Infographic | 4:12 min read

Exempt vs Non-Exempt Employment

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What are the key tax differences?

It’s important for small business owners to understand the key differences and responsibilities in dealing with exempt and non-exempt employees.  Failure to comply with the Fair Labor Standards Act (FLSA) as well as state and local regulations related to employee classification may result in fines for employers, whether they are non-exempt or exempt organizations. 

What is an Exempt Employee?

Most typically, an exempt worker is one that is paid a salary in return for professional services. This exempt employee is not covered by FLSA provisions on minimum wage and overtime pay. Typically independent contractors are not covered by the FLSA, but an economic realities test should be applied to determine whether a worker is in fact an independent contractor.

Some examples of an exempt employee might typically include office managers, lawyers, teachers, engineers and sales managers. 

If an employee earns a minimum base salary as provided in the FLSA regulations and be generally paid the same amount each week, regardless of quantity or quality of work, they are exempt from FLSA provisions.

Further, employees must also meet one or more of the DOL's job duties test to be classified as exempt from the overtime and minimum wage provisions of the FLSA. Be mindful that some jurisdictions have additional rules regarding who qualifies as exempt vs. nonexempt.

What is a Non-exempt Employee?

Simply put, Under the FLSA, a non-exempt employee is entitled to receive at least the minimum wage and overtime pay. Non-exempt employees are typically compensated on an hourly basis but some may be paid a salary. As an employer, you should understand what the FLSA is and the regulations that enforce it require when an employee is nonexempt.

Non-exempt workers are individuals who are eligible for FLSA requirements, including the federal minimum wage and overtime pay for working more than 40 hours per week. While most non-exempt positions are paid hourly, it is possible to earn a salary or incentive compensation instead.  Some examples of non-exempt employees include carpenters, electricians, mechanics, food service and retail workers. 

Exempt vs Non Exempt Graphic

Why is it Important to Understand the Differences?

The FLSA requires employers to pay all nonexempt employees at least the federal minimum wage for hours worked, plus overtime pay at one and one-half times the regular pay rate for hours worked over 40 during a workweek. Employers with nonexempt employees must also be mindful of any requirements imposed by state and local law.

It’s important to also note that there are legal and financial consequences for employers who don’t classify employees properly.

Tax Implications for Exempt Employees

Most exempt employees receive a fixed salary each pay period, so their earnings are considered regular income and are subject to federal income tax, at minimum. Exempt employees might also be eligible for pre-tax benefits like health insurance, retirement plans.

Note that employers are responsible for withholding taxes from an employee's paycheck and remitting them to the appropriate government agencies. The amount of taxes withheld will depend on the employee's salary, as well as the information they provide on their W-4. 

What about state laws and other jurisdictions?

In addition to federal regulations, some states have unique wage and hours laws that affect exempt, nonexempt, or both categories of employees. It is the employer’s responsibility to understand these statutes in addition to FSLA regulations. This is especially important for multi-state employers.

Mistakes for Employers to Avoid in Dealing with Exempt Employees

  • Docking salary for poor performance
  • Reducing their salary for misconduct without a written policy
  • Making a deduction for partial-day absences
  • Requiring exempt employees to work the day before and after a company holiday in order to receive "holiday pay."
  • Reducing salaries for emergency company closings
  • Violating limits on using bonuses to meet the salary requirement
  • Paying part-time exempt employees less than what is required
  • Reducing exempt employees’ compensation for sick days.
  • Failing to ensure compliance with state requirements.

Employer Best Practices

  • Have a clear and comprehensive job description that supports that an employee’s job duties meet the requirements for the primary duties test.  It’s also a good idea to audit your job descriptions annually. 
  • On the subject of audits, it’s also a best practice to audit employee job duties and basis of pay to ensure proper classification under the FLSA.  Ensure that you have proper documentation to justify the exemption status. 
  • Consult with legal counsel if they are unsure of how to proceed with an FLSA exemption audit or they have a position that they believe may be at risk of misclassification. An outsourced HR function may also have the expertise to assist. 
  • Consistently stay on top of applicable state or local wage and hour laws that may have additional requirements to ensure compliance with all applicable laws.

It’s important that both employees and employers understand the key differences between the exempt and non-exempt worker classifications. The financial impact for both parties is substantial, primarily regarding tax rates and deductions. Further, there are legal ramifications for employers if they don’t follow FLSA and state regulations. 

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The information provided in these articles is intended for informational purposes only. It is not to be construed as the opinion of Central Bancompany, Inc., and/or its subsidiaries and does not imply endorsement or support of any of the mentioned information, products, services, or providers. All information presented is without any representation, guaranty, or warranty regarding the accuracy, relevance, or completeness of the information.