From W-2 employees to 1099 contractors to hourly and salary-based employees, there’s a lot to take into consideration when classifying your workforce. But, it’s important to make sure you understand these differences to avoid making payroll mistakes and getting on the wrong side of the IRS.
Once you’ve determined that a worker is an employee (not a contractor), there are two basic types of employment classifications in the workplace — exempt employees and non-exempt employees. These terms are defined by the Fair Labor Standards Act (FLSA), which specifies that certain employees must receive a minimum wage and also overtime pay when they work more than 40 hours a week. Others are exempt from minimum wage and overtime requirements.
Read on to understand how to tell the difference between these types of employees and what each classification means.
What’s the test for exempt vs. non-exempt employees?
You should look at three criteria to know whether an employee should be classified as exempt or not:
- Job duties. If they work in executive, professional, or administrative — managerial or supervisory — roles
- Salary basis. If you pay your employees an annual salary rather than an hourly wage
- Salary level. If they meet the other criteria above, and you pay them more than $35,568 annually
If you want to find more specific guidance, the Department of Labor has a specific list of tests (and descriptions of the different roles) you can apply for different types of employees. Let’s dig a little deeper to see what rules apply to each classification, and how to classify your employees to make sure you are paying them correctly.
What is an exempt employee?
Exempt employees are not covered by the FLSA’s overtime and minimum wage pay requirements, which means they are generally paid on a salary basis. Their role typically involves administrative, executive, or professional duties (as defined below).
Also, these employees must be paid a minimum of $684 per week or $35,568 annually to be considered exempt from FLSA regulations. Please note that the salary threshold is a recent increase from $455 a week or $23,660 annually and shifted an estimated additional 1.3 million workers to the non-exempt category — and therefore eligible for overtime pay.
The FLSA recognizes the following broad categories of employees as exempt:
- Executive: Their duties involve managing the enterprise or a division or subdivision of the enterprise. They manage the work of at least two other full-time employees and have a decision-making role in the hiring, firing, or advancement and promotion of other employees.
- Professional: Their primary area of work requires specialized knowledge that is customarily acquired by a prolonged course of advanced intellectual instruction, and is in a field of science or learning.
- Administrative: Their primary area of work is directly related to the management or general business operations of the employer or the employer’s customers, and they use discretion and independent judgment for significant decisions.
- Highly compensated employees: They may be exempt if they earn an annual salary of $107,432 or higher and perform and perform at least one of the duties of an exempt executive, administrative, or professional employee.
- Computer: Anyone employed as a computer systems analyst, software engineer, computer programmer, or a job performing similar duties.
- Outside sales: Their primary duties are making sales (as defined by the FLSA), or obtaining orders or contracts for services or the use of facilities. The employee must be regularly engaged in work outside of the employer’s regular place of business.
Outside of these standard categories, there are a few other areas where employees are commonly classified as exempt. These include:
- Computer professionals that are paid at least $27.63 per hour
- Salesmen, partsmen, and mechanics employed by automobile dealerships
- Workers employed by certain seasonal and recreational establishments
- Farmworkers who are immediate family members of the employer and are engaged in the production of livestock
- Drivers, driver’s helpers, loaders, and mechanics. They are considered exempt if they are employed by a motor carrier, and if their duties involve the safety of vehicles in transportation of passengers or property
- Commissioned sales employees working in the retail or service industry. They are considered exempt if at least half their earnings are made from commissions and they make at least one and a half times the federal minimum wage, $7.25, for each hour worked on average
Typically, an employee must meet all the standards described by the Department of Labor’s tests. Please check with a tax professional or HR representative if you have any questions about how to apply the classification tests.
What is a non-exempt employee?
Unlike exempt employees, most non-exempt workers are paid by the hour and eligible for overtime pay rates (at one and half times their normal rate of pay) for any hours worked above the standard 40-hour workweek. They are also entitled to the federal minimum wage, the tipped wage minimum, or their state’s minimum wage if it’s higher. But, remember that not all non-exempt employees are paid by the hour.
Non-exempt status also doesn’t limit the number of hours an employee may work in a workweek and applies to employees who are at least 16 years of age. Overtime pay does not apply to weekends, holidays, or “regular days of rest” unless overtime hours were worked on those days.
Hopefully, now you have a good understanding of the difference between exempt and non-exempt employees. Keep in mind that most states have additional guidelines and laws to abide by, so visit your state’s department of labor website to check them out. And if you have questions about the difference between exempt and non-exempt employees — or what the classifications mean — be sure to talk to an expert.