By Attorney Jonathan Magna

The Fair Labor Standards Act (“FLSA”), amongst other things, establishes a minimum wage, establishes overtime pay, sets minimum recordkeeping requirements, and sets youth employment standards.  While certain provisions of the FLSA can seem fairly straightforward, e.g., pay a certain minimum amount per hour or pay time-and-a-half after forty hours of work, other provisions can be more complicated.  For example, determining whether a worker is an employee or an independent contractor becomes very fact specific.  Employee exceptions from the FLSA also depends heavily on the facts of the situation. The rules surrounding tipped employees places additional exposure to liability on employers. Finally, a U.S. Department of Labor (“DOL”) Wage and Hour Division audit can come with steep fines, penalties, and even criminal sanctions.  The DOL does not disclose whether an employee filed a complaint during the audit process.  However, there is a good chance that employee complaints triggered the DOL audit. If so, the DOL is aware of potential violations before they even begin to audit employer records.  Attorneys at CTM Legal Group can help employees and employers navigate the complex requirements of the FLSA. Employers undergoing an audit from the DOL should retain an attorney to assist during this process.    

1. Wage and Hour Basics

The FLSA sets the federal minimum wage at $7.25 per hour[1].  The federal minimum wage rate has not been updated since 2009.  However, states and local governments also set their own minimum wage rates.  The State of Illinois set the minimum wage at $13.00 ($7.80 for tipped employees) per hour as of January 1, 2023, with increases to $14.00 ($8.40 for tipped employees) per hour and $15.00 ($9.00 for tipped employees) per hour on January 1, 2024, and January 1, 2025, respectively.  Employers can pay employees under the age of 18 a reduced wage[2].  In the City of Chicago (as of July 1, 2023), minimum wage is $15.80 ($9.48 for tipped employees) per hour for employers with 21 or more employees and $15.00 ($9.00 for tipped employees) per hour for employers with 4 to 20 employees.  The City of Chicago also provides a reduced hourly rate for youth workers[3]. 

For tipped employees under the FLSA, the total compensation per workweek must meet or exceed the non-tipped minimum wage rate.  Employers can apply a tipped credit towards a tipped employee's minimum wage.  The tip credit consists of the amount of tips actually received by the employee.  Meaning if there is any tip sharing amongst employees only the amount actually received by the employee can be counted as a tip credit.  The tip credit claimed cannot be more than the tips actually received by the employee and cannot be more than the difference between the applicable minimum wage and the minimum tipped wage even if an employee earns more than that amount in tips. The same tip credit must be used for straight time hours and overtime hours[4]. 

The FLSA requires employers to pay time-and-a-half (1.5) times the employee's hourly rate for all hours worked over 40 hours in a workweek.  For tipped employees, the process is more complicated. 

Employers frequently and mistakenly base overtime payments on the tipped minimum wage and apply the wrong tipped credit for hours in excess of 40 per workweek.  Additionally, employers will calculate the tip credit for the pay period (e.g. 2 weeks) instead of calculating the tip credit for the individual workweek. Below are two examples using the federal minimum wage that correctly demonstrate calculation of the tip credit and overtime payments. 

Example 1:

Tipped employee works 50 hours in a work week.  Federal minimum wage is $7.25 per hour and the direct cash wage paid to the employee is $2.13 per hour.  The employee receives sufficient tips for the workweek that meet minimum wage. Total straight time and overtime should be calculated as follows:

$2.13 (direct cash wages) + $5.12 (maximum tip credit) = $7.25 per hour

$7.25 X 50 hours = $362.50 (Straight time pay)

$7.25 X 0.5 X 10 overtime hours = $36.25 (overtime pay)

$362.50 + $36.25 = $398.75 (total straight time and overtime pay)  

Example 2:

Tipped employee works 50 hours in a work week.  Federal minimum wage is $7.25 per hour and the direct cash wage paid to the employee is $4.00 per hour.  The employee receives sufficient tips for the workweek that meet minimum wage and the employer applies $5.12 per hour as a tip credit. Total straight time and overtime should be calculated as follows:

$4.00 (direct cash wages) + $5.12 (maximum tip credit) = $9.12 per hour

$9.12 X 50 hours = $456.00 (Straight time pay)

$9.12 X 0.5 X 10 overtime hours = $45.60 (overtime pay)

$456.00 + $45.60 = $501.60 (total straight time and overtime pay) 

In other words, an employer cannot apply more than the maximum hourly tip credit when calculating required overtime payments even if the tips received exceed the minimum wage[5]. 

2. Enterprises

Some employers will have multiple operating locations with each location set up as an independent organization.  The FLSA regulations define employer, establishment, and enterprise differently.  The term “employer” means any person (individuals, corporations, partnership, etc.) that acts directly or indirectly in the interest of an employer in relation to an employee[6].  The term “establishment” means a distinct physical location of a business[7]. The term “enterprise” means the related activities performed (either through unified activities or common control) by any person or persons for a common business purpose[8]. 

