempt employees often require advanced knowledge or special skills to perform their primary duties, while non-exempt employees are focused on more routine work.

How Do You Determine Exempt vs. Non-Exempt?

Employers should spend time obtaining a thorough understanding of the FLSA requirements for employee classification. To be classified as exempt, employees must be paid on a salary basis at or above the required salary threshold, regardless of hours worked each workweek, and carry out job duties that fall into one of the DOL's exempt categories. Additionally, the employee would have to satisfy any state-specific requirements for exemption.

Are Independent Contractors Exempt or Non-Exempt?

Independent contractors are not considered employees and therefore do not fall under the FLSA guidance on this topic. However, you should be aware of the tax laws and other regulations affecting independent contractors in your workplace.

How Could a Business Closure Impact Exempt and Non-Exempt Employees?

If your business is temporarily closed due to a natural disaster or public health pandemic — such as the closures caused due to COVID-19 — and you have non-exempt employees (those who are entitled to minimum wage and overtime), you typically aren't obligated to pay them as long as they have not performed work. Employers must compensate non-exempt employees who are working remotely and those employees should accurately record all time worked, including overtime.

Exempt employees typically must receive their full salary in any workweek in which they perform work, regardless of the total number of hours actually worked. If your company closes, you must generally pay an exempt employee their full salary if the employee worked any part of the workweek.

Ensure You’re Classifying Your Employees Correctly

Determining an employee's exempt or non-exempt status may not always be cut-and-dry. Additionally, there may be state or local regulations to follow when it comes to overtime or minimum wage requirements. Failure to pay overtime to incorrectly classified workers can leave you open to litigation and/or penalties. If you don't have a classification process in place, Paychex HR Services can offer their support and guidance in this complex area of employment regulation. Additionally, you may want to closely review the 2022 proposed changes to the federal overtime rule.

The ability to compensate employees competitively as part of an effective talent acquisition strategy is top-of-mind for hiring teams and HR professionals who continue to grapple with today's labor shortage struggles. To meet these challenges, many HR leaders are offering remote work and other incentives to encourage candidates to accept job offers, according to the 2022 Paychex Pulse of HR Survey. Among the most effective tactics that HR leaders have deployed includes offering higher pay as a component of a competitive offer.

With these factors in mind, it's important to understand base pay as part of overall compensation packages when employees consider a job offer at your business or negotiate a raise.

What Is Base Pay?

Base pay, also commonly referred to as base salary or basic salary, is a fixed amount that an employer agrees to pay an employee in exchange for time and services agreed upon before the employee begins working. Base compensation is most often expressed as an hourly rate, monthly income, or annual salary. It doesn't include benefits or additional earnings, such as commission, tips, overtime pay, or bonuses. With this in mind, base pay may only be one part of an employee's total compensation.

What does base pay mean to job candidates and potential new hires? A job offer may include base salary as well as other details about future wages, such as potential commission for a sales job. But it's typically determined by the employer based on a set workweek and a variety of additional factors including the individual's experience, job duties, and skills. Base pay is often a starting point for salary negotiations, and may increase over time based on employee performance or other demonstrations of an employee’s value to the company. And in times when recruiting and hiring are especially challenging, employers may raise base pay to compete for top talent.

Who Receives Base Pay?

While some employees receive a base annual salary distributed across pay periods, others may receive base compensation paid as an hourly wage. More specifically, base salaries are typically paid to employees who meet the criteria for exemption from minimum wage and overtime pay requirements outlined by the Fair Labor Standards Act (FLSA). Other employees may receive their compensation on a per-hour, shift, or day basis. These are typically non-exempt employees under the FLSA who are owed minimum wage for all hours worked and overtime for hours worked over 40 among other protections. If you aren't already familiar with the distinctions between exempt and non-exempt employees, it's important to understand each of these worker classifications. The Department of Labor has created materials to help you classify employees correctly, adhere to these federal standards, and properly pay employees for time worked. Keep in mind that your business may also be subject to state and local wage and hour laws.

Base Pay vs. Gross Pay

Having a firm understanding of base pay vs. gross pay is of utmost importance, especially when negotiating employee salaries. As previously stated, base pay is the hourly rate or salary that an employee earns before any additional payments are added. On the other hand, gross pay includes base earnings plus overtime pay (if applicable), commissions, bonuses, tips, etc. before deductions are taken. In most cases, base pay is a set amount that changes infrequently (e.g., annual performance reviews, market adjustments, etc.), while gross pay may fluctuate based on additional incentives.

In addition to base pay vs. gross pay, you should also keep in mind net pay, which is the amount an employee “takes home” each pay period. This is gross pay minus taxes and other deductions.

How Is Base Salary Calculated?

Variables such as the employee's experience level, certifications, and market value for employees in similar roles can all help an employer establish an appropriate base rate while taking into consideration the number of hours the employee will work per week, typically 40 hours for a full-time employee. You may also want to look at salary research data from the U.S. Bureau of Labor Statistics (BLS), which offers information across professions, industries, and geographic areas.

