Non-Exempt vs Exempt Employees: A Guide for Businesses

The non-exempt vs. exempt employees question refers to the workers covered and not covered by the Fair Labor Standards Act (FLSA), respectively. Non-exempt workers are protected by this act, which mandates aspects such as minimum wage and overtime pay. Exempt workers, on the other hand, aren’t covered and thus don’t get these benefits.

Understanding this distinction is rather important for employers because it directly impacts their payroll management. They need to know which of their workers are exempt and which aren’t so that they can prepare and calculate their overtime and benefits packages for extra hours worked.

In this article, we’ll explore the exact differences between these two types of employees and all the implications that come with them. Let’s get started!

Key Takeaways

• Exempt employees receive a fixed salary and are not covered by the FLSA, which means they aren’t entitled to a minimum wage or overtime pay.
• Non-exempt employees are covered by the FLSA, entitled to a minimum wage and overtime pay, and paid by the hour.
• Misclassifying non-exempt workers as exempt can result in severe legal consequences and significant financial penalties.
• Independent contractors aren’t employees and, as such, don’t fall under either the non-exempt or exempt category.
• Both types of employees are subject to tax withholding and are eligible for unemployment benefits.

What is an Exempt Employee?

An exempt employee is a worker who is not covered by the Fair Labor Standards Act (FLSA). This means they aren’t entitled to receive overtime compensation or minimum wage. One of the main reasons for this is that they receive a stable or fixed salary.

Jobs in the executive and administrative departments, the computer technology field, and workers with professional roles such as lawyers, engineers, doctors, accountants, and outside sales are categorized as exempt.

But where and how did the exempt and non-exempt classifications originate?

In 1938, the FLSA passed the category that identified exempt employees to establish ground rules for fair labor practices and regulations.

Aside from the jobs that fall under the exempt category, the FLSA adds that employees who earn at least $684 weekly or $35,568 annually, employees of American vessels, railroads, local broadcast stations, and motion picture theaters, as well as farm workers and taxi drivers, are also considered exempt. The additional qualification was recently included in 2022.

While exempt employees are not eligible for overtime pay, they may be entitled to receive year-end bonuses, retirement plans, and paid sick or vacation leaves instead.

What is a Non-Exempt Employee?

A non-exempt employee is one covered by the FLSA and, as such, entitled to a minimum wage and overtime pay. The Department of Labor mandates that covered employees receive overtime pay for hours worked over 40 in a workweek at an increased rate.

In calculating a non-exempt employee’s overtime compensation, their hourly rate is multiplied by 1.5. It is important to note that the minimum wage may differ based on their employment location.

Non-exempt employees use a timecard to monitor their work hours and cross-reference the hours they have completed with their wages. Examples of non-exempt employees are servers, maintenance crew, para-professional workers, interns, and people in the clerical sector.

People who work under a supervisor who delegates their tasks or those who are not involved in important decision-making processes in the business are also considered non-exempt.

Exempt vs Non-Exempt Employee Summary:

Here’s a brief table summarizing the differences between exempt and non-exempt employees:

FLSA Wage and Hour Laws

Among the main responsibilities of the Fair Labor Standards Act (FLSA) is governing and ascertaining the regulations on minimum wage and overtime compensation.

Consequently, the Department of Labor’s Wage and Hour Division executes the FLSA’s regulations. The federal minimum wage is set at$7.25per hour.

In 2023, the following states increased the minimum hourly wage for non-exempt employees:

In some instances, an employee may have been granted or entitled to a performance-based increase that already matches the new minimum wage rate. Employers are advised to assess how the increase will impact employee satisfaction, fairness, and operational costs.

Exempt Employee vs. Non-Exempt Employee: Pros and Cons

Here are the most important advantages and disadvantages to exempt and non-exempt employees for both the workers and their employers:

#1. Exempt Employees Pros & Cons

Let’s start with the pros for employees:

• Fixed salary. Exempt employees receive a fixed paycheck regardless of the hours worked, resulting in increased security and predictable income.

