Over the past 20 years, one of the greatest sources of legal exposure for California employers has been “misclassification” of employees. For purposes of payroll, workers are generally classified in one of two basic categories: employees “exempt” from overtime pay versus “non-exempt” employees.

The federal Fair Labor Standards Act (“FLSA”) and California law both set forth standards for wages and overtime pay. In California, employers must generally comply with whichever standard is the strictest in the particular circumstance. In most instances, California’s Labor Code and Industrial Wage Orders will offer more protection than the analogous federal law, and so employers will be bound to follow the state’s mandates.

While employees who are exempt can be paid a straight wage without regard to the number of hours worked, non-exempt employees must be paid in accordance with the hours they work, and if these non-exempt employees work overtime, their pay structure must reflect payment for that overtime work.  In California, overtime pay applies to any work of more than eight hours in any workday or more than 40 hours in any workweek.  Non-exempt employees are also entitled to mandatory meal and rest periods that can otherwise be skipped by busy exempt employees.

For employees who are exempt, the unvarying salary paid to them is intended as compensation for all hours worked each week and exempt employees do not receive overtime pay. But who qualifies as exempt under state and federal law is not merely a matter of opinion by the employer or subject to an agreement by the employer and employee.  And a person’s job title — regardless of how prestigious it sounds — is also irrelevant. There are definitive criteria used to determine whether an employee is properly classified as exempt.  These tests, which examine an employee’s salary and his or her usual job duties must both be satisfied in order for an employee to be properly classified as exempt.

The FLSA defines several categories of workers who may be exempt from overtime laws, including executives, certain professionals, and administrative personnel, among others. It can be very costly to miscategorize an employee as exempt. Under federal law, an employer can face liability for back wages, taxes, penalties, interest, and attorney fees. Plus, aggrieved employees can seek unpaid wages or overtime for a period going back two years.

California’s criteria for exempt employees are similar to those in the FLSA, and its punishments for non-compliance are more onerous than the federal law’s.  For example, back wages recoverable for violations under state law can go back a full four years.  And California law has some additional requirements before an employee can properly be found exempt, as well as  a number of unique exemptions, that are not found in the FLSA.

For example, in order for executive, administrative, and professional workers who would otherwise be exempt from overtime under federal law to be exempt under California law, those employees must meet certain salary and duty criteria. In terms of minimum salary requirements, for a salaried employee to be considered exempt under state law, the employee must receive two times the minimum wage.

To maintain a proper exempt classification for an employee, the employer also cannot have a policy of docking an exempt employee’s pay for productivity or performance issues. While isolated deductions will generally not cause an employer to lose the exemption classification for an employee (as long as the employer reimburses the employee for the improper deduction), employers should be aware that they can lose the exemption for an “actual practice” of improperly making deductions from an exempt employee’s salary. An actual practice is determined by looking at the number and frequency of improper deductions, and whether the employer has a policy either permitting or prohibiting improper deductions.

Instead of a salary basis, some exempt employees may be paid on a “fee basis,” i.e., an agreed-to sum for a single job, regardless of the time required for its completion.  An employee paid on a fee basis, like a salaried employee, must be paid a sufficient amount to meet the minimum salary requirement of two times minimum wage for exempt employees; this is generally determined by the time worked on the job and whether payment of the fee divided by the number of hours worked would meet or exceed the weekly two-times minimum wage requirement if the employee had been paid hourly.

Because the salary criteria is tied to the state’s minimum wage, whenever the minimum wage increases, employers must ensure that those employees who are classified as exempt still meet the threshold of having a salary at least two times minimum wage. Employers should note that the state minimum wage increased to $9.00 per hour in 2014 and is set to increase again to $10.00 per hour in 2016.

The other part of the test of whether an employee is properly classified as exempt is related to the employee’s duties. Under federal law, an exempt employee must be “primarily engaged in” duties that meet the test of the exemption.  California uses a similar test but its test is more precise: “primarily engaged in” means that at least one-half of the employee’s time spent working must be spent doing exempt work.

