Conducting an Internal Wage and Hour Audit: Part 2

February 1, 2022

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This guide addresses wage and hour audits under the federal Fair Labor Standards Act (FLSA),  including preliminary issues private sector employers should consider, common wage and hour  issues to evaluate, options for responding to problems discovered during the audit, and best  practices going forward. 

Common Wage and Hour Issues to Evaluate 

1. Exempt Versus Nonexempt Status 

2. Employee Versus Independent Contractor Status 

3. Calculating Overtime Pay 

4. Timekeeping 

5. Meal Periods and Rest Breaks 

6. Tips, Tip Pooling, and Tip Credits 

7. Equal Pay 

8. Child Labor Practices 

9. Payroll Practices

Common Wage and Hour Issues to Evaluate 

Issues employers evaluate during wage and hour audits vary based on: 

• The reason for the audit. For example, different issues must be reviewed if: 

• an employer is conducting a comprehensive review of its wage and hour practices to proactively address wage and hour compliance issues or to prepare for a corporate transaction; or 

• an employer wants to ensure that workers are properly classified as exempt or nonexempt after a change in the law relating to a specific exemption. 

• The employer’s industry and the nature of the work performed. For example, employers in: 

• manufacturing may be more likely to focus on compensable time or meal periods and rest breaks; and 

• the restaurant industry may be more likely to focus on tip pooling and tip credits. 

• The extent to which the employer uses certain types of workers, such as: • independent contractors; 

• minors; 

• volunteers; and 

• interns. 

• The location and number of worksites. 

• Requirements under state and local wage 

and hour laws.

 

Generally, when planning and conducting a wage and hour audit, employers consider whether: 

• Workers are properly classified (see Exempt Versus Nonexempt Status and Employee Versus Independent Contractor Status). 

• Overtime pay is calculated properly (see Calculating Overtime Pay). 

• Compensable time is accurately captured and recorded (see Timekeeping). 

• State and local meal period and rest break requirements are satisfied (see Meal Periods and Rest Breaks). 

• The employer is complying with tip requirements (see Tips, Tip Pooling, and Tip Credits). 

• Compensation practices comply with the federal Equal Pay Act (EPA) and any applicable state or local equivalent (see Equal Pay). 

• The employer is complying with child labor laws (see Child Labor Practices). • Payroll practices comply with applicable law (see Payroll Practices). 

1. Exempt Versus Nonexempt Status 

To reduce the risk of worker misclassification, employers often examine exempt classifications as part  of a wage and hour audit. To determine if employees are properly classified as exempt under the  FLSA’s executive, administrative, professional, or highly compensated employee (HCE) exemptions, an  employer generally should confirm that each employee satisfies both: 

• The salary basis requirement (or the fee basis requirement for certain exemptions), unless the employee is: 

• a business owner; 

• a teacher; 

• practicing law or medicine; or 

• a computer professional earning at least $27.63 an hour for every hour worked. 

• The applicable exempt 

duties test. 

Audits should also address any different or additional exemption requirements under applicable state or  local law. 

 

Salary Basis Requirement 

When analyzing its compliance with the FLSA’s salary basis test, an employer should confirm that: 

• Certain exempt employees receive a predetermined salary each pay period that is not subject to reduction based on the quality or quantity of work performed. 

• The minimum salary received by exempt executive, administrative, and professional employees, for example, is $684 a week. Special salary levels apply to US territories. 

• The employer is not taking any salary deductions that jeopardize an employee’s exempt status. 

(29 C.F.R. §§ 541.600 and 541.602.) 

For information on the DOL’s rulemaking on minimum salary and compensation levels for certain  exemptions, see Practice Note, Latest Developments: DOL Rulemaking to Increase the Minimum Salary  for White Collar Exemptions Under the FLSA. 

For more information on the salary basis test, see FLSA White Collar Exemptions Checklist: Salary Basis  Test. For minimum salary requirements under state law, see Minimum Salary Thresholds for Exempt  Employees Under State Law Chart: Overview. 