• High earning potential. While they aren’t entitled to overtime pay, exempt employees typically earn more than non-exempt workers.

• Lucrative benefits. Exempt employees are often entitled to various benefit packages, like health insurance and retirement benefits.

Here are the cons for employees:

• No overtime pay. Exempt employees have a fixed salary that won’t increase, no matter how much they exceed their 40-hour workweek.

• Potential for long hours. In addition to not being eligible for overtime, exempt employees are often required to work much longer than non-exempt employees.

• Higher expectations. Exempt employees often receive their salaries based on performance, so employers have high expectations for their goals and performance metrics.

Now, let’s see the pros for employers:

• Predictable labor costs. Employers have an easier time budgeting their labor costs in advance, as they give exempt employees fixed salaries.

• Focus on performance. Compensation can be directly related to performance, allowing employers to award bonuses and perform salary adjustments based on output.

Lastly, here are the cons for employers:

• Higher salary costs. Even without paying overtime, employers often compensate non-exempt employees with lucrative salaries.

• Potential misclassification issues. Misclassifying a non-exempt employee as exempt can lead to legal and financial penalties.

#2. Non-Exempt Employees Pros & Cons

Let’s explore the pros and cons of non-exempt workers, starting with the pros for employees:

• Overtime compensation. The most direct benefit of being a non-exempt employee is the eligibility to be compensated for overtime at a rate of at least 1.5 times the regular rate.

• Payment for all hours. Since non-exempt employees are paid by the hour, they will always receive every last penny for the work that they performed.

• Potential for flexible hours. Non-exempt employees can have roles that offer increased flexibility in schedules. They can also work part-time.

Going forward, here are the cons for employees:

• Inconsistent income. Since they are paid for the hours worked, non-exempt employees will have a varying income, which makes it unpredictable.

• Potentially lower base pay. While they are eligible for overtime pay, non-exempt workers typically have lower salaries than exempt workers.

Now, let’s switch to the pros for employers:

• Improved labor cost management. Since the compensation is directly tied to their hours worked, employers have a better overview of their operational expenses. Moreover, they control the rates and can pay a minimum wage, which is particularly important during periods of lower demand or production.

• Flexibility. Employers can hire non-exempt employees for shorter periods or as part-time workers. This allows them to adjust staffing to their specific needs.

Finally, here are the cons for employers:

• Time-tracking requirements. Tracking the hours for each employee can be a demanding aspect of running a business. It can take a lot of administrative effort, but it’s essential for ensuring compliance with FLSA.

• Inconsistent labor costs. Since employees can work fewer than 40 hours one week and more than 40 hours in another, this can lead to fluctuations that increase unpredictability when calculating labor costs.

Non-Exempt vs. Exempt Employees Pros & Cons Summary

Here’s a brief overview of the pros and cons of non-exempt and exempt workers for both employees and employers:

Exempt vs. Non-Exempt Employees Tax Implications

Now that we’ve enumerated the pros and cons of being a non-exempt vs. exempt employee, let’s briefly discuss tax implications.

There are no distinctions between non-exempt vs. exempt employees when it comes to their tax obligations. The IRS taxes exempt and non-exempt income the same and uses their filing status and tax bracket in determining their taxes owed.

With exempt and non-exempt workers subject to paying federal income tax, including state and local taxes, this also means they are entitled to certain tax benefits or tax breaks.

Tax benefits are useful in reducing an employee’s tax liabilities. Employers are responsible for withholding income taxes from their employees’ pay. Employers use their employee’s Form W-4 to determine the exact amount that goes to their employee’s taxes and contributions.

Unemployment Benefit

FUTA (Federal Unemployment Tax Act) and SUTA (State Unemployment Tax Act) are taxes meant to provide funding for the federal and state government’s unemployment support programs.

