Overtime: to pay or not to pay

Attention Pizza Operators: There is no absolute limitation (except relating to child labor) as to the number of hours that an employee may work in any workweek. The federal Fair Labor Standards Act (FLSA) does not require that an employee be paid overtime for hours worked in excess of eight per day, or for work on Saturday, Sunday, any holiday or during the employee's regular day(s) of rest. The employee may work as many hours a week as he/she and his/her employer sees fit, provided that any hours worked in excess of the maximum workweek prescribed by the FLSA, are compensated as overtime wages.

An employee's workweek is a fixed and regularly recurring period of seven consecutive 24-hour periods. Once the beginning time of an employee's workweek is established, it remains fixed regardless of the schedule of hours worked. This is generally established when you state that your pay-period ends on a particular day.

For example, John, an hourly employee has a scheduled workweek of 9-5, Monday through Friday with a pay period ending on Sunday. He should be paid overtime for hours exceeding 40 within that period. Some states, such as California may require that overtime be calculated daily. For example, John works nine hours on Monday, seven hours on Tuesday and eight hours the rest of the week. California would require that John be paid one hour of overtime for Monday although his weekly average does not exceed forty hours.

The general overtime pay standard of the FLSA requires that overtime must be compensated at a rate not less than one and one-half times the regular rate at which the employee is actually employed. What is to be treated as the 'regular rate' of pay cannot be left to a declaration by the employee and employer; it must be drawn from individual situations and is a matter of mathematical computation. Therein, the regular rate is determined by dividing total remuneration (excluding statutory exclusions) by the total number of hours actually worked.

For example, John's hourly wage is $10.00/hour, and he usually exceeds his performance goals and earns a $100/week bonus. His regular rate is ($10.00 x 40 hours + $100)/40 hours. This equation yields a regular rate of $12.50/hour. This regular rate is in some instances different each week, where employees are compensated at different rates for different tasks or where an employee receives incentive compensation.

Every business is well aware of traditional overtime rules. Often errors are made, but the spirit of the rules is generally followed. Most businesses operate under the premise that some workers are exempt from the overtime rules. They generally refer to these workers as being on salary or salaried. This is where most smaller businesses error. The eligibility for a business to categorize an employee as exempt is based on statute. Most often, the employee classification is based on the definition of Executive Employees. This employee group is defined as one:

a) "Who has management duties of the enterprise or department or subdivision thereof."

b) "who customarily and regularly directs the work of two or more other employees therein"

c) "who has the authority to hire, fire, advance, promote or affect other changes of status of employees"

d) "who customarily and regularly exercises discretionary powers"

e) "who does not devote more than 20 percent (or in the case of an employee of a retail or service establishment, does not devote as much as 40 percent) of his hours of work in the workweek to activities which are directly and closely related to the performance of an hourly employee"

f) "who is compensated for his services on a salary basis at a rate of not less than $250 per week.

It is important for all businesses to understand the laws surrounding overtime eligibility in order to avoid a costly lawsuit. You need to be careful that you have not simply tacked a glorified title to an otherwise hourly task.

Pizza Hut recently settled two class-action lawsuits in California. These cases involved allegations by general managers that they were wrongly classified as exempt and overtime wages were withheld. California requires that employees classified as exempt must spend over 50 percent of time on managerial duties and earn at least the state-mandated minimum salary.

Although Pizza Hut met federal overtime laws, their records were not extensive enough to prove the amount of hours allotted to managerial tasks or tasks typically done by hourly employees. Because of this lawsuit, Pizza Hut will increase their record keeping ensuring that their employees are compensated correctly even in states with varying overtime laws such as California. (California has a more rigid set of rules requiring 50 percent of the exempt employees time must be spent strictly on managerial tasks while the FLSA allows the exempt employee to simultaneously perform the duties of an hourly worker.)

The general rule is that you follow the Federal guidelines if they are more restrictive than the state in which you operate. If the requirements for your state are more onerous, then you must follow those rules. The rules may be found online at www.dol.gov/dol/esa/public/whd_org.htm.

The federal Fair Labor Standards Act (FSLA) applies to all businesses with annual sales of $500,000 or more. Many cases involve allegations by managers or assistant managers who were denied overtime, because their employer improperly classified them as exempt.

For example, Long John Silvers is involved in a court case involving allegations that the company mis-classifies their managers as executives in order to avoid paying overtime. Again, the federal FLSA allows any employee who manages other workers or the business while simultaneously performing the duties of an hourly worker to be classified as exempt from the overtime rules. This explanation is included in the 'long test' as prescribed in the FLSA.

Is your manager and/or assistant manager really an exempt employee? The challenge is more slanted to a lower volume restaurant. It would appear to be more difficult to satisfy the 40% standard where there may not be two or more employees working and where the salaried person is the only compensated employee responsible for pre-opening store procedures. There are several opportunities that you can utilize to support the 41% test, and you should on a test basis ask your manager to document their activities for a period of time, preferably covering a consecutive seven-day period.

The real problem lies in not knowing that your salaried employees may not qualify as exempt. Since you probably are compensating the manager at a reasonable wage taking into consideration overtime, the problem lies in the lack of communication between the employer and employee where the employer states that the average of hours is intended to be 50 (10 hours of overtime) when they knew they would be 60. When the employee consistently works the 60 hours, the employer is obligated for overtime at a much different rate than would have been negotiated on the front side.

Let's think about our employee, John, who is promoted to manager and given a salary of $687.50/week based on a 50-hour workweek as agreed upon with the owner of the restaurant. This is comprised of $500 for the first 40 hours (12.50/hr) and $18.75/hour for the 10 hours of overtime ($187.50). John regularly puts in 60 hours per week and spends 50% of his time taking orders at the cash register. In order to calculate the overtime pay, the owner must calculate the regular rate ($687.50/50 = $13.75) and pay overtime based on that rate.

In this example, the employee would be paid the following:

$687.50
(salary with built-in overtime pay)

+ $206.25
(regular rate of $13.75 x 1.5 = $20.625/hour x 10 hours overtime)

$893.75

This is where the dollars add up quickly. Where companies like have gotten in trouble is by not classifying their employees correctly or not calculating their overtime correctly. PMQ

Michael A. Roberts, CPA, has been associated with Horne CPA Group since 1987, where his practice is concentrated on providing consulting and accounting services to restaurant franchisees nationwide. For the past 18 years, he has worked with more than 600 restaurants in 42 states. He frequently speaks at conventions and is a consultant to various organizations within the franchise community.

Horne CPA Group was established in 1962. Headquartered in Jackson, Mississippi with 9 offices across the South, Horne CPA Group enjoys a practice of national scope. The firm is currently ranked among the nation's Top 100 accounting firms and among the Top 10 firms in the Southeast.

Contact Mike Roberts at 615-312-9050 or mike.roberts@hcpag.com for information on tax or management advisory services.