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Avoiding Overtime Penalties

Avoiding Overtime Penalties

Retailers can incur costly penalties for violating the overtime regulations of the Fair Labor Standards Act (FLSA). Here’s what you need to know about wage-and-hour regulations, to keep your business safe from prosecution.

By Phillip M. Perry

Wage-and-hour law has long bedeviled retailers, and, increasingly, federal and state prosecutors are finding that willful violations of the overtime regulations of the Fair Labor Standards Act (FLSA) are criminal acts for which business owners are liable. The Biden administration is expected to reduce the number of employees exempt from overtime by raising the required salary threshold and tightening the workplace duties tests. 

So how do you determine who is exempt from overtime rules? How do you calculate time-and-a-half when employees work through their lunch hours and fail to record their hours? And how about remote workers? 

The wrong actions can spark costly penalties. “Employers who fail to correctly pay overtime must make up back wages plus ‘liquidated damages’ equal to an equivalent amount,” says Douglas E. Witte, who represents businesses in labor and employment law matters at Boardman & Clark in Madison, Wis. “If the U.S. Department of Labor thinks an employer willfully violated the law, the statute of limitations gets bumped up from two to three years. And employers may also have to pay attorneys’ fees for individuals who have brought successful lawsuits.”

The Department of Labor, the IRS and state agencies have been increasing audits and suits for wage-and-hour violations. But the latest legal wrinkle is even more troubling: an increase in criminal prosecutions. “The U.S. Department of Justice and state prosecutors are devoting more attention to finding that violations of the Fair Labor Standards Act (FLSA) and other wage-and-hour laws constitute criminal acts,” says Robert E. Gregg, co-chair of the Employment Practice Law Group at Boardman & Clark. “Both employers and managers are facing prosecution, in addition to civil liability. The big difference is that the company pays most of the civil liability. In criminal cases, the individual gets convicted.”

Workplace observers expect compliance to get tougher as the federal government starts tightening regulations. “Part of the Biden platform was to empower workers,” says Ann F. Kiernan, an employment law attorney and lead trainer at Fair Measures, a management practices consulting firm in Denver, Colo. “I expect a lot of pro-employee activity, to include increased enforcement by the Department of Labor.”Among the likely regulatory steps over the coming months include boosting the overtime salary threshold and rewording exemption parameters. Many states are also passing legislation aimed to protect and expand employee overtime.

THE EXEMPTION PUZZLES

It follows that all employers should make a point of correctly categorizing workers as either exempt or non-exempt from overtime. 

• Exempt employees are paid a salary—which must be at least $684 per week or $35,568 per year (NOTE: this requirement can vary by state)—for the work they perform; therefore, as salaried employees, they are not eligible to receive overtime pay and are excluded from minimum wage requirements. In addition, exempt status also generally only applies to employees who hold executive, administrative or professional roles that require a higher level of expertise and knowledge. Salaried managers and floral designers could qualify for exempt status; however, it would be wise to consult an attorney specializing in labor law for ultimate clarification and determination—or research the “duties tests,” which are addressed in the fourth ensuing paragraph.

• Non-exempt employees are paid an hourly wage—which must be at least the federal minimum wage of $7.25 per hour (or a specific state’s minimum hourly wage if it is higher than $7.25; currently 30 states and Washington, D.C. have minimum wages higher than the federal minimum wage)—and they must be paid overtime of not less than one-and-one-half times their regular hourly wage for all hours worked over 40 hours in a workweek (defined as a “fixed and regularly recurring period of 168 hours—seven consecutive 24-hour periods”).

Retailers with only local traffic often erroneously believe that overtime law does not apply to them because the FLSA covers enterprises engaged in interstate commerce. In reality, any local enterprise comes under the FLSA umbrella if it performs seemingly innocuous tasks such as making phone calls or sending emails to vendors or customers in other states, transacting credit card payments with distant individuals or entities, or receiving goods or services from beyond state borders. Many retail florists perform at least one—if not all—of these activities. “It’s the rare business that is not involved in some way with interstate commerce,” says Matthew C. Heerde, principal at Heerde Law in New York, N.Y.