Employers operating as an enterprise should be mindful that the actions of one location can impact a separate location.  For example, assume a retail store operates two locations, with each location organized as a separate limited liability company (“LLC”).  The stores are under common control of an ownership group and are engaged in the same retail business.  Those stores will likely be considered an enterprise.  In this example, if one employee works at both locations, then the total hours worked at each location are counted for overtime purposes.  Meaning if an employee works 30 hours per week at one location and 20 hours per week at another location the total hours worked is 50 hours per week and overtime must be paid on 10 hours.  In this example overtime payment is required even though the two stores are separate limited liability companies.   

3. Independent Contractor versus Employee

An area of interest for the DOL is wrongly classified employees, particularly employees that are wrongly classified as independent contractors.  The DOL will consider various factors to determine whether a worker is misclassified as an independent contractor[9].  The factors considered are the following:

1. The extent to which the services rendered are an integral part of the principal's business.
2. The permanency of the relationship.
3. The amount of the alleged contractor's investment in facilities and equipment.
4. The nature and degree of control by the principal.
5. The alleged contractor's opportunities for profit and loss.
6. The amount of initiative, judgment, or foresight in open market competition with others required for the success of the claimed independent contractor.
7. The degree of independent business organization and operation.

All the above factors are considered under a “totality of the circumstances” test.  Meaning that not every single factor needs to be present for a finding that an alleged independent contractor is an employee, and the employment determination is based on the total facts of a particular situation[10]. 

Misclassifying employees as independent contractors can result in costly violations of the FLSA.  Missed overtime wages or failure to meet the minimum hourly wage can result in significant liability. 

4. Exempt versus non-exempt employees

Misclassification of employees as exempt from the FLSA is another area of interest for the DOL.  The FLSA provides an exemption from minimum wage and overtime provisions for bona fide executive, administrative, professional, and outside sales employees.  The job title of the employee does not matter, rather the specific duties of the employee and minimum salary requirements must be satisfied.  Below are the requirements for employees to be exempt from the FLSA[11]:

     A. Executive Exemption

• The employee must be compensated on a salary basis of not less than $684.00 per week;
• The employee's primary duty must be managing the enterprise or managing a customarily recognized department/division of the enterprise;
• The employee must customarily and regularly direct the work of at least two or more full-time employees; and
• The employee must have hire/fire authority or recommendations to hire, fire, promote are given a particular weight.

     B. Administrative Exemptions

• The employee must be compensated on a salary basis of not less than $684.00 per week;
• The employee's primary duty must be the performance of office or non-manual work directly related to the management or general business operations of the employer or the employer's customers; and
• The employee's primary duty includes the exercise of discretion and independent judgment with respect to matters of significance.

     C. Learned Professional Exemption

• The employee must be compensated on a salary basis of not less than $684.00 per week;
• The employee's primary duty must be the performance of work requiring advanced knowledge, defined as work which is predominantly intellectual in character and which includes work requiring the consistent exercise of discretion and judgment;
• The advanced knowledge must be in a field of science or learning; and
• The advanced knowledge must be customarily acquired by a prolonged course of specialized intellectual instruction.

     D. Creative Professional Exemption

• The employee must be compensated on a salary or fee basis (as defined in the regulations) at a rate not less than $684 per week;
• The employee's primary duty must be the performance of work requiring invention, imagination, originality or talent in a recognized field of artistic or creative endeavor.

     E. Computer Employee Exemption

• The employee must be compensated either on a salary or fee basis (as defined in the regulations) at a rate not less than $684 per week or, if compensated on an hourly basis, at a rate not less than $27.63 an hour;
• The employee must be employed as a computer systems analyst, computer programmer, software engineer or other similarly skilled worker in the computer field performing the duties described below;
• The employee's primary duty must consist of:

1. The application of systems analysis techniques and procedures, including consulting with users, to determine hardware, software or system functional specifications;
2. The design, development, documentation, analysis, creation, testing or modification of computer systems or programs, including prototypes, based on and related to user or system design specifications;
3. The design, documentation, testing, creation or modification of computer programs related to machine operating systems; or
4. A combination of the aforementioned duties, the performance of which requires the same level of skills.

     F. Outside Sales Exemption

• The employee's primary duty must be making sales (as defined in the FLSA), or obtaining orders or contracts for services or for the use of facilities for which a consideration will be paid by the client or customer; and
• The employee must be customarily and regularly engaged away from the employer's place or places of business.

Note on Highly Compensated Employees.  Highly compensated employees that are paid an annual compensation of $107,432.00 per year with minimum weekly salary of $684, are exempt from the FLSA if they customarily and regularly perform one of the duties of an exempt executive, administrative or professional employee identified above. 

5. Wage and Hour DOL Audit Process

If the DOL audits an employer, that employer should retain legal counsel.  The DOL is empowered to investigate violations of the FLSA and other laws under its jurisdiction.  An employer may first become aware of a DOL audit when an agent arrives at the establishment. The DOL investigator is not required to preschedule visits to an establishment. Generally, the DOL investigator may observe normal business operations. The agent may interview employees and request records that the employer is required to maintain.  The DOL investigator will not disclose whether a complaint was made against the employer and it will not disclose the name(s) of any employees that filed a complaint. The Best way to be prepared for a DOL audit is to take proactive steps to identify potential issues.

