Classification Confusion in State as Employers Struggle to Comply with Ambiguous Standards, Differing Interpretations

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1 Classification Confusion in State as Employers Struggle to Comply with Ambiguous Stards, Differing Interpretations One area of lab employment law that Califnia employers continue to struggle with is proper classification of employees as exempt versus nonexempt, independent contract versus employee. In Califnia, tests to determine wher an employee is exempt are different than federal stards are extremely subjective, reby leading to differing interpretations expensive litigation. Similarly, analysis in Califnia as to who qualifies as an independent contract is overwhelming confusing. Different state agencies utilize different facts to determine independent contract status, reby leaving an employer with little guidance certainty on issue. The consequences an employer faces f misclassifying an employee as exempt as an independent contract are devastating fail to take into consideration employer s good faith effts to get classification crect. The brief summary below of classifications tests Califnia employers are fced to navigate, as well as severe penalties y face f misclassification, emphasizes need f immediate refm in this area. Exempt NonExempt? An employee who is properly classified as exempt under one of Califnia s six main exemptions generally is excluded from wage--hour requirements in Califnia, such as minimum wage, overtime pay, meal rest periods, as well as recdkeeping requirements. The problem f many employers is that aside from salary basis requirement in each exemption, criteria utilized to decipher between an exempt employee versus a nonexempt employee is ambiguous, reby creating a significant risk f employers. Executive Exemption The primary inquiry under this exemption is wher employee s monthly salary is me than two times minimum wage, which is now $3,120 due to minimum wage increase in Califnia that took effect July 1, If employee does not satisfy this salary basis test, Wksheet f Determining Exempt NonExempt re is no need to examine any furr. Assuming, however, that employee earns at least Exempt Analysis Wksheet - Professional Exemption wksheet does not imply guarantee that analysis of position as exempt will be recognized as accurate by minimum requirement, n an employer must evaluate Division of Lab Stards Enfcement. Exempt Analysis Wksheet - Computer Professional Exemption wher employee spends me than 50% of his her time wksheet does not imply guarantee that analysis of position as exempt will be recognized as accurate Current Employee by Division of Lab Stards Enfcement. customarily regularly exercising his her independent Exempt Analysis Wksheet - Executive/Managerial Exemption Department judgment discretion in perfmance of following duties: wksheet does not imply guarantee that analysis of position as exempt will be recognized as accurate by Supervis Title Current Employee Division of Lab Stards Enfcement. responsibilities involving management of business Date of Evaluation Department Exempt Analysis Wksheet - Professional Exemption Evaluat Supervis Title wksheet does not imply guarantee that analysis of position as exempt will be recognized as accurate by / an established department within business; Current Employee Division of Lab Stards Enfcement. In der to be exempt as a professional, employee must meet tests 1 through 3 below: Date of Evaluation Department Exempt Analysis Wksheet - Salesperson Exemption 1. The employee must eir be: directing wk of two me employees; a. Licensed Evaluat certified Supervis by Title state of Califnia primarily engaged in practice of one of following wksheet does not imply guarantee that analysis of position as exempt will be recognized as accurate by recognized professions: Current Employee A professional employee in computer Division field of is exempt Lab Stards from overtime Enfcement. pay if employee meets authity to hire fire employees, has ability all Law following Date of tests: Evaluation Medical Accounting (does not include paralegals) Department (does not include nurses; 1. Primarily engaged in wk that is intellectual creative. may include physician assistants; to make recommendations regarding hiring, firing, Describe Evaluat employee s intellectual special creative exemption wk. Supervis Title f physicians Teaching An executive is one who is paid on an hourly basis) Architecture Current in charge Employee of a unit with permanent status function who dinarily supervises activities of s. In der f an employee to be exempt as an executive, all six of following tests must be met: Engineering Date of Evaluation Optometry promotion of individuals. (includes 1. licensed Has civil, duties responsibilities Department involving management of enterprise in which he/she is mechanical, employed electrical of a customarily Dentistry recognized (does not department subdivision; Evaluat engineers, but not juni include dental 2. Primarily engaged Describe in duties wk that responsibilities requires Supervis The challenge f a lot of employers under this exemption engineers drafters) hygienists exercise involving Title except of in discretion management very independent of enterprise judgment. of a customarily recognized department subdivision. Describe ways in In which der to be employee exempt limited customarily as a circumstances) professional, regularly employee uses discretion must meet independent tests 1 through judgment. 