Small retailers may also believe they can ignore overtime law because their revenues come in under the $500,000 level at which the FLSA normally kicks in. Yet even the smallest operation is subject to the FLSA on a so-called “per-employee basis” if even a single worker spends a substantial amount of time performing the tasks enumerated in the previous paragraph. Finally, state and local overtime laws that mimic FLSA regulations often apply to the smallest of employers, regardless of interstate commerce status.

Errors are easily made. “Employers most often get into trouble for misclassifying employees as exempt,” says Witte. Ignorance of the law is no excuse, he adds, and wise businesses keep paperwork to support their decisions. “The burden of proving exempt status is on the employer.” Employers must be able to convince regulators that exempt personnel fall into one of the so-called “white-collar categories” labeled executive, professional or administrative. Exemptions may also be granted for some people who are computer professionals, engage in outside sales or are highly compensated.” Employers can review the complete duties tests by visiting any of the following websites:

• dol.gov/agencies/whd/fact-sheets/17a-overtime

• flsa.com/coverage.html

• shrm.org/resourcesandtools/tools-and-samples/hr-forms/pages/cms_009647.aspx

• eddy.com/hr-encyclopedia/the-duties-test

For exempt-status individuals, nondiscretionary bonuses and commissions, paid annually or more often, may be used to satisfy up to 10 percent of the minimum salary requirement ($684 a week/$35,568 per year), which many observers believe is due for an increase. “I think we’re going to see the Biden administration raise the salary threshold, perhaps linking it to cost of living increases,” Witte proffers.

Paycheck size alone, though, is not sufficient criteria. “Employers sometimes fail to understand that exemption from overtime requires not only meeting the salary threshold but also passing the so-called ‘duties tests,’” says Heerde. While the duties tests vary by exempt category, they boil down to one essential: The exempt person must exhibit sufficient independent authority to make essential decisions in their daily work. Just being assigned an impressive-sounding job title is not enough.

Employers should brace for changes in these exemption parameters. “The DOL is likely to take a strong look at the duties tests for white-collar exemptions,” says Witte. “The language has not been tweaked in recent years to reflect the way people work today. It may become harder to prove that a certain individual exercises independent judgment and authority rather than just processes papers or follows a flow chart of actions.” 

As the above comments suggest, qualifying for exempt status often requires judgment calls—and that’s just where employers often get into trouble. There is a common temptation—conscious or otherwise—to classify people as exempt to avoid the costs of overtime. This is exactly the problem the Biden administration has stated it wants to address. State and local governments have also been tightening regulations and increasing inspections to ensure that exempt personnel are really exercising management-level decision-making.

Retailers often run afoul of the law by exempting some upper-level personnel who do not exercise sufficient management duties. “Many times, assistant store managers classified as exempt do not really qualify,” says Witte. “Maybe they have keys to open and close the store, and maybe they do some things with the registers, but otherwise they are working the floor like everyone else and do not have sufficient authority or enough qualifiable duties. This problem has been on the radar of the Department of Labor for some time. Employees have filed complaints, and there have been class-action lawsuits.” 

Misclassifications can be costly for employers, especially when an exempt individual’s salary has steadily increased over time. Should a DOL inspector issue a violation, the employee’s elevated salary is first broken down into an hourly rate, which is then utilized as the basis for calculating past overtime and penalties. “Sometimes an employer will react to a steadily rising paycheck by saying something like, ‘This person has been starting to work too much overtime; let’s just make [him/her] salaried,’” says Bob McKenzie, president of McKenzieHR, a payroll and HR services company in Brunswick, Ga. “That’s not allowable unless the individual truly qualifies for exemption.” 

The lesson is clear: Employers should assume non-exemption when classification is ambiguous. “The law is deferential to workers in wage-and-hour actions,” says Heerde. “The consequences can be costly for an employer who does not have sufficient records to refute an employee’s wage-and-hour claims before an administrative agency or court.” 

