The Fair Labor Standards Act (FLSA), the federal law governing the payment of minimum and overtime wages, has proven itself to be an employer’s worst nightmare, and it may only get worse as the wage and hour landscape continues to rapidly evolve. An employer who violates the FLSA is subject to unpaid wages plus an equal amount in liquidated damages, unless the employer can prove that it acted in good faith and reasonably believed it was in compliance with the law. Monetary damages also extend forward until the employer corrects the FLSA violation; in other words, monetary damages may continue to increase even as the FLSA lawsuit is litigated. In 2013, about 10 percent more wage and hour suits were filed than in the previous year.

With these types of claims at an all-time high, it is essential for employers to ensure that their employees are classified and paid properly. Failure to do so can result in damaging claims and significant liability.

To this end, an employer’s strongest defense is an internal wage and hour audit of its wage payment practices and job classifications for overtime purposes. The resources required to conduct an audit will pale in comparison to the costs of becoming embroiled in litigation.

A wage and hour audit reduces the likelihood that an employer will face such increasingly popular FLSA lawsuits because an employer can remedy problems discovered in an audit before they spiral into a lawsuit. Unlike a lawsuit, an audit allows room for error and correction.

There is no single “perfect” way to conduct an internal wage and hour audit, because much of an audit is personalized to the individual employer’s needs and goals. At a minimum, however, an audit must review and evaluate the employer’s exempt and non-exempt job classifications, and timekeeping and pay practices and policies. This requires:

1. Ensuring proper classification of employees as exempt or non-exempt

Generally, to qualify for exemption (as bona fide executive, administrative or professional employees), employees must meet certain tests regarding their job duties and be paid on a salary basis at not less than $455 per week. For the exemption to apply, an employee’s specific job duties and salary must meet all of the requirements of the applicable regulations promulgated by the U.S. Department of Labor. Thus, an employer must carefully review the job duties of each employee in question. Although an employer should maintain accurate job descriptions for each job in its workforce, job descriptions alone rarely reveal whether an employee is exempt or non-exempt. Analyzing an employee’s status based solely on a job description or a job title is often insufficient because some employees with a certain job title may be exercising more discretion that qualifies them for some type of exemption under the FLSA.

Typically, this involves utilizing investigative interviews or questionnaires to determine the type and level of work being performed, and whether such work involves a certain degree of decision-making or authority, such as the ability to hire or fire employees, or the regular exercise of discretion and judgment in the performance of assigned duties.

2. Ensuring proper pay practices and policies

The audit should analyze an employer’s pay practices to ensure that all time worked is properly recorded and compensated, which includes an assessment of the employer’s regular rate calculations, overtime calculations, and the number of hours actually worked by employees.

An employer’s pay practices should be carefully analyzed to assure that exemptions under the FLSA are not destroyed by such pay practices.

For example, an employer may risk destroying an employee’s exemption if it docks a salaried employee’s pay for a partial day absence. Pay practices also should be carefully analyzed to assure that the employer is paying its overtime-eligible employees correctly and that overtime pay is being properly calculated. Under federal law, overtime pay for eligible employees is determined by multiplying the number of hours in excess of 40 in a workweek by 1.5 times the employee’s regular rate of pay. State law may require otherwise.

In addition to the employee’s base hourly rate, other forms of compensation, such as commissions, prizes, shift differentials and certain performance bonuses, must be factored into the regular rate for purposes of determining overtime pay. For instance, if an employee receives a quarterly performance bonus pursuant to a company policy, that bonus must be prorated over the course of the quarter in which it was earned and included for purposes of determining a new, higher regular rate for that period of time, which will increase the employer’s overtime obligation.

Above and beyond actual calculation of overtime pay, it is important for employers to verify that their employees are receiving proper pay for time considered “worked” under applicable laws. For instance, certain types of waiting time, on-call time, meal periods and rest breaks, time spent in training and meetings, and travel time are considered time worked and must be included in calculating employee overtime.

If an employer’s internal wage and hour audit reveals compliance problems, the employer should remedy the problems as soon as possible or, at least have a carefully-considered reason for not fixing the problems. Employers should keep the results in a confidential file, only accessible to employees on a strict, need-to-know basis.

An internal wage and hour audit is an essential preventative tool for employers. Not only can internal wage and hour audits reduce the risk of FLSA lawsuits and hefty damage payments, but they help employers navigate the messy waters of the FLSA and its regulations. An annual — or at least an “as needed” — wage and hour audit should be at the top of every employer’s “to do” list.