We have closely monitored and continued to receive inquiries regarding the new rules that will take effect on December 1, 2016, regarding who is exempt from the Fair Labor Standards Act’s overtime rules. As the effective date looms, the clock is ticking for employers to ensure they will be in compliance under the new rules, which are forcing many employers to make changes. Determining the best option for compliance depends on a number of case specific factors, and understanding the new rule is essential for choosing the best option.
Though we know many of our readers are well-versed in FLSA exemptions, some background information puts the new rules in context. The most commonly used exemption to the FLSA’s overtime requirement is for executive, professional, and administrative (“EAP”) employees. To qualify for the exemption, the employee must 1) be paid a predetermined and fixed salary that is not subject to reduction because of variations in the quality or quantity of work (the “salary basis test”), 2) be paid a certain salary level (the “salary level test”), and 3) primarily perform certain duties as defined in the regulations (the “duties test”). In addition, the regulations exempt certain highly compensated employees (“HCEs”) who earn above a higher total annual compensation level. The distinction for HCEs is that the duties test is significantly less stringent than under the standard salary level.
The new rule changes only the salary level test and salary basis test, as discussed below.
Updated Salary Levels
Under the former rule, an employee had to be paid at a rate of at least $455 per week ($23,660 annually) to qualify under the EAP exemption. Under the new rule, the employee must be paid at a rate of at least $913 per week. Moreover, the new rule provides that the salary level will be automatically updated every three years to the 40th percentile of the weekly earnings of full-time nonhourly workers in the lowest-wage Census Region. The first update will be effective January 1, 2020, and the updated amount will be posted at least 150 days prior to that date.
In addition, the new rule updates the total annual compensation for HCEs from $100,000 to $134,004. This automatically increases every three years based on the 90th percentile of full-time salaried workers nationally.
Use of Nondiscretionary Bonuses, Incentive Payments, Commissions
Under the former rule, employers could not use bonuses or incentive payments to count toward the salary level. The new rule allows employers to use nondiscretionary bonuses and incentive payments (including commissions) to satisfy up to 10% of the $913 standard salary level. These must be paid quarterly or more frequently. At the end of each quarter, if the employee has not been compensated at the minimum standard salary level for the quarter (i.e., 13 times the weekly salary amount of $913) when accounting for salary and nondiscretionary bonuses / incentive payments, then the employer can pay the deficiency in one final payment. Significantly, that payment must be made no later than the first pay period after the end of the quarter.
The word nondiscretionary is emphasized because employers cannot use discretionary bonuses to satisfy any portion of the $913 standard salary level. Discretionary bonuses are those which are entirely in the employer’s discretion and not pursuant to any preannounced standards.
A notable distinction exists for HCEs. Under both the old rule and new rule, HCEs must be paid the standard salary level on a salary basis, and employers may not use bonuses or incentives to satisfy any portion of the standard salary level. Nondiscretionary bonuses and incentives may be used to satisfy the total annual compensation requirement for HCEs. Thus, under the new rule HCEs must be paid at least the rate of $913 weekly without accounting for any nondiscretionary bonuses or incentive payments. The 10% rule does not apply to HCEs. However, nondiscretionary bonuses and incentive payments may be used when accounting for the total annual compensation requirement of HCEs.
Factors to Consider in Evaluating Options
The new rule has forced employers to make decisions, particularly regarding employees currently treated as exempt and who earn between $455 and $913 per week. As an initial matter, employers should consider whether the employee meets the applicable duties test. The Department of Labor estimates there are 732,000 U.S. wage and salary workers who currently earn between $455 and $913 per week and have been improperly treated as exempt because they fail the duties test. For employers who have one of these employees, perhaps the new rule can be viewed as an “opportunity” to reclassify the employee as non-exempt and ensure that the employee is properly being paid overtime.
The Department of Labor also estimates that 4.2 million workers are properly being treated as exempt under the current rule and earn between $455 and $913 per week, meaning that they will become non-exempt under the new rule absent intervention by the employer. For these employees, generally speaking, employers must decide between raising the salaries to meet the new salary level, or ensuring that the employee is properly paid overtime for all hours worked in excess of 40 hours in a workweek.
There are various means of accomplishing the latter. There is a common misconception that nonexempt employees must be paid on an hourly basis. While there are certain advantages to that method of payment for non-exempts, it is not mandatory and non-exempt employees may be paid on a salary basis so long as the employee is being paid minimum wages, overtime, and proper records are kept. Employers also may choose to ensure the employee does not work overtime, through adjusted work schedules or other means. Of course this does not alleviate employers from paying overtime when it is worked. Thus, employers who choose this course must ensure that proper policies, procedures, and practices are in place to ensure that these employees are not working overtime. Whether employers choose to pay overtime or seek to avoid the employee working overtime, employers must ensure that proper record-keeping are in order to track the employees hours.
A cost analysis is likely to weigh heavily in determining the employer’s best option, and a thorough audit to determine how many hours the employee works in a workweek is essential in that analysis. Counsel can be very valuable in assisting with such an audit and providing ideas on available options, as well as auditing whether or not the employee meets the duties test in the first place. Even if the employer does not seek that assistance, employers would be wise to consult counsel regarding any planned changes to evaluate whether the changes are in compliance with the FLSA and other employment laws.