Avoid Costly Penalties for Overtime Violations

Abstract: Employers failing to pay overtime to nonexempt workers face costly penalties. The stakes have been raised higher with new regulations from the U.S. Department of Labor which more than double the minimum salary for exemption. Employers must now review their workforce and reclassify individuals as required.

Who qualifies for overtime? More people than ever, thanks to new rules from the U.S. Department of Labor (DOL), mandating which employees are entitled to extra pay when working more than 40 hours a week. If you’re like most employers, you may be experiencing a resulting surge in your “nonexempt” workforce—and in your payroll. Moreover, you may find it difficult to decide who is exempt from overtime.

“The topic of overtime is challenging for most employers,” says James B. Sherman, President and CEO of Wessels Sherman, a Chicago-based employment law firm (w-p.com). “The law is not as simple as it looks, and there is a lot to learn about what is required when determining which employees are exempt. It’s not just a matter of who is salaried and who is not.”

Maybe the law’s confusing, but you ignore it at your peril. “The penalties for violating wage and hour laws can be severe,” says Matthew C. Heerde, a New York City-based employment law attorney (heerdelaw.com). “They can be devastating for a small business. I have dealt with employers who contemplated bankruptcies after being caught.”

Bear in mind, too, that you are responsible for supporting your exemption decisions. “The law assumes everyone is entitled to receive overtime pay unless the employer can show that certain employees are exempt,” warns Ann F. Kiernan, a New Brunswick, NJ-based employment law attorney and lead trainer at Fair Measures, a management practices consulting firm in Denver (fairmeasures.com).

More workers qualify

Federal overtime provisions are contained in the Fair Labor Standards Act (FLSA). The big news is that new regulations from the DOL escalate the risk of making employee classification errors. The qualifying salary floor has been raised to $913 per week (up from a former $455). Employees paid less must be classified as “nonexempt” (that means “nonexempt from overtime”), and must be paid time-and-a-half when working more than 40 hours per week. Individuals paid more than $913 weekly are exempt from overtime—maybe. They also have to meet strict—and often confusing–standards about just how they are paid and what job duties they perform.

“A more than doubling of the salary level required for exempt status means employers must make some pretty tough decisions as to whether they want to bump up salaries or reclassify employees,” says S. Libby Henninger, a shareholder in the Washington, DC office of San Francisco-based Littler Mendelson, the nation’s largest employment law firm (littler.com). “It can mean not just the paying of more overtime but also a change in how the business operates.”

For example, businesses may have to mandate that employees newly classified as nonexempt cease doing any work at home, including the answering of email, as such activities may push them continually over the 40-hour weekly work limit, leading to significant increases in payroll costs.

The lower the average pay scale in any business or region, the higher the number of people subject to reclassification under the new rules. “Some of the biggest impact is being felt by smaller businesses, and those in less urban areas where hourly wages and salaries are lower,” says Henninger. “Many of these businesses are reclassifying a third of their workforce.”

Are you covered?

What should you do now? Your first step is to determine if your business is covered by the law. Here’s the rule: The FLSA covers any business that generates over $500,000 in annual gross revenue and is engaged in interstate commerce. Sounds simple, right? In practice, though, things get complicated fast. Smaller enterprises often find themselves subject to wage and hour law.

Take that interstate commerce requirement. Maybe you think your business activities are well contained inside your state lines. Fact is, that’s pretty rare. Your business can be deemed as engaged in interstate commerce through acts as seemingly innocuous as receiving goods from out of state, mailing letters to addresses in another state, participating in telephone conversations or email communications across state lines, or even making credit card transactions involving distant financial institutions. “It’s the rare business that is not involved in some way with interstate commerce,” says Heerde.

Too, the $500,000 revenue limit will not necessarily save your very small business from the need to follow the wage and hour law. “A business which does not generate $500,000 in annual revenues can still be subject to FLSA on a ‘per employee’ basis,” cautions Heerde. Here’s how: If a substantial part of an employee’s work is related to interstate commerce, that employee is likely covered individually. Suppose your employee Andy makes frequent telephone calls to prospects or customers in another state. Or regularly receives goods that have been delivered from another state. Or regularly processes credit card transactions with out-of-state financial institutions. Andy is likely covered by the FLSA, even though other employees in your workplace might not be.

And even the tiniest of businesses face another risk: “State wage and hour and overtime laws often apply to businesses with annual revenues of under $500,000,” says Heerde.

Employers face penalties

Failure to meet overtime obligations can spark costly penalties, says Heerde. These start with back pay, which includes underpayment in wages and overtime. If the underpayment is deemed to be willful you may also be subject under Federal law to what is called “liquidated damages,” which amount to a doubling of the back pay amounts. If your actions have violated your state’s wage and hour laws your employees may be awarded additional damages. “You can end up paying damages simultaneously under federal and state law,” says Heerde. Finally, you will also likely need to pay reasonable attorney’s fees incurred by an employee who has brought a lawsuit.