3 below: 1. The employee Date must of Evaluation eir be: is what activities qualify as use of independent discretion b. Primarily engaged in an occupation commonly recognized as a learned artistic profession. Learned artistic profession means an employee a. Licensed who Evaluat is certified primarily by engaged state in of Califnia perfmance primarily of: engaged in practice of one of following recognized professions: judgment as opposed to routine duties. The Division of Law OUTSIDE SALES: Medical Accounting Wk requiring 3. Primarily knowledge engaged of in an duties advanced that consist type in of a field one science me of learning following: customarily acquired by a (does not include paralegals) (does not include nurses; prolonged course The application 2. of specialized Customarily of systems intellectual regularly analysis instruction An outside techniques directs salesperson study, wk procedures, of as is two distinguished exempt me including from may from overtime employees. include consulting a general requirements physician with academic users, assistants; if he/she to meets both tests below: Lab Stards Enfcement (DLSE) has defined this term education determine from an List apprenticeship, hardware, employees software, who from are system customarily training functional in perfmance regularly specifications. supervised of routine special by this mental, exemption employee, manual, f physicians ir titles. physical processes wk that is an essential Teaching 1. part Eighteen of necessarily years of age incident older. to any of above wk. The design, development, documentation, analysis, creation, testing, paid modification on an hourly of basis) Architecture computer systems OR programs, including prototypes, based on related to, user system design specifications. Engineering Is employee 18 years of age older? Optometry Yes No to mean comparison evaluation of possible courses Wk that is iginal The documentation, creative in testing, character creation, (includes a recognized licensed modification civil, field of of artistic computer endeav programs (as opposed related to to wk design which can be produced of software by a person 2. Spends me than 50% of his/her hardware endowed f with computer mechanical, general operating manual electrical systems. intellectual ability Dentistry wking time training), (does away not from employer's place of business, selling tangible result of intangible items, obtaining ders which depends primarily on invention, imagination, engineers, but not talent juni of employee include contracts wk dental f products, services use of facilities. Wk perfmed that is an essential part Describe employee s duties. incidental to in conjunction with of conduct acting making a decision after various of necessarily incident to any of above engineers wk. drafters) hygienists employee's except in own very outside sales solicitations, including incidental To qualify as deliveries collections, is not considered eir a learned artistic profession, wk must be predominantly limited intellectual circumstances) exempt wk (i.e. delivery, repair maintenance). varied in character (as opposed 3. Has to routine authity mental, to manual, hire List mechanical, fire employee s employees physical duties wk) make suggestions percentage of such character of time recommendations, required that f each: possibilities have been considered. The employee must have output produced which result will accomplished be given particular cannot be weight, stardized as to in hiring relation firing to a given as period to of advancement time. promotion b. any Primarily change engaged Dutiesof status in occupation of employees. commonly recognized as a learned artistic Percentage profession. of time Learned artistic profession means an employee who is primarily engaged in perfmance of: Does employee have such authity? authity power to make an independent choice, free from If employee does not have such authity, how much weight is given to his/her suggestions Wk requiring knowledge of an advanced type in a field science learning v customarily acquired by a recommendations as to hiring, firing, advancement, promotion change of status? prolonged course of specialized intellectual instruction study, as distinguished from a general academic education from an apprenticeship, from training in perfmance of routine mental, manual, immediate direction supervision with respect to matters physical processes wk that is an essential part of necessarily incident to any of above wk. OR of significance. v Wk that is iginal creative in character in a recognized field of artistic endeav (as opposed to wk which can be produced Note: Outside by a salespersons endowed are with not required general manual to meet intellectual minimum ability