Sort it out: missing the mark on employee classification or compensation will cost you

California CPA, May, 2003 by Mark E. Terman, Lin M. Meyer

PERSONAL BANKERS for Bank of America's wealthiest clients settled for $22 million. Farmers Insurance Exchange claims adjusters were warded more than $90 million. Starbucks, PacBell and RadioShack "working" managers are poisd to receive millions.

To what do employees owe these sizable awards? Their employers failed to properly classify them as exempt or nonexempt from overtime pay. As a result, the employers find themselves saddled with costs that include up to four years of unpaid wages--plus interest, statutory penalties and attorney fees.

Employer misclassifications of employees can quickly erupt into class action lawsuits sparked by just one disgruntled former or current employee. California and federal laws are onerous in this area, and both permit personal liability upon the officers and managers who controlled the decision not to pay overtime.

CONSIDER YOURSELF WARNED

Employers who look to others in their industry and rationalize, "They don't comply, so I won't either" or "Our industry is too important to the state to be a target" should beware.

Over the past several years, California's Department of Industrial Relations, the federal Department of Labor and employee-side class action law firms have targeted working managers in a variety of industries--and it's not letting up.

The legal profession once perceived the work performed by paralegals to be exempt. Yet in 1998, the DOL said that paralegals more appropriately fit into the category of nonexempt employees who apply particular skills and knowledge in carrying out assignments, but do not regularly exercise independent judgment or discretion.

The lesson learned is that this is a risk employers can't ignore. Dealing with this risk means employers must analyze and satisfy two basic tests to determine whether or not an employee is exempt. The tests, among other wage and hour rules, can be found in the California Industrial Welfare Commission wage orders posted at www.dir.ca.gov/IWC/WageOrder Industries.htm.

Employers are required to conspicuously post applicable wage orders in the workplace. Wage Order 1, for example, applies to manufacturing companies. Wage Order 7 applies to mercantile businesses. Wage Order 4 applies to professional, technical, mechanical and clerical occupations, including professional service firms. The focus of this article is on the essence of Wage Order 4's overtime and exemption rules.

THE SALARY BASIS TEST

To satisfy the first test, the "salary basis" test, the employee, whether full or part time, must be paid at least a $2,340 per month salary. This is based on the rule's twice minimum wage requirement. The salary amount cannot be deducted from or added to because of actual hours worked.

THE DUTIES TEST:

THE ROOT OF MANY PROBLEMS

The duties test requires that employees routinely spend more than 50 percent of their working time performing exempt duties. Most of the overtime litigation is borne from this more difficult test.

Keep in mind that the law and the California Department of Industrial Relations state that job titles, large salaries and highly skilled work are not determinative. Instead, employers must analyze the work performed by each employee under professional, administrative and executive exemptions.

EXEMPT DUTIES UNDER THE PROFESSIONAL EXEMPTION

To be considered exempt from overtime pay under the professional exemption, employees must be:

* Licensed in California and spend more than 50 percent of their time engaged in the practice of law, medicine, dentistry, optometry, architecture, engineering, teaching or accounting; or primarily engaged in an occupation commonly recognized as a learned or artistic profession as defined in Wage Order 4; and

* Customarily and regularly exercising discretion and independent judgment when performing that work.

Unlicensed professionals typically must satisfy one of the other exemptions.

EXEMPT DUTIES UNDER THE ADMINISTRATIVE EXEMPTION

For the administrative exemption, employees must spend more than 50 percent of their time performing the following duties:

* Office or non-manual work directly related to management policies or general business operations of the employer or its customers;

* Regularly exercise discretion and independent judgment; and

* Regularly and directly assists a proprietor, other executive or administrator; or perform, under only general supervision, specialized work requiring specialized training, experience or knowledge; or executes, under only general supervision, special assignments and tasks.

EXEMPT DUTIES UNDER THE EXECUTIVE EXEMPTION

The executive exemption applies to employees who spend more than 50 percent of their time performing the following duties:

* Managing a unit, department or enterprise of the employer;

* Directing or supervising the work of at least two full-time employees;

* Exercising authority to hire, fire, promote or change the status of other employees or their recommendations for such changes are given deference; and

* Customarily and regularly exercising discretion and independent judgment.