If violations are deemed to be willful, investigators can go back three years when checking your records, notes Kiernan. And you could be penalized for all of the accumulated overtime, plus liquidated damages and attorney fees. “Willful violations can also be prosecuted criminally, and with a second conviction you might go to jail. You might be fined as well.”

Worse yet, owners and even managers can be personally liable for back wages, overtime and attorneys’ fees. “Anyone is at risk who sets work hours, supervises, and is responsible for hiring and firing,” says Sean F. Darke, a senior attorney at Wessels Sherman. “While most states require businesses to indemnify individuals, if the employer goes bankrupt the individuals can be chased by attorneys.”

That brings up an important rule: Don’t try to pretend you don’t know certain employees are working overtime. “You cannot be willfully blind to overtime that is being worked,” says Kiernan. “Suppose, for example, that you leave your office at 5:00 PM and a clerical worker named Sally is still laboring on a project which ends up sitting on your desk when you arrive the following morning. It should be obvious to you that Sally worked overtime.”

One final thing: What happens if federal and state law conflict? “The federal law does not have an exemption for state law,” says Darke. “That means the law with provisions most favorable to an employee is deemed to have control.”

Exempt workers

To be exempt from overtime an employee must meet certain standards regarding salary and duties. “An exempt employee must be paid on a salary basis,” says Kiernan. “And that salary must be for the same amount every week, no matter how much or how little the person works, or whether that person’s work was of good or bad quality. Finally, the salary must be at least $913 weekly.” If any condition is missing, the employee is nonexempt from overtime.

But salary’s not the whole story. To qualify as exempt, an employee must also perform duties of a certain nature. While there are a number of exempt categories, for most readers of this magazine the important ones are executive and administrative.

“Executive employees are exempt if their duties are exclusively management in nature, if they supervise at least two people, and if they have the ability to hire and fire–or at least contribute substantially to such decisions,” says Kiernan.

As for the administrative exemption: The person must perform office or non-manual work related to the general operations of the business, and must exercise discretion or individual judgement with respect to matters of significance. “This person cannot be an assistant,” says Kiernan, “but must be a high level person who exercises independent judgment in making decisions. An example would be the power to rewrite the employee handbook.”

Both the executive and the administrative exemptions require that the individuals make upper level managerial decisions, says Kiernan. Those qualifying for an administrative exemption need to be involved in high level duties such as budgeting, committing money for new initiatives, and project managing. “When deciding who is exempt, one good question to ask is this: ‘Is the person just following a cookbook?’ If so, the person is likely nonexempt and qualifies for overtime pay.”

Morale problems

If you’re like most employers, the new regulations are throwing a significant number of employees into your nonexempt pool, making them subject to overtime. That can create a significant morale problem. “For many professional people there is a negative connotation about being deemed an hourly worker,” says Henninger. “Reclassifying them as nonexempt may make them feel they are being demoted, and that a lot of their flexibility is being taken away since they have to start tracking their hours.”

What to do? “Our advice is to emphasize to people that they are not being demoted, and that the change does not speak to the importance of their position,” says Henninger. “The fact is that more employees are becoming overtime eligible because of a change in the federal law.”

Here’s another idea: “Consider having everyone in the company, from the president on down, start recording their hours worked,” says Kiernan. “That can be easily done by signing in and out of a computer.” Attorneys, she points out, have been doing this for years.

“You can also continue to pay salaries to people who are moved into nonexempt status, even though they must start tracking their hours worked,” says Kiernan. “That’s perfectly legal, as long as the salary is equal to or higher than they would be paid if the amount were calculated on an hourly basis.”

On a related note, people need to understand that overtime should only be worked with the permission of management. “Keep in mind, though, that if someone works overtime and failed to get permission, you still have to pay them,” says Kiernan. “In such a case you might fire them for insubordination, but the overtime amount must be paid.” (For several challenging overtime scenarios, see the quiz in the sidebar, “Do They Get Overtime?”)

The challenge for employers

Wage and hour law is a complicated topic that can be challenging for any employer to handle properly. And the regulations can be vague: Sometimes it will be tough to figure out whether a certain worker is exempt. When a particular case is ambiguous, follow this rule: It is always legally safer to classify the worker as nonexempt and pay overtime.
“Wage and hour law compliance may be the last thing on your mind as you run your business,” says Heerde. “But keep in mind it can be a nightmare if one of your employees finds an attorney who realizes the individual is owed money, or if a federal or state agency shows up at your door. An ounce of prevention is worth a pound of cure.”