Misclassifying employees as exempt can have costly consequences for employers. If you’re like most employers trying to protect themselves from such painful financial blows, you probably take care to ensure that your exempt employees’ job duties qualify as exempt.

A recent California Court of Appeals ruling, however, serves as a valuable reminder that exempt status hinges on more than just an employee’s job duties—how you pay the employee matters, too.

Claims adjustor seeks overtime

“Jason” was an insurance claims adjustor for San Jose-based Koning & Associates from May 2004 through October 2005. He was paid $29 per hour with no minimum guarantee of the number of hours he would work.

Jason was paid based on the total hours he submitted to the employer. If he worked fewer claims in a pay period, he earned less pay than if he worked more claims. Regardless of how many hours Jason worked, though, he still received $29 per hour. He estimated that he worked an average of 20 hours of overtime each week during the 66 weeks he was employed by Koning.

Jason sued the employer for overtime pay. The trial court ruled in the employer’s favor, finding Jason was an exempt administrative employee and, therefore, not eligible for overtime pay.

On appeal, Jason argued that because he was compensated based on his hours worked, he didn’t receive a salary and couldn’t be categorized as exempt. The Court of Appeals agreed.

It’s not just the amount of pay

Industrial Welfare Commission Wage Order No. 4 lays out detailed requirements for the administrative exemption. Among other things, it provides that an exempt employee must be primarily engaged in exempt duties and earn a monthly salary equivalent to at least twice the state minimum wage for full-time employment (currently, a monthly salary of at least $2,773.33 per month).

The court acknowledged that the amount Jason was paid exceeded the minimum amount required for the exemption but explained that the amount didn’t settle the issue. The question for the court was whether the manner in which he was paid qualified as a salary.

When is an employee paid a salary?

Wage Order No. 4 doesn’t define the term “salary.” The court pointed out, though, that it also doesn’t use a more generic term like “compensation” or “pay.” Either of those terms would encompass hourly wages, a fixed annual salary, “and anything in between,” the court said.

A salary, however, is generally understood to be a fixed rate of pay, distinguished from an hourly wage, the court said. The use of the word “salary” implies that an exempt employee’s pay must be something other than an hourly wage, the court said.

The court noted that the California Division of Labor Standards Enforcement interprets wage orders as incorporating the federal salary-basis test for purposes of determining whether an employee is exempt. Under that test, an exempt administrative employee must be paid on a “salary or fee basis.”

The relevant federal regulations explain that an employee is paid on a salary basis if he or she regularly receives a predetermined amount each pay period, constituting all or part of the employee’s compensation, and that amount cannot be reduced because of variations in the quantity or quality of work performed.

An exempt employee must receive the full salary for any pay period in which he or she performs any work, without regard to the number of days or hours worked.

According to the regulations, an employee is not paid on a salary basis if deductions from his or her predetermined compensation are made for absences occasioned by the employee or the employer’s operating requirements. If a salaried employee is ready, willing, and able to work, deductions can’t be made for time when work isn’t available.

Koning argued that an employer can calculate a salary based on hours worked, which the court conceded. But the court also noted that the resulting salary must be a predetermined amount not subject to reduction based on quantity or quality of work. Jason’s pay varied according to the amount of hours he worked; he wasn’t paid a predetermined amount.

The employer also argued that some sort of reduction in workload must occur for an employee to lose his or her exemption. The court recognized that, in practice, Jason was always paid the equivalent of $29 per hour for 40 hours per week so that he, in effect, received an unvarying minimum amount of pay. It also recognized that, as a general matter, an exempt employee can be paid extra for extra work without losing the exemption.

The problem for the employer, though, was that it admitted it never paid Jason a guaranteed salary and that he made less money if he worked fewer claims. That, the court found, was the same thing as saying the employee wasn’t paid a predetermined amount that wasn’t subject to reduction.

Jason, therefore, wasn’t paid a salary and wasn’t exempt from overtime. Negri v. Koning & Associates, Calif. Court of Appeals (Dist. 6), No. H037804 (2013).

What it means for you

If you classify employees as exempt under the professional, executive, or administrative exemptions in Wage Order No. 4, you must pay attention to more than just their job duties. You must also make sure you pay them a predetermined salary of at least twice the minimum wage, regardless of how many hours they work.

With the higher hourly rate you probably pay such employees, your potential liability for overtime could be significant otherwise.

Practice tip: You aren’t required to pay exempt employees for any workweek in which they perform no work.