Exempt Duties 

An employer should also confirm that each exempt employee satisfies the duties test for at least one  exemption. Each exempt classification has different requirements and the audit should be tailored to  the specific exemption under review. The most common exemptions are: 

• Executive exemption. An employer should confirm that the employee: 

• as their primary duty, engages in management of the employer’s business or a customarily recognized department or subdivision of that business; 

• customarily and regularly directs the work of at least two other full-time employees (or the equivalent); and 

• has the authority to hire or fire other employees or to provide recommendations on the hiring, firing, advancement, promotion, or any other change of status of other employees that are given particular weight. 

(29 C.F.R. § 541.100(a); DOL: Fact Sheet #17B: Exemption for Executive Employees Under the Fair Labor Standards Act (FLSA); see also FLSA White Collar Exemptions Checklist: Executive Exemption.) 

• Administrative exemption. An employer should confirm that the employee’s primary duty: 

• is the performance of office or non-manual work directly related to the management or general business operations of the employer or its customers; and 

• includes the exercise discretion and independent judgment in matters of significance. 

(29 C.F.R. § 541.200(a); DOL: Fact Sheet #17C: Exemption for Administrative 

Employees Under the Fair Labor Standards Act (FLSA); see also FLSA White Collar Exemptions Checklist: Administrative Exemption.)

• Professional exemption. An employer should confirm that the employee’s primary duty is the performance of work requiring: 

• advanced knowledge “in a field of science or learning customarily acquired by a prolonged course of specialized intellectual instruction”; or 

• “invention, imagination, originality or talent in a recognized field of artistic or creative endeavor.” 

(29 C.F.R. § 541.300(a)(2); DOL: Fact Sheet #17D: Exemption for Professional 

Employees Under the Fair Labor Standards Act (FLSA); see also FLSA White Collar Exemptions Checklist: Professional Exemption.) 

An exempt employee’s actual day-to-day job duties must satisfy the applicable duties test. Job  descriptions may be inaccurate, vague, or out of date, and are not dispositive of the work the  employee actually performs. (For more information on job descriptions, see Practice Note,  Importance of Job Descriptions.) Thus, to understand an employee’s actual job duties, an employer  should also consider: 

• Observing employees. 

Observing employees is the most accurate way to determine if they satisfy the exempt duties test, but is potentially the most time-consuming and expensive. 

• Interviewing employees. 

Asking employees to describe their day-to-day responsibilities and activities, including what duties they perform and how much time they spend on each aspect of their job responsibilities, is typically more efficient than observing each employee. However, employees may not accurately describe their responsibilities and interviews may raise concerns among employees that they are misclassified or entitled to back pay. 

• Interviewing supervisors. 

While this may be the most efficient approach and is less likely to raise a red flag with employees, some supervisors may not be able to provide accurate information about employees’ actual day-to-day job duties (for example, if they oversee a large number of employees at different levels or work at different worksites).

 

2. Employee Versus Independent Contractor Status 

In light of increasing scrutiny over independent contractor classifications, companies that engage  independent contractors may want to confirm that those workers are properly classified as part of a  wage and hour audit. If individuals classified as independent contractors are found to be employees,  the employer can face significant liability, including back wages (including unpaid overtime pay),  unpaid benefits, liquidated damages, back taxes, and possible penalties. 

Common independent contractor classification mistakes: 

• Assuming a worker with an independent contractor agreement is an independent contractor. While a solid independent contractor agreement is important, the agreement alone is insufficient to ensure independent contractor status if the worker’s actual relationship with the company is as an employee. 

• Subjecting independent contractors to frequent oversight and instruction. Instruction, training, feedback, discipline, and other types of oversight by the company engaging an independent contractor increase the likelihood that the worker is an employee. 

• Retaining independent contractors on a full-time or at-will basis. Workers who devote all or most of their professional time working for one company and at-will workers who may be terminated at any time, with or without cause, are more likely to be employees. 

• Compensating independent contractors on an hourly or other periodic basis. Workers who are paid at fixed intervals, rather than for designated results or projects, are more likely to be employees. 

To minimize the risk of independent contractor misclassification, employers should analyze  independent contractors using the same factors as the DOL and courts. Audits should also address  whether any independent contractors are properly classified under applicable state and local law.  