salary requirement training), that applies result to of executive, which depends administrative primarily on executive invention, exemptions. imagination, talent of employee wk that is an essential part The DLSE states that f executive exemption, most of necessarily incident to any of above wk. CalChamber Page 1 of 3 To qualify as eir a learned artistic profession, wk must be predominantly intellectual varied in v character INSIDE (as opposed SALES: to routine mental, manual, mechanical, physical wk) of such character that frequent problem employers encounter is failure to distinguish output produced An inside salesperson result accomplished one who sells cannot merchise be stardized in a ste in relation sales lot to (f a given example, period car of time. RV sales lot) one who sells a product service via a company telephone. Certain inside sales employees wking under Wage Orders 4 7 are exempt from overtime. This exemption applies to overtime only, not all wage hour laws. discretion independent judgment from use of independent v managerial skills. An employee who merely applies his her memy in following prescribed procedures determining which v Califnia Business Issues

2 required procedure out of company manual to follow, is not exercising discretion independent judgment. Administrative Exemption Similar to executive exemption, an employee classified under this exemption also must receive a minimum monthly salary of two times minimum wage. Additionally, employee must spend me than 50% of time customarily regularly exercising his her independent judgment discretion in perfmance of following duties: responsibilities involving office nonmanual wk that is directly related to business s management policies general business operations; regularly directly assisting a propriet an employee employed in a bona fide executive administrative capacity; perfming specialized technical wk that requires special training, experience knowledge with limited supervision. One of key provisions of this exemption that has caused numerous employers confusion is what duties qualify as office nonmanual wk that is directly related to management of business. In 2001, 1st District Court of Appeal said determining this provision depends upon wher activities perfmed fulfill administration of business versus simply ultimate end product of business widely referred to as administrative/production dichotomy (Bell v. Farmers Insurance Exchange, 97 Cal.App.4th 805). In Bell, court determined that claims representatives who wked f an insurance company were not properly classified as exempt because claims adjusting was end product f company, rar than administrative wk. F years following decision in Bell, employers have struggled with determining wher an employee s duties fall neatly into one categy of administration/production dichotomy as opposed to, which y generally do not. In 2011, Califnia Supreme Court provided somewhat furr guidance on issue by stating that administration/ production dichotomy is not a dispositive test on this issue should be used in analysis only after reviewing applying actual language of primary sources, such as statutes regulations (Harris v. Superi Court, 53 Cal.4th 170). Despite this clarification, administrative exemption continues to be an ongoing source of litigation f employers throughout Califnia. Professional Exemption/Learned Exemption An employee under this exemption also must meet monthly salary basis test of two times minimum wage, 1 as well as following: licensed certified by State of Califnia primarily engaged in practice of law, medicine, dentistry, optometry, architecture, engineering, teaching accounting; primarily engaged in an occupation commonly recognized as a learned artistic profession. Learned artistic profession has been defined as customary regular exercise of independent judgment discretion in: (a) wk requiring knowledge of an advanced type customarily acquired by a prolonged course of specialized intellectual instruction study; (b) wk that is iginal creative in character in a recognized field of artistic endeav result of which depends primarily on invention, imagination talent of employee; (c) that is predominantly intellectual varied in character such that output produced result accomplished cannot be stardized in relation to a given period of time. Similar to exemptions listed above, determining what responsibilities qualify as exercise of independent judgment discretion is most problematic fact f employers under this exemption. Computer Professional Exemption This exemption also has a salary basis test, yet is unique as compared to exemptions. Specifically, in der to qualify f this exemption, employee must receive a minimum monthly salary of $7,165.12/annual salary $85, The employee also must be primarily engaged in duties that require use of independent discretion judgment in perfmance of one me of following duties: application of systems analysis techniques procedures; design, development, documentation, analysis, creation, testing, modification of computer systems programs; documentation, testing, creation, modification of computer programs related to design