Best Practices in HR

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Aaron Carr
  November 23, 2018

Salary vs. Hourly — Which is Right for Your Small Business

A salaried employee is one that is paid a fixed rate at set intervals for a job whereas an hourly employee is paid by the hour for work performed. There are pros and cons to paying salary vs. hourly. We’ll discuss the benefits of each type of employee pay, such as ease of administration and accuracy so that you can decide what works best for your small business.

Which is Right for Your Business: Salary or Hourly?

Exempt employees are most often paid a salary while non-exempt are most often paid hourly. Let’s take a look at pros and cons of each, and provide some examples to see which is best for your business, the kind of workers you employ and the kind of scheduling (and flexibility) you need.

Service companies, retail and foodservice industries tend to pay hourly since the work schedule is rarely consistent and most of the workers are non-exempt.

On the other hand, professional firms with standard weekday working hours and exempt employees often pay workers a salary since most team members work similar hours or the same schedule each week. In other cases, professional firms like consulting services and lawyers don’t have standard hours at all. Employees are simply paid a salary to do the job — regardless of the hours it takes.

Additional pros and cons are below, provided from both the employer view and the point of view of the employee — in case you’d like to explain the benefits of being paid salary vs. hourly to your team members.

How Salary Works

Paying an employee a salary is often the easier way to manage payroll. You choose the annual rate, divide it by the number of pay periods, and that’s how much the employee will be paid. The math is simple. It’s also the most common way to pay exempt employees since they are most likely to work a standard schedule. A salary can be paid to full-time or part-time employees.

Here are two salary examples:

Full-time Salary Example

Susan is your sales manager. She works full time and you pay her $60,000 per year as a salary. She earns $5,000 per month ($60,000 / 12 = $5,000). She is paid weekly, so that means she earns $1,250 each week. Because of her management responsibilities and other criteria, she is also exempt and not eligible for overtime.

If she works 35 hours in the office one week and 42 hours the next, her salary stays the same each week regardless. In fact, she often checks email at night or makes phone calls to clients on the weekend, and those hours aren’t tracked anywhere. It’s all part of the job she’s paid a salary to do. As long as she is doing the job she was hired to do, she gets paid her salary. If not, docking her pay is not an option.

Part-time Salary Example

Salary vs Hourly Fit Small Business

Kristen is your part-time receptionist. She works mornings from 8 a.m. to noon, five days a week. Because she always works the exact same hours, you find it easier to pay her a salary — it’s simpler for you to budget, and she also knows what to expect each week in her paycheck. So, you pay her a salary of $15,000 a year for part-time hours and process her payments weekly at $288.46 a week. ($15,000 / 52 = $288.46).

She is a non-exempt employee. This means that when there’s a week that she works extra hours (perhaps on the weekend for a special event), you have to add those additional paid hours to her salary. She keeps track of her time and lets you know on any week that she works more than the agreed-upon 20 hours per week. However, that’s the rare exception. She never works overtime.

In fact, you can pay any non-exempt employees a salary if you prefer. It’s just not as common because you’d still have to calculate overtime, so why not pay them only for the hours worked?

In addition, the government has guidelines for pay rates and break times for non-exempt employees that you often have to track. Many employers simply pay those employees hourly as they have to track paid breaks and unpaid lunch time anyhow in case they’re audited by the labor board.

Here’s what attorney Marylou V. Fabbo, a partner with Skoler, Abbott & Presser, P.C., one of the largest law firms in New England exclusively practicing labor and employment law, has to offer:

Marylou Fabbo, Attorney, Skoler, Abbott & Presser, P.C.

Marylou Fabbo Salary vs Hourly

Under the Fair Labor Standards Act and some state laws, an employer may want to reduce overtime obligations to non-exempt employees whose hours vary from week-to-week by paying them on a salary basis and taking advantage of the “fluctuating workweek” method of calculating overtime. Under the “fluctuating workweek” method, employees who are entitled to overtime pay because they are non-exempt, are paid a fixed weekly salary for all hours worked.

The salary is then divided by the actual number of hours the employee worked in the week to determine the employee’s base regular rate of pay. Employers may then pay those employees an additional .5 times their base rate for each hour worked over 40 in a workweek rather than 1.5 times the regular rate.

The downside of paying a non-exempt employee on a salary basis to take advantage of the flexible workweek method is that doing so can be complicated. Use of the flexible workweek method of calculating overtime requires weekly calculation of the regular rate that, depending on the size of the organization or its resources, may be overly burdensome.