3. Calculating Overtime Pay 

Under the FLSA, employers generally must pay overtime compensation for all hours worked over 40  in a workweek, unless the employee is exempt. Overtime is generally calculated at 1.5 times the  employee’s regular rate of pay and the DOL has issued extensive regulations defining the regular rate  of pay and explaining how to calculate overtime pay (29 C.F.R. §§ 778.0 to 778.603). 

In addition, overtime is calculated differently for employees who are paid using the fluctuating  workweek (FWW) method, which allows employers to pay nonexempt employees a fixed weekly salary  despite fluctuating hours if certain conditions are met (29 C.F.R. § 778.114; see also Practice Note, The  Fluctuating Workweek Method of Paying Overtime Under the FLSA). 

During an audit, employers should make reasonable efforts to confirm that: 

• Nonexempt employees are properly paid for all 

overtime hours worked. 

• The regular rate of pay and overtime pay are calculated properly.  

4. Timekeeping 

Compensable Time and Off-the-Clock Work 

Under the FLSA, an employer generally must pay an employee for all work the employer “suffers or  permits” (29 U.S.C. § 203(e)(1), (g)). Many wage and hour cases focus on whether nonexempt  employees were properly paid for all compensable time, including working time that falls outside of  the employee’s prescribed on-duty hours. For that reason, audits may include a review of whether  nonexempt employees have engaged in off-the-clock (OTC) work, and if so, whether they have  been properly compensated for that time. 

Common examples of pay practices employers may audit include whether employees have been paid  for: 

• Time spent on activities that may qualify as the beginning or end of the employee’s compensable time, such as: 

• donning and doffing clothing, safety equipment, and work-related gear; 

• logging in and out of computer systems; 

• walking to work stations; or 

• waiting for work to begin. 

• Time spent checking smartphones, responding to messages, and working remotely. • Certain travel time. 

• Certain training time. 

• On-call time. Whether an employer must pay for an employee’s on-call time generally depends on whether the employee can use the time effectively for their own purposes. 

Fair Rounding Practices 

Under the FLSA, employers are permitted to round compensable time to 5-, 10-, or 15-minute  increments for payroll and recordkeeping purposes if the rounding process does not unfairly benefit  the employer. A fair time-rounding system rounds employee hours both up and down. Over a period of  time, the system should average out so that employees are fully compensated for all working time. (29  C.F.R. § 785.48(b).) If employers round time, they should consider auditing the time recorded to ensure rounding does not benefit the employer over employees. 

Suspicious Time Entries 

As part of the review of timekeeping records, employers should pay attention to time entries that  might be viewed as red flags by plaintiffs’ counsel or an agency investigator. For example, an  employee’s time entries that show only eight-hour shifts when the employee actually worked irregular  hours may suggest that the records are not accurate or that the timekeeping procedures are not being  followed or are not adequate. The employer should follow up with the employee or their supervisor to  resolve any discrepancies.

5. Meal Periods and Rest Breaks 

The FLSA does not require meal periods or rest breaks, but DOL regulations recognize that brief rest  breaks (typically 20 minutes or less) are common and require those rest breaks, if offered, to be  compensated as hours worked. Unauthorized extensions of rest breaks, however, do not need to be  counted as hours worked if the employer has a policy that: 

• The authorized break may only last for a specific 

length of time. 

• Any extension of the break is not permitted. 

• Any extension of the break results in disciplinary 

action. 

In contrast, bona fide meal periods are generally not counted as hours worked and do not need to be  paid. As a rule of thumb, employers that offer meal periods of at least 30 minutes, during which  employees are completely relieved of duty, will ensure that their breaks are bona fide. 

During an audit, employers should confirm that employees: 

• Are paid for breaks when the FLSA requires 

compensation. 

• Are completely relieved of their duties during 

unpaid meal periods. 

Unlike the FLSA, state and local law may require meal periods or rest breaks for certain employees,  including by specifying when those breaks must occur during a shift. Audits should address those  requirements and ensure that, where necessary, employees are compensated for that time.  