of software hardware f computer operating systems; employee is highly skilled is proficient in etical practical application of highly specialized infmation to computer systems analysis, programming, software engineering. Again, what tasks qualify as use of independent discretion judgment versus simply complying with directions is difficult f employers to determine under this exemption. Outside Sales Exemption This exemption is available to any person, 18 years of age older, who customarily regularly wks me than half wking time away from employer s place of business selling tangible intangible items obtaining ders contracts f products, services, use of facilities. In 1999, Califnia Supreme Court provided some clarification on this exemption by stating that duties which are only incidental to outside sales wk such as delivery, repair maintenance are not considered exempt wk that applies toward time requirement (Ramirez v. Yosemite Water, 20 Cal. 4th 785). 1 A licensed physician under this exemption must receive an hourly wage of $73.57 higher in der to satisfy minimum salary requirement. 2 This minimum salary requirement is adjusted annually by DLSE accding to rate of inflation Califnia Business Issues 57

3 Notably, re is no salary basis test f this exemption, only a time requirement as to amount of time employee must spend engaged in outside sales activities. Given that employees are outside of office, as required by exemption, it is difficult f employers to monit m make sure y are spending most of ir time engaged in exempt wk, as opposed to incidental duties. Commissioned Salesperson Exemption This exemption applies to any employee who earns me than 1.5 times minimum wage, of which half must be derived from commissions. If an employee satisfies this requirement, n he/she is exempt only from payment of overtime. Unlike exemptions, individuals who satisfy this criterion still are entitled to receipt of wage--hour requirements, such as meal rest periods. Consequences f Misclassification as Exempt v. NonExempt The financial consequences f misclassifying an employee as exempt instead of nonexempt are devastating f an employer. First, in almost every misclassification claim, re is an allegation of unpaid overtime. Given that exempt employees generally are neir required n expected to track ir time, employers do not have time recds that document hours wked. Accdingly, it is a he said/she said dispute burden falls on employer to disprove an employee was misclassified refe entitled to overtime pay f up to past four years. 3 In addition to alleged unpaid overtime wages, re are piggyback claims that usually are asserted as well, including inaccurate itemized wage statement f failing to list hours wked hourly rate on wage statement, missed meal rest periods, as well as statuty penalties under Lab Code Private Attney General Act, Sections 2699 et seq. When misclassification affects a categy of employees as opposed to just one employee, litigation usually is filed as a class action, reby significantly increasing even furr cost f employer to defend. Of course, if employee is able to recover even $1 of his/her alleged unpaid wages penalties, employee s attney also can recover reasonable attney fees, reby adding an layer of cost onto employer. Federal Law Recent Activity Federal law also sets fth four exemptions f employees to be excluded from both minimum wage overtime pay. 4 These exemptions are similar to Califnia, yet less restrictive. Specifically, federal law has a salary basis test f administrative, professional executive exemption as well, but salary basis is limited to $455/week. F outside sales exemption, re is no minimum salary requirement f computer professional employees, salary basis test is eir $455/week $27.43/hour. With regard to duties test, unlike Califnia, re is no specified amount of time that an employee must spend on exempt duties in der to qualify as an exempt employee. While it is a rule of thumb that term primary duty means duty upon which employee spends me than 50% of his/ her time, a duty may noneless still be primary duty even if he/she spends less than majity of time on that task (see 29 Code of Federal Regulations, Section ). When amount of time falls below 50% threshold, analysis of primary duty includes several facts, including imptance of exempt duties versus non-exempt duties, freedom from supervision, frequency of employee s exercise of discretion, amount of time spent on duties (see Donovan v. Burger King Cpation, 675 F.2d 516 (2nd Cir. 1982), stating that federal law f executive exemption analysis does not focus solely on amount of time spent on exempt duties; Spinden v. GS Roofing Products Company, Inc., 94 F.3d 421 (8th Cir. 1996), quoting an employee s primary duty is that which is of principal imptance to employer, rar than collateral tasks which may take up me than fifty percent of his her time. (citations omitted)) Federal law also has a highly compensated employee exemption that exempts employees from minimum wage overtime pay if employee s annual compensation is $100,000 me employee perfms primarily nonmanual wk. Califnia does not have a similar