There is a strong presumption in favor of paying employees overtime when applicable, and providing them with the protections of various wage-hour laws. Employers always have the burden of establishing that an exemption from some or all of these laws applies. The exemptions for sales employees are particularly confusing for many California employers, and misclassification in this area can be costly.

Both California and federal law contain exemptions from overtime and other wage-hour requirements for certain sales employees. California employers that are subject to the federal Fair Labor Standards Act (FLSA) (i.e., they employ at least two employees and generate annual sales of at least $500,000) must ensure they satisfy the requirements of federal and state law when applying these exemptions.

Inside Sales Employees

Employees who are paid commissions may be exempt from overtime under the inside sales exemption.

California law provides that only employees covered by Industrial Wages Orders 4 (those working in “professional, technical, clerical, mechanical and similar occupations”) and 7 (those working in the retail industry) may be covered by the exemption.

To qualify for the California exemption, these employees must be paid more than one and one-half times the applicable state minimum wage for every hour worked, and at least 50% of those wages must represent “commissions” (i.e., a percentage of the price of the service or product sold).

In addition, the employees must be selling (not producing) a product or service. The timing of commission payments is also important. As the California Supreme Court recently explained in Peabody v. Time Warner Cable, more than 50% of an employee’s wages must come from commissions in each workweek. Otherwise, the exemption is inapplicable for that pay period.

Also, the inside sales exemption in California only exempts covered employees from the payment of overtime. These employees must still receive required rest breaks and meal periods, and they are subject to other wage-hour laws applicable to non-exempt employees.

Under the federal FLSA, the inside sales exemption is more difficult to satisfy than under California law. Similar to California, the FLSA exemption, commonly referred to as the 7(i) exemption, requires that employees’ regular rate of pay exceed one and one-half times the applicable state minimum wage for each hour worked, and at least 50% of those wages must represent “commissions.” In addition, however, the 7(i) exemption only applies only to “retail” and “service” establishments-such as retail stores, hotels and restaurants. So, an employee may be covered under California’s inside sales exemption (e.g., an employee selling leases in an office environment), but not meet the requirements of the more restrictive 7(i) exemption.

Outside Sales Employees

Both California law and the FLSA contain exemptions for outside sales employees. However, there are key differences between state and federal law in this area.

To qualify for the exemption in California, employees must be 18 years of age or older and spend more than more than 50% of their working time away from the employer’s principal place of business actually selling products, services or use of facilities. Only time spent “directly involved” in selling items or obtaining orders or contracts is counted towards the more than 50% requirement.

Under the FLSA, the requirements are much less strict. The employees’ “primary duty” must be making sales, but there is no more than 50% requirement. In addition, there is no age limitation, and the FLSA permits employees to engage in incidental work that “furthers the employee’s sales efforts,” without jeopardizing the exemption.

Tips for Employers

Because of the substantial liability associated with misclassifying employees as exempt, employers should carefully evaluate the requirements of any exemption before applying it a particular position or group of employees.

California employers often forget about the FLSA’s requirements, because they are usually much less protective of employees than California law. The 7(i) exemption for inside sales employees is an important exception to this general rule. Many California employers have faced claims before the Division of Labor Standards Enforcement and in court because they classified employees under the inside sales exemption without meeting the 7(i) requirements.

In addition, California’s inside sales exemption only exempts covered employees for the payment of overtime. There are a number of other laws relating to rest breaks and meal periods, minimum wage, recordkeeping, for example, that still apply to exempt inside sales employees.

The outside sales exemption can also create problems for California employers. The exemption only applies if the employees are working out of the office-even a home office-for more than 50% of their time. Simply reassigning an employee to a remote location will not qualify. Also, sales employees who spend too much time on “incidental” sales tasks are not covered by the exemption.

Employers should keep carefully consider these principles before classifying employees as exempt under either of the sales exemptions.