Also, there must be a “clear mutual understanding” that the fixed salary is compensation for how many hours the employee may work in a particular week rather than for a fixed number of hours per week. The lack of the clear mutual understanding could place the employer at risk of a wage lawsuit.

Pros of Paying Employees a Salary

The biggest benefit of paying a salary to employees is that you can budget your payroll for the year in advance. With professional office workers, you likely know how many hours each person will work like 20, 30 or 40 hours per week. You set up your payroll system to pay them a salary, and keep your payroll expenses consistent as well as make payroll processing easier by not having to calculate actual hours worked.

Additional benefits of a salary payment type are described below.

To the Employer

When you pay a salary to an employee, your payroll expenses remain stable. You don’t worry about tracking time the employee takes for breaks, and the employee is often happier because he or she can rely on a steady paycheck each pay period. It also makes your payroll process simpler.

Your payroll system will be set up based on your pay period or payroll time frame — weekly, every other week or monthly. You input the annual salary into your payroll system, and each pay period it calculates the pay based on the payroll time frame.

Here are examples of the same $50,000 per year salary paid in different payroll cycles.

  • Weekly pay = 52 weeks a year: The employee would receive $962.54 gross pay per week.
  • Bi-weekly pay = 26 pay periods: The employee would receive $1,923.01 gross pay every other week
  • Semi-monthly pay = 24 pay periods: The employee would receive $2,083 gross pay twice a month.
  • Monthly pay = 12 pay periods: The employee would receive $4,166.67 gross pay each month.

It also makes paying vacation and sick-time pay easier as well, as you can pay these at a daily or weekly rate instead of an hourly rate. Read our article for more info on setting up a paid time-off policy.

Another benefit is that you’re paying employees for the job or the results of their work, rather than the time put into doing the job. As long as the employees get the job done, you have already agreed on what salary to pay. You don’t need to worry about calculating or paying overtime if the employee has to work extra to meet a deadline.

To the Employee

Getting paid a salary helps stabilize the employee’s income and allows him or her to budget since the pay will be consistent each pay period. Some employers that provide hourly pay, also guarantee a base salary for a fixed number of hours even if the employee isn’t scheduled or doesn’t work those hours.

An example might be a plumber who makes $20 per hour. To keep the employee happy, the employer might say, “I’ll pay you a salary of $600 a week (30 hours), even on weeks we’re not busy.” A base salary ensures the employee can rely on steady pay, even during slow work weeks. If the plumber only works 25 hours that week, he or she will still get paid a salary that compensates the plumber as if he or she worked 30 hours. That aids with employee retention.

Then, on weeks where the employee works more than 30 hours, he or she gets paid for those hours after 30. Once he or she gets to 40 hours, the pay rate goes to time and a half.

Cons of Paying Employees a Salary

The downside of paying employees a salary is that most businesses have both types of employees — exempt and non-exempt. For the exempt employees, there’s no issue as long as they have been classified correctly into an exempt status. However, if you pay non-exempt employees a salary, you will still have to calculate the number of hours they work because they’re non-exempt as well as track their paid breaks, unpaid lunch and overtime hours.

These employees might be referred to as “salaried-non-exempt” with their salary based on a “set” number of hours agreed in advance. Any time the employee works more hours than scheduled and agreed upon for their salary, you will have to add those additional hours as paid hours. It’s an “exception.” You also still have to abide by overtime laws, such as paying time and a half for overtime worked. That means you have to pay close attention to their hours worked so that you can adjust their salaried pay if they work more hours than agreed.

Another downside of paying a salary, or agreeing to pay an employee a salary in your offer letter, is that you’re obliged to pay them, even if you’re not busy that week. Let’s say your computers go down for a day, and your training managers are unable to lead any webinars or have to cancel their training sessions. You still have to pay them, even if you send them home early with no work to do. Had they been paid hourly, you’d only have to pay them for hours worked.

How Hourly Works

Paying employees hourly is more intuitive for both employer and employee. When an employee works 10 hours, you pay them for 10 hours. When they work 35 hours, you pay them for 35 hours. Their hourly rate is agreed upon in advance. However, hourly pay is not best if your employees are in upper management, are exempt or you can’t track how many hours they work exactly. Most non-exempt employees are paid hourly, but you can pay either exempt or non-exempt employees hourly. Here are two examples.

