One of the most expensive assumptions in small business HR is this: "They're on salary, so they don't get overtime."
It's an understandable belief, and it's wrong often enough to produce a steady stream of back pay claims. Under federal law, an employee is exempt from overtime only if their job meets specific tests. How they're paid is just one of them.
What exempt actually means
The federal Fair Labor Standards Act (FLSA) requires employers to pay nonexempt employees overtime at one and a half times their regular rate for every hour worked over 40 in a workweek.
Some employees are exempt from that requirement, most commonly under the executive, administrative, professional, computer employee, and outside sales exemptions. To qualify under most of them, an employee generally has to pass three tests:
- Salary basis: paid a predetermined, fixed salary that isn't reduced because of the quality or quantity of work.
- Salary level: paid at least the minimum salary threshold.
- Duties: the job's primary duty genuinely fits the exemption.
Fail any one, and the employee is nonexempt regardless of their title or how they're paid.
The salary threshold
The federal minimum salary for most exemptions is $684 per week ($35,568 per year), after a federal court vacated a 2024 rule that would have raised it.
Several states set their own higher thresholds, and you have to meet whichever is higher. California, for example, requires exempt employees to earn at least twice the state minimum wage for full-time work.
Where businesses go wrong
Treating a title as a classification. Titles like manager, coordinator, or specialist don't create an exemption. An office manager who mostly handles data entry and scheduling likely fails the administrative duties test.
Assuming salaried means exempt. A salary is necessary for most exemptions, but it's never enough on its own. A salaried employee who doesn't meet the duties test is owed overtime.
Making improper deductions. Docking an exempt employee's pay for a partial-day absence, or for a slow week, can undermine the salary basis the exemption depends on.
Miscalculating the regular rate. For nonexempt employees, nondiscretionary bonuses, such as production or attendance bonuses, generally have to be included when you calculate the overtime rate.
Letting work happen off the clock. Answering email at night, prep work before a shift, and finishing tasks after clocking out all count as hours worked for nonexempt employees if you know, or should know, it's happening.
Offering comp time instead of overtime. Private employers generally can't replace overtime pay owed now with paid time off later.
Overlooking state rules. Some states go well beyond federal law. California requires daily overtime for hours worked over 8 in a workday, in addition to weekly overtime.
What a claim can cost
When nonexempt employees are misclassified as exempt, the exposure usually includes:
- Back wages for unpaid overtime, generally reaching back two years under federal law, or three years for willful violations.
- Liquidated damages, which under the FLSA can equal the back wages owed, effectively doubling the bill.
- Attorneys' fees for employees who win.
- State penalties, which in some states add significantly on top. In California, claims can reach back as far as four years under the state's unfair competition law.
Misclassification also rarely affects just one person. If a role is misclassified, everyone in that role usually is, which is how these claims become class or collective actions.
Employees versus contractors
A related, and often bigger, risk is treating workers as independent contractors when the law considers them employees. The tests differ by agency and by state, and the federal standard has shifted in recent years. California applies the strict ABC test to most workers, which presumes a worker is an employee unless all three of its conditions are met. If contractors do core work for your business, that arrangement deserves its own review.
How to check your own classifications
- List every salaried role and what the person actually does day to day, not what the job description says.
- Compare each role against the duties test for the exemption you're relying on.
- Confirm each exempt salary meets both the federal and state thresholds.
- Review how you calculate overtime for nonexempt staff, including bonuses.
- Check your timekeeping for off-the-clock work.
- Document why each exempt role qualifies.
If you find a problem, fix it going forward and get advice on how to handle past pay. Reclassifying employees and addressing back pay is worth doing deliberately rather than in a rush.