OFF THE CLOCK

While misclassification is the most common error in wage-and-hour law, employers can also be penalized for allowing work time to go unrecorded. “Employees often fail to report off-the-clock hours,” Witte notes. “Maybe they work through their lunch hour, or they come in early or stay late and don’t record it because they’re afraid of getting into trouble with their boss for working overtime. This is an area that the Department of Labor continually receives complaints about.”

Retailers seem especially vulnerable to the temptation to let things slide. “Sometimes store personnel will work off the clock for a few minutes—either at the workplace or at home, maybe checking their emails or making a phone call or two—and the retailer thinks that’s OK,” says Vicki M. Lambert, CPP, president and academic director of ThePayrollAdvisor.com. “One retailer got into trouble by having employees drop off packages to customers on their way home from work but failed to pay the workers for the delivery time. The fact is that having employees work off the clock is not OK, even if it’s for only a few minutes.”

Retailers can also suffer for the often-uncertain level of need for employee labor. “Very often, retail workers will come to the stores in response to a store manager’s order but are then told to stand by because they are not needed for a while,” says Witte. Retailers must pay for such so-called “engaged to wait” time.

While one might suspect that some misguided employers overlook or even encourage off-the-clock labor, the fact is that workers can also be to blame, says Lambert. “Sometimes, employees will get enthusiastic and think, ‘Well, I’ll just do this job off the clock really quick, and then my boss will be really happy.’ And they end up getting the employer in trouble.”

Other times, employers will allow record-keeping to fall through the cracks. “Problems can arise when an hourly recording system is not sufficiently detailed or not contemporaneous,” says Heerde. “Later, when an issue arises, the employer has to track down evidence of work hours by sorting through old emails and other records to prove an employee was paid correctly.”

Accurate and detailed record-keeping is especially important for retailers who invoke the Section 7(i) exemption of the FLSA. Under this exemption, retailers need not pay overtime to workers who earn at least half of their pay on a commission basis and who receive at least one-and-a-half times the applicable federal or state minimum wage. Both conditions must be supported by adequate records for retailers to avoid costly penalties.

The record-keeping challenge has increased as more people work from home. “One of the most common mistakes is failing to correctly track remote workers’ time,” says Lambert. “In fact, employees must be compensated for all time worked, even if off-the-clock labor violates company policy.” 

Employers who wish to discipline employees who put in extra time without permission must use nonfinancial procedures such as verbal and written warnings; personnel file notations; or terminations, if appropriate.

FREELANCERS AND INDEPENDENT CONTRACTORS

Employers are not obligated to pay overtime to freelancers and independent contractors. Just who qualifies for that status, however, is not always clear. “Distinguishing between employee and freelancer or independent contractor status is an ongoing challenge,” says Heerde. “Because many states have different standards from the federal government about where to draw the line, compliance and enforcement issues arise.” Individuals classified as freelancers or independent contractors will sometimes later file complaints claiming that they were actually employees and are due back overtime. This can lead to costly litigation.

To qualify as a freelancer or an independent contractor, a person must have legally established a formal business enterprise (federal, state and local business licenses and permits: tax registrations; DBAs; EINs; etc.).

By definition, both freelancers and independent contractors work for organizations temporarily, with a nonemployee status, but there are some differences between the classifications. For example, most freelance jobs are generally part time and smaller or limited in scope and time frames: a day or part of a day, a week or even longer. Independent contractor projects are typically larger jobs, with longer time frames. In the eyes of the IRS, however, a freelancer and an independent contractor—also called a 1099 contractor—are the same thing.

Wage-and-hour attorneys expect the federal and state governments to tighten the standards that determine who is in business for themselves. “I think the Biden administration will make it much more difficult to classify someone as a freelancer or an independent contractor,” says Witte. “Things will probably head the way of California, which has an extremely restrictive test.” In early May, the DOL withdrew a regulation introduced by the Trump administration that would have made it easier to classify someone as a freelancer or an independent contractor.