To calculate base pay, you can use one of the following calculations, depending on the employee's classification:

[Regular pay amount per payment period] x [# of payment periods in a year] = Annualized base pay

[# of hours worked in a week] x [# of weeks in a year] x [hourly wage] = Annualized base pay

Base Salary Calculation Examples

Using the basic calculations above, let's take a look at how base salary and base pay can be calculated, along with basic calculations for bonuses and overtime:

Example 1: Base Salary

[Regular pay amount per payment period] x [# of payment periods in a year] = Base salary

[$2,000 bi-weekly salary] x [26 pay periods] = $52,000 base salary (annually)

Example 2: Base Pay

[# of hours worked in a week] x [# of weeks in a year] x [hourly wage] = Base pay

[30 hours worked per week] x [52 weeks] x [$25 per hour] = $39,000 base pay (annually)

Example 3: Bonus as a Percentage of Annual Salary

[Employee's annual salary] x [Percent bonus rate] = Bonus amount

[$52,000 annual salary] x [3% bonus] = $1,560 bonus

Example 4: Overtime Pay

[Regular pay rate] x [1.5] x [number of overtime hours] = Overtime pay

[$20 an hour] x [1.5] x [5 overtime hours] = $150 overtime pay

Factors Impacting Base Pay

It's ultimately up to the employer to determine base pay, but new hires and employees may negotiate for a higher base pay, pointing to any number of factors. While businesses need to ensure they provide pay that meets applicable wage and hour law requirements, base pay can be negotiated or determined by variables such as:

• The employee's experience, skillsets, education, and specialized knowledge
• Any professional certifications that relate to the job
• Amount budgeted for the position
• Geographic location
• How much competitors are paying for similar roles based on market data
• How much current employees in similar roles are compensated
• How long a position has been unfilled
• Whether other forms of compensation are offered, such as equity
• Cost-of-living adjustments

Whether you're trying to bring a new hire on board or are in negotiations with a current employee, consider how important a standardized compensation formula and well-designed salary structure are for cultivating a fair and equitable workplace — in addition to the base pay variables mentioned above. Designed to help businesses recognize a position's value in the overall labor market as well as its internal value to the company, these tools can help businesses take a formulaic approach toward eliminating bias and developing more equitable pay practices.

Align Your Base Salary With Industry Standards

To recruit and retain top talent, employees' total compensation packages — a large percentage of which may be base pay — need to be competitive yet also reasonable and fair. Partner with experts in HR to help you effectively find and retain great talent, offer salaries that make sense for your business and industry, and keep you in compliance with applicable wage and hour laws and regulations. Working with an expert payroll provider can also help you pay your workforce accurately and on time, every pay period.

Restaurants and quick-serve restaurant franchises can find it challenging to stay compliant with the many regulations that apply to the food service industry. Violations can be costly and dangerous – many regulations for the food service industry carry significant fines for noncompliance, and failing to follow proper procedures in a restaurant can lead to illness or injury. Managers and owners who do not stay current with laws that apply to their restaurants can put themselves, their staff, and their customers at risk.

Health and Safety Laws

OSHA

The Occupational Safety and Health Administration (OSHA), an agency run by the U.S. Department of Labor, enforces safety rules that are designed to protect employees from known safety and health hazards. While several states have their own occupational safety and health rules, they must meet or exceed the minimum safety standards set by OSHA.

To stay in compliance with OSHA regulations, food service managers and franchisees must follow protocols around many operational functions, including having the right type of fire extinguishers present, ensuring employees have protective clothing or equipment, timely reporting and recording workplace injuries and illnesses, and appropriately displaying accident prevention signage throughout the restaurant, to name just a few.

Health codes

The U.S. Food and Drug Administration outlines specific food service codes and regulations for each state. Within these codes, the FDA indicates a range of regulations, such as how frequently a restaurant or quick-serve restaurant must be inspected by local health agencies or proper storage and handling procedures for different types of food.

Many state health codes for food service require that managers, and sometimes even employees, successfully pass a designated food handling course. This course is designed to make sure all employees are knowledgeable about safe food handling practices, thereby minimizing the risk to patrons. Even if a food safety course is not required in your state, it may be beneficial to have employees attend anyway. Since food safety course instructors are required to stay current with the state health codes for food service, they can be a valuable resource to your employees.

Since improper food handling can lead to severe food-borne illnesses, and given that some food establishments can serve hundreds of people per day, the restaurant and quick-serve restaurant industry is heavily regulated.

Wage and Hour Laws: Tips, Minimum Wage, Overtime

The Fair Labor Standards Act (FLSA) as well as many state and local laws and regulations impact how tipped employees must be paid, how tips must be accounted for, and how overtime and other payroll issues must be handled. This means that food service managers have an extra layer of regulations that affect their payroll management procedures.

Even if your restaurant does not have tipped employees, minimum wage regulations may be a concern. Restaurants and quick-serve restaurants operating in multiple states or municipalities must be aware of potential varying minimum wage rates and ensure that all employees are paid in compliance with applicable rate(s). If local, state, and federal minimum wage rates differ and an employee is covered by multiple requirements, the employee must be paid the highest applicable rate.

There are also overtime regulations at the federal level under the Fair Labor Standards Act (FLSA). State and local laws may provide for additional requirements and/or coverage. For example, according to the FLSA, the correct overtime rate, one and one-half times the employees regular rate, must be paid to a non-exempt employee for all hours worked over 40 hours in the same workweek. In certain states, however, employers may also be required to pay certain employees the correct overtime rate for all hours worked over eight hours in one workday.

Payroll Tax Laws: Tipped Employees

Tipped employees also have special tax obligations that require compliance and oversight by managers. When tips are shared among team members via a tip pool, the regulations can become even more complicated. Fortunately, food service managers who accurately follow tip reporting codes can benefit from the FICA Tip Tax Credit. To qualify, managers must complete IRS Form 8846 to receive the credit and IRS Form 8027 to report tips if the restaurant employs more than 10 tipped employees. In addition, other federal tip reporting requirements may apply, depending on your sales volume, percentage of tipped sales, and methods of tip distribution.

Paying restaurant employees properly can be extremely challenging, but taking the pain out of restaurant payroll is possible with thorough knowledge and planning. If agency regulations aren't your specialty, many local small business associations offer classes on payroll and tax codes. Your payroll service provider can also provide assistance regarding relevant laws, and regulations that may affect your business.