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Winter 2005 Overtime

Who gets paid overtime? If you’re like most employers, that question causes more than a few sleepless nights. After all, a good deal of money rides on the answer. Load up on hourly workers to avoid it, and you bloat your payroll and erode your profits. Or exempt the wrong people from overtime, and you face a more serious risk: costly litigation from employees claiming they were misclassified and should be paid for those OT hours—plus interest.

No wonder employers often feel caught between red ink and a lawsuit. Is there a solution? Maybe. New overtime regulations from the Department of Labor bring some clarity to a woolly patchwork of rules.

The new rules, which took effect August 23, 2004, seem to be a mixed blessing. On the one hand, it looks as if more lower-income workers will be eligible for overtime—which would cost you, the employer, more in wages. But the news isn’t all bad: The new rules will eliminate many expensive wage-and-hour lawsuits.

Three key changes

The complete regulations are long and complex (see sidebar), but to get the basic thrust of these regulations, you need to know three key provisions. The first two are expected to add a substantial number of employees who are eligible for overtime; the third is expected to reduce that number somewhat.

1. All employees earning less than $455 a week (that translates to $23,660 a year) are now “non-exempt”—that is, they’re eligible for overtime pay. The limit used to be $155 a week. This new rule is expected to add 6.7 million non-exempt employees.

2. Workers earning more than $455 a week and less than $100,000 a year are subject to protections from loss of overtime pay, under standard “duties tests” (explained below) that are equal to or more protective than former tests. This provision should also increase the number of non-exempt employees.

3. Employees who earn more than $100,000 a year are subject to a new set of “duties tests” that are less protective than the ones for middle-tier employees. This provision is expected to result in 107,000 highly-paid employees losing overtime protection.

There will be some losers and winners when this shakes down. Here’s your chance to eliminate costly mistakes—government penalties—before they happen. Take action quickly to make sure you comply with the new regulations. “Most employers are looking at jobs now and auditing their positions,” says Joseph P. Harkins, a partner at Littler Mendelson (Washington, DC), the nation’s largest employment law firm. “It’s important to do this and make adjustments where required.”

Delay too long, and you can get hit with costly financial penalties from two sides. First, employees may sue you for misclassifying them as exempt from overtime, leading to back-wage settlements. Second, you may be hit with government fines. “If you do not comply with the new rules, you could be penalized for any overtime that the Department of Labor [DOL] believes you should have paid to employees,” says Timothy S. Bland, a partner at Ford & Harrison (Memphis). “You can also be assessed liquidated-damages fines totaling double the back pay you’re deemed to owe misclassified employees.”

In either case, you need to act now to avoid potential financial consequences. Be alert for what attorneys call “task creep.” This is the gradual modification in the duties performed by an employee, such that a formerly exempt employee becomes non-exempt or vice versa. Task creep can occur unnoticed and lead to serious misclassifications.

How will this affect your payroll costs? If you’re like most employers, it will mean higher outlay for wages. Your own experience, though, will depend on your location and current wage structure. “This law will impact employers very differently depending on where they live,” says Robert D. Lipman, managing partner at Lipman & Plesur (Jericho, NY). Smaller employers in general may be the most affected.

The muddled middle

You’re most likely to come to grief trying to classify people in the “muddled middle”—those who earn more than $455 weekly but less than the amount that’s defined as “highly compensated.” (By the way, there are special rules for employees who earn $100,000 or more a year. That probably doesn’t apply to most specialty retailers’ employees, but check with your attorney and your accountant for specifics.) Harkins says “most employees fall in between the lower and upper thresholds. Employers are struggling to figure out where these individuals fit.”

Unfortunately, the new guidelines aren’t much help. “You must still deal in vague terms such as ‘independent judgment,’ ‘discretion,’ and ‘responsibility to hire and fire,’” he says. You and your attorney will have to take a close look at the law, but to get you started, here are some key points:

You can classify as “exempt from overtime” certain employees whose workplace activities “primarily involve executive, administrative or professional duties.” In addition to the salary tests described earlier, exempt employees in these categories must meet the following “duties tests.”

For an executive

The “primary duty” must be the “management of the enterprise.” Additionally, this employee must be one who “customarily and regularly directs the work of two or more other employees.” Finally, this employee must either have the authority to hire and fire other employees, or offer suggestions and recommendations that carry “particular weight” regarding personnel actions. Smaller employers may need to take a close look at their operations to see if their assistant managers are still exempt, particularly in light of the fact that they must supervise two full-time employees.

Another new wrinkle: Owning 20 percent or more of the equity in the business does not automatically make someone exempt. That employee must also be actively engaged in management.

For administrative employees

The “primary duty” must be “the performance of office or non-manual work directly related to the management or general business operations of the employer or the employer’s customers.” The primary duties must also include the “exercise of discretion and independent judgment with respect to matters of significance.” In other words, they must have decision-making authority.

You may already be relying on the administrative exemption for employees who aren’t managers but who are critical to your operation. Unfortunately, the language of the new regulations offers little or no clarity in this area. “We had hoped the administrative exemption would be cleared up and made easier to apply,” says Bland, “[but] that’s not the case.”

Just how much “discretion and independent judgment” has to exist is extremely difficult to assess in the real world. “Some employees have very little discretion in the job and are obviously not exempt,” says Bland, and “a few have so much discretion they clearly are exempt.” But most employees fall into a gray area, “so it comes down to a judgment call.”

Define your terms

The new regulations attempt to define the key terms—”particular weight,” “management,” “discretion and independent judgment,” and more, which you’ll need to review with your lawyer.

But the term “primary duty” is particularly important and merits a look. The term has been expanded from “time spent on exempt work” to “the perceived value of exempt work” The new regulations discard the old rule that an exempt employee could not spend more than 20 percent of time on non-exempt work. It’s not even necessary to spend more than 50 percent of work time on a duty for that activity to be “primary.” Instead, the determination must be made on case by case, taking into account such matters as “the relative importance of the exempt duties”… “the employee’s relative freedom from direct supervision”… and wage disparities between that employee and your non-exempt employees.

An employer might claim that many non-exempt tasks performed by an employee are in support of exempt tasks. For example, an administrative assistant might be doing a lot of clerical tasks, but they all support getting vendor agreements in order. As a result, this employee might well be classified as exempt.

At what point do non-exempt duties threaten “exempt” status? There’s no hard and fast rule, and it’s complicated. Just look at what the regs offer as guidance: “exempt executives make the decision regarding when to perform non-exempt duties and remain responsible for the success or failure of business operations under their management while performing the non-exempt work.” Confusing? Yes. Lots of gray area? Right. Room for error? You bet.

Given the number of employees in the muddled middle, the vagueness of the duties tests, and the often confusing legal language of the new regs, you’ll likely have to do some serious analyzing, and perhaps get some help from your attorney, to avoid non-compliance penalties.

Better safe than sorry

Many employers are taking the “better safe than sorry” option. “I don’t see a lot of clients going out of their way to make hourly people salaried,” says Harkins, “but I do see employers taking salaried people and putting them into the hourly category. So I wouldn’t be surprised if the new legislation increases the number of people eligible for overtime to a level even higher than what the DOL has predicted.”

Now is the time to take a new look at your own employees and classify them correctly. The law presumes your employees are hourly, and it’s up to you to show otherwise. Says Harkins: “It’s always legally safer to pay wages and overtime.” But if you’re in doubt or just plain confused, check with your attorney. Chances are, the legal fees will be cheaper than the government’s bite if you miscalculate, guess wrong, or just keep doing business as usual.

Phillip M. Perry

Perry is a freelance writer based in New York, NY.

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