The executive and professional exemptions are the two exemptions that most people think of when they think of salaried exempt employees. An employee will usually qualify for the executive exemption in California when at least 50 percent of his or her responsibilities involve the management of the business, or of one of its departments or other subdivisions.  Management means that the employee regularly exercises discretion and independent judgment, regularly directs the work of more than one employee, has the authority to hire, promote, and fire employees, or make recommendations on such subjects.

An employee generally qualifies for the professional exemption if he or she is licensed or certified by the state and is primarily engaged in the practice of law, medicine, dentistry, optometry, architecture, teaching, accounting, or in a “learned” or “artistic” profession. Learned professions are generally ones that require advanced knowledge in a field of learning customarily only obtained by prolonged, specialized study, and which involve work that is predominantly intellectual and varied, as opposed to routine mental or manual work.  Artistic professions qualifying for the professional exemption are ones where the employee engaged in work that is “original and creative” in a recognized artistic field where the performance of the work depends on the imagination or talent of the employee.

Just because an employee has graduated from college does not mean that he or she automatically qualifies for the professional exemption. In many instances, in fact, education beyond a four-year degree is required to qualify for the exemption. And keep in mind that employees must be “primarily engaged in” work that requires advanced knowledge and in a position that requires the exercise of discretion and judgment, so even if they have the requisite professional training from a college education, the nature of the job duties they perform, if menial enough, could nonetheless require that they be treated as non-exempt, e.g., an office clerk with a college diploma is still considered a non-exempt employee if they are primarily engaged in tasks which don’t use the skills of that degree, and, more importantly, don’t exercise the types of duties required for a professional exemption.

The administrative exemption is the one that has historically caused employers the most trouble when it comes to misclassification lawsuits.  In California, an employee generally qualifies for the administrative exemption if the following requirements are met.

First, the employee must perform either office or non-manual work that is directly related to management policies or the organization’s business operations. This requirement is generally the key requirement. Some examples of positions that often qualify as administrative functions include human resources employees, accounting and tax employees, and marketing and advertising employees. Whether, however, an employee in one of these positions is exempt, depends on whether they meet the other applicable requirements and tests.

Second, and more important, to qualify for the administrative exemption, the employee must regularly exercise discretion and independent judgment, must work only under general supervision, and must perform specialized or technical work that requires special training, experience or knowledge. Finally, to be properly classified under the administrative exemption, the employee must have actually obtained special training, experience, or knowledge to perform the job tasks.  While such employees can perform tasks that don’t meet the above-criteria, e.g., answering phones, word processing, etc., those employees must perform those tasks less than 50 percent of the time.

Many “office workers” such as clerks and secretaries, have been misclassified as exempt under the presumption that the administrative exemption applied.  Those employers have later been subject to lawsuits, sometimes even class actions, for misclassifying those employees, and have had to pay significant amounts to settle those claims or satisfy judgments.

In addition to the general exemption classifications, California also has exempted certain specific professions from overtime pay.  Computer professionals who possess an advanced level of proficiency in the theoretical and practical application of a body of highly-specialized knowledge in computer system analysis, programming, and software engineering are deemed exempt.  The key to this particularized exemption is that it does not apply to any employee who uses a computer to perform their job.  Trainees or employees in entry level positions are generally not exempt, and computer professionals who have not attained a level of skill and expertise that allows them to work independently without supervision are generally not exempt. Unlike the professional exemption, however, the exemption for computer professionals does not require an advanced degree or certain certifications.

Because determining whether an exemption applies to allow an employer to avoid paying overtime requires a fact-intensive application of the various exemptions to the job duties of an employee or class of employees, employers must exercise extreme care in making classification decisions.  Even an innocent misclassifications can result in the employer facing years of liability for unpaid wages, with severe monetary penalties, and attorney’s fees added to that.

It’s a lucrative and relatively easy business for plaintiffs’ attorneys to sue employers once they become aware that a small, medium or large employer has misclassified a significant portion of its workforce. And because employees in professional, executive, and technical positions often work long hours and on weekends, an employer who misclassifies these employees often faces much more than monetary liability than repaying a few hours of back pay to a single employee.