exemption. On March 13, 2014, President Barack Obama announced an executive der to modify federal exemptions to make sure that me employees are nonexempt eligible f overtime pay. The basis f this modification is that President believes too many employees are being denied compensation to which y are entitled f ir hard wk. The executive der did not set fth new requirements f exemptions, but rar, directed Lab Secretary to wk with stakeholders to develop a plan that would exp right to overtime f employees. As of date of this publication, U.S. Department of Lab had not yet published any proposed regulations plan with regard to federal stards f exempt employees. Independent Contract Employee? The hiring of independent contracts is a popular lawful tool employers use as a part of ir overall business model. F businesses, it is a cost-effective way in which to address specialized needs. F entrepreneurs, it is a way in which 3 Most unpaid wage claims under Lab Code are filed concurrently with an Unfair Business Practice claim under Business Professions Code Section Accdingly, although statute of limitations f an unpaid wage claim under Lab Code is only three years, when filed with an unfair competition law claim, time period in which to file is extended to four years (Ctez v. Purlat Air Filtration Products Co., 23 Cal.4th 163, (2000)). 4 Federal law does not have a general meal--rest period mate f all employees such as Califnia, refe federal employee exemptions are limited to minimum wage overtime pay Califnia Business Issues

4 to maximize profits grow ir own business. A rept conducted by Dr. Philip J. Romero in September 2011, The Economic Benefits of Preserving Independent Contracting, concluded that Califnia s economic success depends heavily upon small businesses independent contracts. The study references fact that use of independent contracts provides a benefit to both parties: The contract earns great autonomy higher compensation because y are paid based only on productivity; client gains higher productivity me long-term flexibility from reduced fixed costs. The main concern, however, from all parties involved in independent contract relationship, is subjective inconsistent analysis used to determine wher an individual qualifies as an employee versus an independent contract. The common law test f determining status of an individual as an employee versus an independent contract focuses primarily on who has right to control details of wk perfmed, but also includes consideration of following facts: Wher relationship may be terminated at will ; Wher individual perfming services is engaged in a business distinct from principal s; Wher wk perfmed is typically done under direction of principal without supervision; What required skill is to perfm job; Wher principal supplies tools wksite; What is length of time f which services are to be perfmed ongoing is re a set deadline f services to end; What is method of payment hourly by job; Wher parties believe y are creating relationship of employer-employee. No one fact in this analysis, including right to control, is determinative. Meover, analysis is not based upon totality of circumstances, meaning that even if an employer satisfies a majity of se facts in fav of independent contract classification, re is no guarantee that such a classification is accurate. Rar, application imptance of each fact is determined on a case-by-case analysis. To add to confusion intimidation of this analysis f employers, not all state federal agencies utilize common law test. In fact, Califnia Department of Industrial Relations, which utilizes common law test, admits that an individual may be considered an independent contract f its purposes, but an employee f an state agency s test, vice versa. Accdingly, even if Internal Revenue Service DLSE confirms that in ir opinion individual is an independent contract, an federal state agency, such as U.S. Department of Lab (DOL) Franchise Tax Board, could subsequently determine wise. A recent appellate decision in Dynamex Operations West, Inc. v. Superi Court, 2014 WL (2014), has complicated issue even furr by providing an interpretation as to wher an individual is an employee versus an independent contract. Specifically, in Dynamex, court relied upon Industrial Welfare Commission (IWC) Wage Orders definition of an employee, rar than common law facts set fth above to determine proper classification. The IWC definition is broader than common law facts, refe arguably includes me individuals as employees rar than independent contracts. This inconsistency uncertainty regarding proper definition of an independent contract places employers at an extreme disadvantage with regard to ir success at complying properly classifying individuals as employees versus independent contracts. Recent Federal Activity In 2011, DOL released its five-year strategic plan, which focused heavily on going after misclassification of wkers as independent contracts. The DOL estimates that at least 30% of individuals are misclassified as independent contracts. Since release of this plan, DOL has certainly ramped up its effts on this issue. It has entered