Hourly Example for a Non-exempt EmployeeSalary vs Hourly

Max works full time as a mechanic making $18 an hour. At your company, full-time work is typically 37.5 hours a week. You pay your employees weekly.

Most days Max is scheduled to work 8 a.m. to 3 p.m. with a half-hour lunch, or 7.5 hours per day. But there are many days when Max stays late to finish a repair or leaves early if the shop isn’t busy. Sometimes, you ask Max to work on a weekend for an emergency repair. Of course, you pay him for those extra hours.

Due to Max’s job role, he is classified as a non-exempt employee, so you also have to track Max’s paid break time, unpaid lunch time and any overtime. Last week, Max worked 44 hours. He was paid his hourly rate for 40 of those hours and he was paid overtime at 1.5 times his hourly rate for the other four hours. This week, he only worked 32 hours because the shop wasn’t that busy. In this example, 32 hours is all Max is paid this week. See below:

  • Last week: Max worked 44 hours total. 40 were paid at $18 an hour = $600. Four were paid at $27 an hour = $108. Total paid last week: $708
  • This week: Max worked 32 hours paid at $18 an hour. Total paid this week: $576

Paying hourly ensures employees are paid for the exact amount of time that they work. It requires that you track that time in a timekeeping system like Homebase, and use a payroll system that can determine, based on state law, how to calculate and pay the employee correctly for overtime and breaks.

Try Homebase

In addition, we recommend using a low-cost payroll provider like Gusto that interfaces with Homebase (they work together) to simplify these calculations and ensure you’re compliant with state, federal and local labor laws.

Try Gusto

Hourly Example for an Exempt Employee

Salary vs Hourly

Jo works as an HR manager for your firm. She is paid $25 per hour. Some weeks, she works 10 hours and other weeks she works 50 hours, such as when it’s time for open enrollment for benefits or when she’s helping your supervisors conduct performance reviews.

Rather than pay her a salary, with the same gross pay each pay period, you prefer to pay her for the hours she works in the time period she works them.

Paying her a salary would require you to estimate how much to pay her as you really don’t know what her workload looks like from week to week. Instead, she’s paid hourly.

When she worked 10 hours, she received $250 in gross pay. When she worked 50 hours she earned $1,250 in regular pay, and also $375 in overtime pay. Because she’s paid hourly, even if she’s exempt, she has to be paid overtime for hours worked over 40. Other federal laws may come into play like providing her with benefits if you have more than 50 employees and she averages more than 30 hours a week, for example.

Here’s an opinion from another labor law attorney based out of California, Andrea W. S. Paris:

Andrea W. S. Paris, California Employment Attorney, Law Office of Andrea W.S. Paris

Andrea W. S. Paris Salary vs Hourly

I’m an employment attorney with experience advising and litigating issues of exempt vs. non-exempt employees and how paying hourly vs. salary is problematic. In order for someone to be considered an exempt employee — executive, administrator or professional — one of the indispensable requirements is that the person is paid a certain minimum salary set by federal and state law.

Thus, even if someone has the title of CEO, the law will consider that person a non-exempt employee entitled to overtime pay and other protections if she or he is paid on an hourly basis.

One exemption that does allow hourly payment of wages is the computer software exemption. In that case, it may make sense to pay the employees hourly if the company believes it would incentivize employees to work longer hours that they may if they were to receive a salary regardless of the number of hours worked. The positive here is that it may incentivize employees to put in more work and allows the company to track the number of hours each employee works. However, the drawback is that it may be difficult for the business to budget payroll costs.

Fabbo adds:

Employers are required to pay exempt employees for a full day if they show up to work at all.

In some cases, exempt employees can only work part of a day — such as when they are recovering from a medical condition. To avoid having to pay the exempt employee for the full day, an employer could consider paying the employee on an hourly basis and only for those hours worked.

Also, when you have two employees working in the same position with one being paid hourly and one paid on a salaried basis, it may suggest to the Department of Labor or other entity that enforces wage laws that the person paid on the salary basis is not truly exempt and has been misclassified.

Pros of Paying Employees Hourly

The biggest benefit of paying workers hourly is that you only pay them for hours worked. So, if your business is busy, and you have lots of customers in a given week, your larger payroll will likely be offset by increased business income.

On weeks when work is slow, you may need employees to work fewer hours. Since you’re paying them hourly, you’ll only pay them for the time worked. In other words, hourly pay allows you to match your payroll expenses to the business workload or income-generating activities.

Additional benefits of an hourly payment type are described below.

