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How to crack the code on inside sales exemptions

Tuesday, September 06, 2022

Imagine that you have a new sales employee who you classify as exempt from overtime pay. You’ve had other sales representatives you classified as exempt in the past, so you figure it’s all the same.

Task completed, you move on with your day.

But a few months later, that employee is back in your office with a formal complaint: It turns out you were wrong. This employee was due pay for their overtime hours. And now you owe them.

So, what does that mean for your business?

In short, it means a very expensive payroll mistake, including back pay, legal penalties, fines and reputational harm.

Getting employee classifications wrong can cost your business big. And this doesn’t just apply to new employees. Team members you’ve had on board for years could be misclassified right now.

While there are different types of overtime exemptions under the Fair Labor Standards Act (FLSA), we’re going to focus specifically on how to determine whether your inside sales employees classify as exempt or nonexempt.

In this article, we’ll:

Decode the key terms

Let’s get this out in the open: “An inside sales FLSA employee exemption” sounds like a mouthful of jargon.

And you’re definitely not alone if you have questions like:

  • What is inside sales and how is it different from outside sales?
  • What exactly does exempt vs nonexempt mean?
  • What even is the FLSA?

Follow along as we decode this lingo below.

First, if you want to correctly classify your inside sales employees, you need to know the difference between inside and outside sales.

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Inside sales:

Applies to employees who sell products or services via phone, email or the internet. In other words, this is sales work that does not happen in person.
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Outside sales:

Applies to employees who sell products or services by physically going into the field to meet with prospective customers. As the name implies, an outside salesperson often works outside of a formal office setting and travels to meet customers face to face.

The important thing to remember here is that it doesn’t matter so much what your employee’s job title is on paper. It matters what their actual job duties are. Job titles don’t determine exemption. Primary duties do.

Next, what exactly do we mean when we say an employee is exempt versus nonexempt? In this case, we’re talking about their eligibility for overtime pay.

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Exempt:

If an employee qualifies as exempt under the FLSA, they are not entitled to overtime compensation for hours worked in excess of eight in a single day or 40 in a single week. In other words, you do not owe exempt employees overtime pay.

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Nonexempt:

If an employee is not exempt under the FLSA, they are entitled to overtime pay at a rate of at least 1.5x the regular rate of pay for each hour worked over 40 in a workweek. In other words, you do owe nonexempt employees overtime pay.

Now for the final term to complete our glossary: What is the FLSA that we keep referencing?

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Fair Labor Standards Act (FLSA):

A United States labor law created in 1938 that established things like the minimum wage, overtime pay, record keeping and youth employment standards affecting employees in the private sector and in federal, state and local governments.

The FLSA is the final word on these issues at the federal level. For our purposes, we’ll be looking at its ruling on overtime pay exemptions.

Now that we know what our terms mean, let’s put them together to understand this key point: Under the FLSA, outside sales employees generally do qualify for an exemption to the FLSA’s overtime requirements, while inside sales employees generally do not qualify for exempt status.

Since this is an article about inside sales exemptions, you might be scratching your head.

Let us explain: We’re not saying inside sales employees never qualify as exempt. Sometimes they can. You just have to know how to read the fine print. Which we’ll get into right now.

Understand the qualifications

Before we dive into the weeds of the FLSA’s criteria for an inside sales exemption, it’s important to know that states also have their own laws on the matter. You can find yours by checking out this breakdown of overtime laws by state provided by the Department of Labor. Before we move on, we’ll leave you with this key disclaimer:

An inside salesperson must satisfy the criteria under both state and federal law in order to qualify as an exempt employee.

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Now, let’s talk FLSA exemption criteria.

While inside sales employees are generally classified as nonexempt, they can be considered exempt if they satisfy all three of the following criteria:

  • The employee must work in the “retail and service industry.”
  • The employee’s regular rate of pay must exceed 1.5x the minimum wage for every hour worked in a workweek beyond the standard 40 hours.
  • The employee must derive more than half of their income from commissions in a representative period.

Let’s unpack what these three points really mean.

Retail and service industry

OK, so what types of businesses classify as retail and service?

If you’re asking the FLSA, employers belong to the retail and service industry if they derive at least 75% of their annual sales revenue from goods or services not for resale and are recognized as a retail or service establishment in their industry.

  • The first half of this means 75% of the business’ gross annual revenue must be from sales to an end user — not wholesale.

  • The second half is a bit more complicated. Long story short, Section 7(i) of the FLSA used to include two lists. One list included the establishments the FLSA viewed as potentially eligible to qualify as a service or retail establishment. The second list categorized businesses that lacked a “retail concept” and were disqualified from the exemption. However, in 2020 the U.S. Department of Labor (DOL) issued a new final rule that repealed these restrictive, partial lists.