Until the new regulations are firmed up, attorneys advise employers to play it safe. “I recommend that employers make sure that freelancers and independent contractors are operating their own businesses [legally established a formal business enterprise] and are in positions to make profits or losses based on their own actions,” McKenzie says. “They should also submit invoices for work done—and their payments should go through the business’s accounts payable department rather than the payroll account.”

COMMON PITFALLS

Employers can also be penalized for errors in these other scenarios: 

• Standby Time  Employees arrive at a store location in response to a manager’s directive, only to be told to stand by because they are not needed for a while. The manager incorrectly fails to record their waiting time as compensable hours.

• Substitute Hours  Instead of paying time-and-a-half to an individual due overtime, the employer grants a day off the following week as compensation. This violates the law requiring overtime for any labor of more than 40 hours in any single workweek.

• Paycheck Deductions  Employers deduct from employees’ wages such things as cash shortages in the registers, merchandise shrinkage or uniform costs. Such deductions can’t be made if the individual’s compensation would fall below the minimum wage or would reduce their overtime pay. Many state laws also restrict such deductions.

STAYING CURRENT 

With increasingly onerous regulations by the federal, state and local governments, payroll has become more complicated in recent years,and employers are likely to encounter even greater challenges as regulators at each of these levels retool wage-and-hour regulations to reflect a greater sensitivity to employee rights. Businesses must skillfully navigate this shifting terrain to avoid errors that spark costly financial penalties. “Employers are responsible for making sure payroll is done correctly,” Lambert states. “They must keep up to date with changing laws.”

In a growing number of cases, as stated earlier in this article, violations can spark criminal rather than civil actions. Intentionality is key. “If failure to pay overtime is simply a result of miscalculation or misclassification, that’s a civil action rather than a criminal one,” Gregg explains. “In order to be a criminal action, the individual must show intentionality. Some examples of intentionality are having people work off the clock so the business can avoid overtime, deliberately pocketing the overtime money or engaging in a variety of tricks to deliberately avoid paying overtime so that people do not get what they’re due.”

Even wage theft done for good purposes can spark criminal prosecution. “Economic hardship brought on by the pandemic caused a number of business owners to avoid paying wages in order to keep their businesses afloat,” Gregg says. “In some cases, they thought, ‘If I can’t pay the rent or utilities and we close, I won’t be able to pay anybody, so everybody will lose their jobs. Therefore, I will not pay them any overtime, or I won’t pay them what they’re due. Or I will pay them under the table so that neither we nor they have to pay the taxes. And we will take the money and pay the bills.’ The fact is that even if business owners didn’t actually stuff the money into their own pockets, the wage theft was an intentional act of breaking the law.”

In other words, flying without an adequate legal radar can result in a crash landing. “Many retailers don’t understand wage-and-hour law and make things up as they go along,” says McKenzie. “They think everything will be okay, but, sooner or later, they get caught.”

QUIZ: Is Your Business Compliant?

Is your retail business prepared to defend its overtime exemptions to inspectors from the Department of Labor? Find out by taking this quiz. Score 10 points for each step your business has taken. Then total your score and check your rating at the bottom of the quiz.

1. Ensured that all exempt (salaried) employees are paid at least the legal salary threshold ($684 per week/ $35,568 per year)

2. Determined that all exempt individuals can pass the appropriate duties tests

3. Assumed “nonexemption” in ambiguous cases 

4. Maintained detailed time sheets to support overtime decisions and any FLSA Section 7(i) exemptions

5. Prohibited all employees from working off the clock, even during lunch hours

6. Paid for all overtime worked, even if employees violate company policy in doing so

7. Instructed employees, including remote workers, to record even short periods of time they work, such as sending or answering business emails or making or returning phone calls

8. Ensured that any freelancers or independent contractors are legitimately self-employed

9. Paid employees for any standby time

10. Avoided questionable paycheck deductions

WHAT’S YOUR SCORE? 

80 or more: Congratulations. You have gone a long way toward preserving your business from costly wage-and-hour violations. 

Between 60 and 79: It’s time to fine-tune your overtime procedures. 

Less than 60: Your business is at risk. Immediately act on the suggestions in this article.

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