6. Tips, Tip Pooling, and Tip Credits 

Special minimum wage and other rules apply to tipped employees, including allowing employers,  under certain circumstances, to credit a portion of employee tips toward the FLSA’s minimum  wage requirement (29 U.S.C. § 203(m)(2)(A); 29 C.F.R. § 531.59(b)). 

During an audit, employers that choose to take a tip credit should ensure that they are: 

• Informing tipped employees of the tip credit provisions before taking a tip credit (for a sample notice, see Standard Document, Tip Credit Notice Under the Fair Labor Standards Act). 

• Paying tipped employees at least $2.13 an hour in cash or direct wages. 

• Taking a tip credit of no more than $5.12 an hour. 

• Making up the difference with additional cash wages if an employee’s cash wages plus their actual tips equal less than the applicable minimum wage. 

• Allowing employees to retain all tips they receive, except to the extent they participate in a valid tip pooling arrangement. 

(29 U.S.C. § 203(m)(2); 29 C.F.R. § 531.59.) 

Any employer of tipped employees, regardless of whether it takes a tip credit, should ensure that  neither it, nor its managers or supervisors, keep any portion of employee tips for any purpose (29  U.S.C. § 203(m)(2)(B)). 

Other tipped employee issues include: 

• Mandatory tip pool requirements. 

• Tipped employees with dual jobs, one tipped and one not, such as a stylist also serving as the salon’s bookkeeper. 

• Tipped employees performing work related to their tipped occupation but that does not directly generate tips, such as a waitress rolling silverware or refilling condiments. 

State and local law frequently regulates tip pooling arrangements, requires a higher cash wage or a  lower tip credit, or prohibits tip credits entirely.  

7. Equal Pay 

The EPA amended the FLSA to prohibit sex-based wage differentials for employees in the same  workplace performing jobs that both: 

• Require equal skill, effort, and 

responsibility. 

• Are performed under similar working 

conditions. 

(29 U.S.C. § 206(d)(1).) 

Employers auditing pay practices should ensure that any wage differentials are based on an exception  under the EPA, such as: 

• A seniority system. 

• A merit system. 

• A system that measures earnings by quantity or quality 

of production. 

• A differential based on any other factor other than sex. 

(29 U.S.C. § 206(d)(1).) 

Employers cannot reduce the wages of any employee to correct an unlawful wage differential (29  U.S.C. § 206(d)(1)). 

State and local law frequently regulates tip pooling arrangements, requires a higher cash wage or a  lower tip credit, or prohibits tip credits entirely 

8. Child Labor Practices 

The FLSA sets minimum working ages and restricts the type of work minors can perform and the hours  they may work. During an audit of child labor practices, common issues employers should review  include ensuring: 

• No employees are under age 14. 

• Employees under age 16 do not work during school hours or more than the number of hours permitted by the FLSA, which vary depending on several factors, such as whether: 

• it is a school day; and 

• school is in session. 

• No employees under age 18 work in occupations identified as hazardous by the DOL (see DOL: Fact Sheet #43: Child Labor Provisions of the FLSA for Nonagricultural Occupations). 

Audits should also address compliance with applicable state and local child labor requirements.  

9. Payroll Practices 

The FLSA imposes payroll requirements on employers. To ensure compliance, wage and hour audits  commonly examine whether the employer: 

• Defines the workweek and workday in compliance with applicable federal, state, and local law. 

• Sets regularly scheduled paydays in compliance with applicable federal, state, and local law. 

• Pays wages in a permissible manner. For example, some states permit employers to require direct deposit or to pay employees using a payroll card (see State Direct Deposit and Payroll Card Laws Chart: Overview). 

• Provides a pay stub or earnings statement, if required by state law (see State Wage Statement Laws Chart: Overview). 

• Tracks accrual and use of vacation, sick, or other paid time off (see Paid Sick Leave State and Local Laws Chart: Overview). 

Employers must also comply with state and local payroll requirements.  kilegal.com KOUTSOUDAKIS & (212) 404-8644 IAKOVOU LAW GROUP, PLLC 40 WALL STREET, 49TH FL, NY, NY 10005

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