     A. Proactive Steps

The best defense to a DOL audit is to be proactive in the business management to ensure compliance with laws and regulations.  Periodically employers should do the following:

1. Review job descriptions and employee classifications for exempt and nonexempt employees;
2. Review timekeeping methods and accuracy of those methods (check these methods for remote workers)
3. Review independent contractor agreements for potential misclassifications
4. Ensure all required posters are up to date and posted correctly
5. Review and update policies and procedures

     B. Opening of the Investigation

The DOL may but is not required to provide advance notice of its investigation.  The DOL will provide you with a letter that requests certain documents.  In a wage and hour audit the DOL will request timekeeping and payroll records, vendor contracts, job descriptions and other documents[12].  The employer must produce these records in a timely manner. 

If an onsite audit is being conducted, the employer should make space available for the investigator.  Preferably this space will be out of sight of the mainstream operations of the business.  The DOL investigator may also inspect the premises and interview employees.

     C. Employee Interviews

The DOL agent has the right to interview employees.  These interviews should not substantially interfere with operations and during a surprise visit you may request that interviews be limited to short periods of time to not interfere with operations or scheduled for a later date. The employer may have an attorney present when members of management are being interviewed.  However, for non-managerial employees the employer may not have an attorney present. 

     D. Document Production

As mentioned above, the DOL agent will be entitled to receive certain documents.  It is a good idea to comply with these requests. Failure to comply in a timely manner will burn any goodwill with the investigator and the agent will have the documents subpoenaed.    

All documents produced should be labeled propriety and confidential.  It is also a good idea to bates stamp (method of page numbering) all documents produced.  If there is later discussion regarding the documents, the bates stamp will useful in quickly identifying specific pages and documents.

The DOL's requests may seem overly broad, unclear, or be unable to be produced in the time specified.  Communication with the DOL agent will be key in resolving these discrepancies or to request extensions to produce.  Also, coordination with legal counsel will be key to determine if certain documents may be withheld (e.g., privileged documents, trade secrets, etc.). Also, an employer may be able to avoid producing certain documents through stipulations.  For example, the DOL may request revenue information of the business to determine that it has jurisdiction.  A company may avoid production of this information by stipulating that it has over $500,000 in revenue. 

After the initial production of documents, the DOL agent may request additional information or documents before the closing conference.         

     E. During the Audit

While the DOL is reviewing the information and documentation it collected the employer should be conducting its own internal audit to identify any legal exposure it may have.  If any issues are identified the employer immediately make those corrections.  Proactively correcting these issues will limit future liability and can be helpful during settlement with the DOL. 

     F. Closing Conference, Settlement or Litigation

At the closing conference the DOL agent will present a report with the DOL's findings.  The agent will identify any remedial actions required to comply with federal law and regulations.  Remedial actions can include corrections to a process or classification, paying back wages, liquidated damages, fines, or other remedial measures. 

Generally, employers should not agree or concede or admit fault at this conference.  Employer should request clarification if needed and request time to produce any supplemental information.  If clarification or supplemental information is provided a follow-up closing conference should be scheduled. 

Once the closing conference has concluded the employer has three options. 

1. Negotiate an informal settlement with the investigator;
2. Negotiate a formal settlement with the DOL's counsel; or
3. Proceed to trial in court.

The best option will depend on the DOL's findings and any disputes of those findings, and the amount of potential liability. 

6. Conclusion

The FLSA and Audit Process can be complicated and filled with many obstacles for the unwary. With the complexity and ambiguity of wage and hour laws employers should have an attorney review internal processes before they become subject to an audit.  CTM Legal group can help employers and employees navigate these complex and ambiguous rules.  Contact us for assistance at (312-818-6700) today. 

[1] https://www.dol.gov/agencies/whd/flsa

[2] https://labor.illinois.gov/laws-rules/fls/minimum-wage-law.html

[3] https://www.chicago.gov/city/en/depts/bacp/supp_info/minimumwageinformation.html#:~:text=As%20of%20July%201%2C%202023,with%204%20to%2020%20workers.

[4] https://webapps.dol.gov/elaws/whd/flsa/otcalc/otExampleTipped725.asp

[5] https://webapps.dol.gov/elaws/whd/flsa/otcalc/otExampleTipped725.asp

[6] 29 USC § 203(d)

[7] 29 CFR § 779.203

[8] 29 USC § 203(r)

[9] https://www.dol.gov/agencies/whd/fact-sheets/13-flsa-employment-relationship

[10] https://www.dol.gov/agencies/whd/fact-sheets/13-flsa-employment-relationship

[11] https://www.dol.gov/agencies/whd/fact-sheets/17a-overtime#footnoteOvertime

[12] See 29 CFR § 516.