Exempt and non-exempt employees are both eligible to receive unemployment benefits. However, they must consult with the authorities in their area because states and locales have different compliance practices and regulations for providing unemployment assistance.

How to Classify Non-Exempt vs. Exempt Employees

There are specific requirements set by the Department of Labor that classify whether an employee is non-exempt vs. exempt.

The following are the main tests used to distinguish between the two categories:

• Salary grade. Exempt employees typically receive a weekly salary of $684 and above. Meanwhile, non-exempt employees are paid hourly wages, with the rates based on the established minimum wage in their state or locale.

• Compensation structure. Another key way of classifying non-exempt vs. exempt employees is by assessing whether they are required to follow a strict and fixed schedule or if they work more flexibly, such as in a contractual or part-time position.

• Job role. Employees taking on a role in the administrative, executive, or computer technology department are considered exempt. Doctors, lawyers, and supervisors are also exempt employees. Non-exempt employees are those whose work requires the close supervision of an individual holding a managerial or higher position. Other job roles that fall under the non-exempt category include servers, maintenance, and clerical tasks.

• Outside sales. An outside sales employee is different from a sales personnel who conducts inside sales of products for the company. Outside sales entails generating sales and getting customer orders and contracts outside of the company’s or the employer’s main area of business. Outside sales employees are exempt from overtime pay.

Non-Exempt vs. Exempt State Laws

All states follow non-exempt vs. exempt FLSA or federal regulations. However, some states have specific regulations and compliance practices that employers must abide by.

Below are some of these state-exclusive laws for hiring non-exempt and exempt employees:

Alaska

In response to the increased minimum wage, exempt employees are now set to receive at least $868 per week.

California

If an employee earns $1,240 weekly, they are considered an exempt employee. The only exception is if the employee’s job is mainly involved in computer software. In California, the monthly rate of computer software-related jobs must be $9,338.78 or more for employees to qualify as exempt.

Meal and rest break regulations for non-exempt workers are quite strict. Non-exempt staff are eligible for a 10-minute break for every four-hour shift, one 30-minute break if their shift lasts longer than five hours, and two 30-minute breaks if their shift lasts more than 10 hours.

Colorado

The Colorado state government requires that employees earn income equal to the minimum wage or make at least $961.54 weekly to be eligible for exempt status.

Aside from regular employees, part-time and contractual workers are also entitled to paid sick leave.

Maine

In Maine, non-exempt vs. exempt employees are distinguished not by their salary but by the roles and responsibilities associated with their position or job title.

New York

Each county in New York has varying requirements for identifying non-exempt vs. exempt employees. New York’s laws on minimum wage and overtime compensation are also more elaborate compared to existing FLSA laws and regulations in other states.

For instance, employees in the administrative and executive department must receive income that’s worth 75 times the minimum wage in the state, while workers in the professional field need not have a minimum hourly, weekly, or monthly rate to qualify as exempt.

How Misclassification of Employees Can Lead to Legal Issues

Misclassification of employees can result in substantial fines from various agencies, including both state and federal ones. These penalties can amount to tens of thousands of dollars in unpaid overtime, on top of which employers must also pay penalties and interest.

The reason for this is that misclassifying a non-exempt employee and treating them as exempt will deny them fundamental rights, such as minimum wage, overtime pay, meal breaks, and rest breaks.

For instance, an employer that misclassifies an employee who has plenty of overtime hours won’t compensate them for these hours at an increased rate and instead use regular rates.

Reduced paychecks can also reflect lower taxes, as employers will withhold smaller amounts for Social Security and Medicare taxes, unemployment insurance contributions, and other deductions. As a result, they will be liable for unpaid taxes and fined by the IRS.

Employees who believe they have been misclassified can file lawsuits to recover unpaid wages, overtime, and other benefits. If an employer commits these violations against multiple employees, they may face a class-action lawsuit that can result in extremely high damages.

Ultimately, a company found to have misclassified employees can face severe reputational damage. This can make it difficult to retain the current workforce and find new talent. Moreover, it can lead to the loss of clients or a reduction in business, which can be detrimental to its revenue.

