Employers face a host of challenges to properly paying employees, particularly when it comes to overtime. When employees are properly classified as “exempt” from the overtime rules, an employer need not worry about these issues. But, the penalties for misclassification can be significant.

Employers who reward non-exempt employees (those entitled to overtime) with additional forms of compensation beyond a base hourly rate, like bonuses or commissions, also face liability if they do not include such payments amounts in the calculation of the overtime owed to these employees.

Minimum Salary Requirements for Exempt Employees

Properly classified “white-collar” executive, administrative, and professional exempt employees are paid for the quality and not the quantity of their work. They are not entitled to overtime. To qualify for these overtime exemptions, employees must perform certain (generally higher level) duties and receive a minimum fixed salary.

Recently, the U.S. Department of Labor amended its overtime regulations to drastically increase the minimum salary requirements for white-collar exempt employees. Effective December 1, 2016, the previous minimum salary of $455 per week ($23,660 per year) will increase to $913 per week ($47,476 per year). Thereafter, the minimum salary will increase automatically every three years, according to an established formula. The new rules permit employers to use nondiscretionary bonuses and incentive payments (those tied to hours worked, production, or efficiency) to satisfy up to 10 percent of the minimum salary requirement.

Currently, California’s white collar exemption requirements are stricter than the federal exemption requirements. For example, the California minimum salary for exempt employees is twice the state’s minimum wage ($41,600 per year), which is much higher than the existing federal minimum salary. Additionally, California rules require employees spend no less than 50 percent of their time on exempt duties, while federal law does not include such a quantitative, time-based requirement.

As a result of the changes the federal regulations, California employers seeking to take advantage of the white-collar exemptions must meet the higher level salary requirements of the federal rules. Otherwise, employees—even salaried employees meeting the stricter duties requirements of California law—will be entitled to overtime under federal law.

Calculating the “Regular Rate” of Pay

Another challenge for employers is properly calculating the overtime rate for non-exempt employees. Many employers mistakenly pay overtime at time and half or double the employee’s base hourly rate, without taking into account other forms of compensation, such as multiple pay rates, shift differentials, commissions, and production bonuses. In fact, these and other forms of non-discretionary compensation received during the workweek must be included in the “regular rate” of pay used to calculate overtime.

The federal regulations—also relied on for interpreting California law on this issue—address how or if an employer must factor various forms of compensation into the “regular rate.” Generally, compensation not measured by or dependent on hours worked, production, or efficiency, such as discretionary year-end bonuses and gifts, are excluded from the regular rate. Similarly, payments for periods when no work is performed, such as holiday, vacation, and sick pay, also do not factor into the regular rate.

But, given the variety of ways that employers compensate non-exempt employees, employers must regularly review their pay practices to ensure compliance with these requirements. Recently, in Flores v. City of San Gabriel, the Ninth Circuit Court of Appeals held in a case of first impression that cash payments made to employees in lieu of health benefits must be included in the “regular rate” under the FLSA, even though the payments did not directly relate to work hours. The court reasoned that the payments were a form of compensation for performing work, and therefore should be included in the regular rate.

Employers Should Conduct Self-Audits to Avoid Costly Penalties

The consequences of failing to satisfy the requirements for the overtime exemptions (i.e., “misclassification”)—including the minimum salary requirement—can be significant. Employers may owe amounts for hours that were worked but not paid, including overtime, failing to provide meal and rest breaks, failing to keep accurate time records, and a variety of other related claims and associates penalties. Employers considered to have “willfully” misclassified face additional penalties, as well.

Similar liability results when employers do not properly pay overtime to non-exempt employees at the “regular rate.” In addition to owed wages, employers may owe penalties for failing to provide accurate wage statements, and “waiting time” penalties to former employees who were not paid all amounts owed at termination. Again, “willful” violations increase the statute of limitations and subject the employer to potential liquidated damages.

To avoid these and similar wage and hour pitfalls, California employers should regularly audit their wage and hour practices to ensure compliance. Employers working with third-party payroll processors should not assume the processors are ensuring each employee meets the minimum salary requirements, or properly calculating the regular rate, either. Instead, employers—who will ultimately be legally response for compliance—should assume primary responsibility for these functions (e.g., identifying amounts to be included in the regular rate), and should rely on their payroll processors to perform the calculations correctly.