To the Employer

Some employers, especially those in businesses like services, hospitality, foodservice, retail and home care, will pay employees only for the hours worked. Often, those hours closely match the busy time frames of the business or the revenue-generating hours of a service. That means the employer pays for work received and can save money by not providing a salary.

For example, in a restaurant, employees might be scheduled for a shift or daypart, such as breakfast, lunch or dinner. On days when the restaurant is busy like Friday nights or Sunday mornings, the business is busier, may have more employees working and those employees may work longer hours. Even though the payroll expenses for those hours are increased, so is the revenue.

In addition, by tracking and paying the employees hourly, the business can match labor costs to a job. For example, if an electrical repair takes two hours, and the electrician is paid for two hours, the business can calculate the labor cost of that repair easily.

To the Employee

Employees who often work overtime typically prefer to be paid hourly as they know they can earn time and a half on any overtime hours. However, if you have employees who have a legal status of exempt, you don’t have to pay them overtime.

You will find that employees sometimes balk at being “promoted” from a non-exempt position like “installer” where they’re paid overtime to a supervisor position of “installation supervisor” where they are reclassified as exempt and no longer paid overtime.

If they’re going to work 50 hours a week either way, most employees would prefer to be paid hourly, regardless of their job title.

Cons of Paying Employees Hourly

The biggest downside of paying employees hourly is that you have to track the hours. That takes time, requires someone to review the hours reported on time cards to make sure there’s no time theft and manage all the calculations. That’s why many companies use a time clock or timekeeping system. Of course, if the hourly employees are also non-exempt, you’d have to track their hours, breaks and overtime anyhow.

In addition, for workers who are exempt, who often check email at night, come in early for meetings, travel for conferences or stay late, all that tracking of hours is a nightmare. Therefore, most business owners choose to pay a salary rather than track and pay hourly for their exempt staff. It just makes the paperwork easier.

Salary vs. Hourly & Exempt vs. Nonexempt

It’s a common misconception that salary means exempt, or not paid overtime, and hourly means non-exempt, or paid overtime. However, exempt and non-exempt are legal employment classifications, not payment types. Let’s be sure that you don’t want to be comparing exempt vs. non-exempt instead.

Salary vs Hourly Image of Exempt vs Non Exempt Employee classification and pay

Salary vs. hourly is not the same as exempt vs. non-exempt.

Federal labor laws like the Fair Labor Standards Act (FLSA) clarify when you can classify someone as exempt and not pay them overtime or classify them as non-exempt. In comparison, salary and hourly are merely means of employee payment.

For example, when you set up employees in a payroll system, one of the first questions likely to be asked is their employment status —  whether they are exempt or non-exempt. While it’s most common to pay exempt employees a salary, non-exempt employees can be paid either way. Look at a screenshot from Gusto showing this data for both a salaried and an hourly employee.

Salary vs Hourly screenshot image of Gusto payroll showing employee pay types

Gusto can pay employees in multiple ways, including salary and hourly.
Source: Gusto

It’s up to you whether you want to pay employees salary vs. hourly. You can choose either as that is considered to be a payment method, not a legal employment status. Other types of payment might include paying an employee by commission or paying an employee by piecework, which is common in manufacturing. Because hourly and salary are the most common options, we’ve focused on those.

Reviewing both options in detail will help you choose the best payment option for your business. There are pros and cons to setting up employee payroll each way that depends on your business, scheduling, and other variables like the kind of work the employee does.

The Bottom Line

To keep things simple, most businesses choose to pay exempt employees a salary since the exempt status doesn’t require hourly work hours to be tracked and to pay non-exempt employees hourly since they have to track those hours per FLSA guidelines.

However, if you have part-time staff who work fixed hours, you can simplify your payroll by paying them a salary and only modifying their pay during pay periods when they work a nonstandard schedule. That also benefits the worker by giving him or her a steady paycheck each pay period, helping the employee plan a budget and improving employee loyalty.

The most important takeaway is that salary vs. hourly is simply a way to calculate and pay employees for their work. It’s not a legal status. The legal status often confused with salary or hourly is the employment classification of exempt vs. non-exempt. Once you choose the employee classification correctly, it’s really up to you to determine the best means of payment.

If you want payroll software that can manage both salary and hourly, in addition to other payment types, and that partners with the free timekeeping system Homebase, consider Gusto. Gusto provides labor law compliance to ensure employees are paid correctly, regardless of their employment status and pay type.

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