What Employers Need to Know for Issuing Pay Stubs, 1099s, and W-2s

Employers must know how to issue accurate pay stubs, Forms 1099, and Forms W-2 that reflect the employee's correct classification.

While the FLSA doesn’t mandate a specific format for pay stubs, there are requirements about what information they should display. These requirements include gross and net pay, hours worked (for non-exempt employees), rates, pay periods, and deductions.

Most of these requirements apply to both exempt and non-exempt employees. The difference is that exempt employees typically don’t have to have “hours worked” on their pay stub, since they receive a fixed salary.

When it comes to issuing Form 1099, there are no exempt vs. non-exempt considerations and differences, since these are given to independent contractors. However, employers should be careful not to misclassify their employees as 1099 workers, as that can lead to fines and back payments, as well as criminal charges and even jail time.

The process of issuing Form W-2 stays the same, as it’s the Wage and Tax Statement for exempt and non-exempt employees. It requires employers to accurately specify employees’ total earnings and taxes withheld to allow them to file and pay their portion of taxes.

If you have a business and want to effortlessly create and distribute relevant documentation, regardless of whether you have exempt or non-exempt employees, you should try our software. We offer:

• Pay stub generator
• Form 1099 generator
• Form W-2 generator

All of our tools are designed to be professional and easy to use. You simply pick a template, input relevant information in a step-by-step manner, and check out to download a finished document.

Transitioning Employees: Exempt to Non-Exempt (and Vice-Versa)

Transitioning employees and reclassifying them from exempt to non-exempt (and vice versa, although less common) requires careful planning to ensure legal compliance. Moreover, these maneuvers can affect employee morale, which is why it’s critical to approach them strategically.

Some of the most common reasons for reclassifying employees include misclassification in the first place, changes in job duties and responsibilities, and cost savings for the employer.

The primary consideration when transitioning employees from exempt to non-exempt is the FLSA and any relevant state laws. The employee becomes eligible for minimum and overtime pay, so the employer must update their payroll system and begin to meticulously track employees’ work hours, as well as apply relevant rates to calculate their paychecks.

On the other hand, if an employer wants to transition an employee from non-exempt to exempt, they must make sure the worker meets the required criteria (e.g., they are gaining an executive, professional, or administrative position).

Throughout the process, it is essential to communicate the change in a timely and transparent manner to the employee. An employer should explain the reasons for the change, emphasize the importance of legal compliance, and address any concerns regarding the salary.

Final Thoughts

Knowing the key differences between non-exempt vs. exempt employees is a necessity for employers. It’s a prerequisite for giving proper compensation to each of their employees and regulating their payroll expenses accordingly.

More importantly, it prevents employers from overstepping boundaries in labor practices, violating rights that may be exclusive to an exempt or non-exempt employee, or depriving employees of benefits that are universally available for both classifications.

Non-Exempt vs Exempt Employees FAQ

#1. Is it better to be an exempt or non-exempt employee?

When it comes to comparing non-exempt vs. exempt employees, exempt employees earn more than non-exempt employees. Ultimately, deciding which of the two categories is better depends on the employee’s preferred work setup and pay structure.

#2. Can you reclassify an employee from exempt to non-exempt?

Yes, you can reclassify an exempt employee as non-exempt. However, it entails proper documentation to describe the job role, the change in compensation, and honoring all laws that apply to the said change. Employers must convey the reclassification to their employees in a clear and concise manner.

#3. Are exempt employees required to work certain hours?

Exempt employees are not required by law to complete a specific number of work hours. On the other hand, the majority of companies hiring exempt staff would often require employees to complete a minimum of 40 work hours per week.

#4. Can exempt employees earn overtime?

No, exempt employees cannot earn overtime because they are not entitled to overtime pay. Employers who want to bridge this gap may offer additional compensation for extra work hours instead.