into multiple interagency agreements with numerous states, including Califnia, to join effts at investigating eradicating wker misclassification. The DOL s 2014 budget reflected its ongoing effts to combat misclassification. The DOL requested $14 million to identify misclassification, unpaid taxes investigate violations, with $10 million in grants to 19 states who have entered into agreements with DOL, including Califnia, to enhance ir effts to detect misclassification. The DOL believes this grant will provide a high perfmance bonus to states that investigate prosecute employers who fail to adequately pay ir share of unemployment insurance due to misclassification, as well as wages unpaid taxes. In August 2014, 9th Circuit Court of Appeals issued a significant decision wherein it determined that despite entrepreneurial aspects of relationship between drivers FedEx, evidence that FedEx had right to control actual control over drivers was overriding, primary fact (Alexer et al. v. FedEx Ground Package System, Inc., 765 F.3d 981 (9th Cir. 2014)). Recent Califnia Activity In March 2013, Califnia Lab Commissioner Julie Su prevailed in a lawsuit against a trucking company f misclassifying its drivers as independent contracts rar than employees, recovering approximately $107,000 in unpaid wages, penalties interest. In August 2013, Commissioner Su also succeeded in recovering $247,681 in unpaid wages from several Nrn Califnia construction companies that misclassified employees as independent contracts. Shtly reafter, Commissioner Su cited a Sacramento lscaping company $664,764 f wage ft violations, including misclassifying employees as independent contracts. Notably, in July 2013, a Califnia Court of Appeal issued 2015 Califnia Business Issues 59

5 a decision in Happy Nails & Spa of Fashion Valley, LP, v. Julie Su that specifies Califnia agencies do not get to re-litigate issue of independent contract classification. In Happy Nails, Califnia Employment Development Department had challenged nail salon about classifying various individuals as independent contracts, yet lost on appeal befe Unemployment Insurance Appeals Board. Several years later, DLSE cited nail salon f failure to provide individuals with itemized wage statements, which nail salon challenged on basis that individuals were classified properly as independent contracts. On appeal, court sided with nail salon, relying on doctrine of collateral estoppel, which precludes same party (Califnia) from re-litigating legal issue of classification. In 2014, AB 1897 (Hernández; D-West Covina) was signed into law, generally imposing joint several liability on client employers that contract f lab services as a usual course of business, f wage--hour violations wker s compensation violations of contract s employees. Although bill specifically states that provisions do not have an impact on a client employer that is utilizing an independent contract does not change definition of independent contract, it is unquestionable that it will. Specifically, in der to avoid liability under AB 1897, client employers may exercise me control over wking conditions of contract s employees, reby satisfying one primary element f determining employee versus independent contract status. Consequences f Misclassifying an Employee as an Independent Contract If employer gets independent contract status analysis wrong, even if mistake is inadvertent, employer could suffer significant consequences from both state federal government, including following: Unpaid wages, plus statuty penalties ranging from $50 per pay period to $10,000 per pay period; Unpaid unemployment insurance compensation, plus up to a 10% penalty on amount assessed; Unpaid payroll taxes, plus statuty penalties ranging from 5% of unpaid taxes to 75% of unpaid taxes if underpayment was due to fraud; Up to $25,000 statuty penalty f willful misclassification; $10,000 criminal fine with imprisonment up to five years; Wkers compensation insurance, plus penalties; Attney fees. CalChamber The majity of employers do not intentionally misclassify ir employees as exempt as independent contracts. Rar, most employers conduct an analysis of subjective facts utilized to determine appropriate classification assume y have labeled ir employees contracts crectly. The significant financial consequences employers face as a result of misclassification fail to take into consideration ir good faith effts to navigate through ambiguous stards ir reliance on a state agency s determination that employer s classification was crect. Befe imposing such devastating penalties, fines, costs against an employer f misclassification, state should revise underlying tests f exempt status independent contract to make facts objective consistent in der to eliminate confusion. Once facts are clear, state agencies courts will be able to separate good acts who are trying to comply from bad acts that disregard law, impose penalties accdingly. Staff Contact Jennifer Barrera Policy Advocate Califnia Chamber of Commerce P.O. Box 1736 Sacramento, CA (916) January Califnia Business Issues

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