What does that mean for you? Without those lists, the DOL now evaluates businesses equally on a case-by-case basis under the same standards when evaluating exemption claims. This change also opens the doors for employers in the retail and service industries to take a fresh look at their inside sales employees and possibly reclassify them as exempt.

Minimum wage

The key to the second exemption criteria is knowing the current minimum wage and doing some math.

Despite the push to increase the minimum wage in 2021, the federal minimum hourly wage remains what it was set to in 2009: $7.25. However, keep in mind that minimum wage has changed at some state, city and county levels. If the federal and state minimum wage are different, your employees are entitled to whichever one is higher. So be sure to check!

Another important factor to remember here is that if you have businesses located in multiple states, your employees will be subject to their specific state’s laws. For example, if you are primarily based out of Colorado but have another location in Arizona, your Arizona employees will be subject to Arizona’s minimum wage rules.

Once you’ve identified the minimum wage for your business’ locations, you can figure out if you’ve met the more than 1.5x the applicable minimum wage rule. Here’s a simple equation you can use:

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Divide the employee's total earnings by their total hours worked during your selected pay period. If the result is greater than time and one-half the minimum wage, this exemption condition has been met.

Commission

Now for the last puzzle piece. If the employee is paid entirely by commissions, or if commissions are always greater than salary or hourly amounts paid, the greater than 50% commissions condition is met.

If you pay an employee a wage in addition to their commissions that could be comparable, you’ll need to separately total the employee’s commissions and other compensation paid during the representative period. The total commissions paid must be more than the total of their other compensation.

Note: Tips paid by customers don’t count.

And finally, the “representative period” is a time frame you select to represent your employee’s work. It must be at least one month but not more than one year to get an accurate picture of the employee’s earnings and test whether they’re paid primarily by commissions.

Remember: Unless all three conditions are met, the inside sales exemption is not applicable and you must provide overtime premium pay to the employee for all hours worked over 40 in a workweek at time and one-half the regular rate of pay.

To provide proof for these three criteria, it’s crucial to maintain accurate records of hours worked each workday and workweek, along with records of the earnings paid. Without these records, you won’t be able to back up your claim that all conditions for the exemption have been met. This is why many business owners choose to work with a professional payroll provider who can produce the tools and reports they need to accurately record employees’ pay and hours.

It’s not a good idea to skimp on these services. Let’s chat about why.

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Know the consequences

Aside from employee misclassifications being one of the most common violations of the FLSA, it’s also one of the top violations the government likes to enforce.

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If you are accused of a misclassification, here’s what could happen:

First, misclassified workers are within their rights to sue you and are entitled to back pay for up to three years, plus legal fees. The court can also heap on more penalties for liquidated damages, injunctive relief, interest, attorney’s fees and others in an amount equal to the owned unpaid wages — essentially doubling the amount you originally owed to the employee.

Even more severe, if you’re found to have willfully and/or repeatedly misclassified workers as exempt, you could be stuck with civil penalties up to $1,000 for each violation. You could also face criminal prosecution resulting in a fine of $10,000 and/or time in prison.

Beyond that, misclassifying an employee can damage your reputation as an employer. Employees talk. When they find out they’ve been denied money, benefits and vacation time they were owed (in some cases for long periods of time), they might just take to the internet to review your performance as an employer and warn others to avoid your business.

So, what’s the takeaway? Reexamine your current classifications and before classifying any other inside sales employees as exempt, make sure they first satisfy the criteria.

When in doubt, it’s best to err on the side of caution and consult with a human resources expert.

Unlock the solution

We get it. Tackling employee exemption classifications can be more than a little complicated. And doing it all on your own can be more than a little exhausting.

If you’re looking for a partner to help you crack the code on your inside sales employee exemptions, we have solutions that can help.

Heartland Payroll+ offers payroll processing, HR and time tracking services. Our solutions provide dedicated support and top-notch tools that can help you classify with confidence:

  • Payroll processing: Pay your employees accurately and maintain regular records of employee earnings.
  • HR services: Get guidance on how to comply with the FLSA’s laws and receive alerts to stay apprised of any changes to employment law.
  • Timekeeping: Track the hours your employees work each day and week and automatically forecast your overtime expenses.

Contact us today to start receiving the support you need to get exemptions right, every time.


Heartland is the point of sale, payments and payroll solution of choice for entrepreneurs that need human-centered technology to sell more, keep customers coming back and spend less time in the back office. Nearly 1,000,000 businesses trust us to guide them through market changes and technology challenges, so they can stay competitive and focus on building remarkable businesses instead of managing the daily grind. Learn more at heartland.us