I. INTRODUCTION

On May 18, 2016, the U.S. Department of Labor issued its Final Rule increasing the minimum weekly salary level required for the Fair Labor Standards Act’s executive, administrative, and professional (“EAP” or “white collar”) exemptions. The Final Rule increases the minimum weekly compensation from $455 to $913 a week and, for the highly compensated employee (“HCE”) exemption, raises the minimum total annual compensation from $100,000 to $134,004. These increased minimum salary requirements go into effect on December 1, 2016.

In addition to increasing the minimum salary requirements, the DOL has adopted a process for automatically updating the EAP and HCE salary levels every three years. Under the new regulations, employers will be permitted for the first time to credit certain incentive payments for up to 10 percent of the EAP salary threshold. These changes, according to the DOL’s accompanying FAQs, will “simplify the identification of overtime-eligible employees, thus making the white collar exemptions easier for employers and workers to understand and apply.” See FAQ No. 4, at https://www.dol.gov/whd/overtime/final2016/faq.htm#G11.

Although the changes made by the Final Rule are significant, and, according to the Administration, will make millions of individuals eligible for overtime, there was considerable concern by the employer community that the DOL would go further. The DOL had requested comment on the EAP “duties” tests in ways that drew substantial complaints by employers during the “notice and comment” period on the proposed regulation. As a direct result of that response, the DOL decided to leave the duties tests for the EAP and HCE exemptions intact. Ultimately, the DOL concluded that “the increase to the standard salary level, coupled with automatic updating in the future, will address concerns that some workers who satisfy the standard duties test should be entitled to overtime pay because they are performing substantial amounts of overtime-eligible work[.]” See FAQ No. 11.

II. KEY SALARY THRESHOLD CHANGES IN THE FINAL RULE

President Obama stated in a March 13, 2014 memorandum to Secretary Perez that the overtime regulations “have not kept up with our modern economy,” and that “millions of Americans lack the protections of overtime and even the right to minimum wage.” The President instructed Secretary Perez that, in the course of proposing changes,

[the Labor Department] shall consider how the regulations could be revised to update existing protections consistent with the intent of the Act; address the changing nature of the workplace; and simplify the regulations to make them easier for both workers and businesses to understand and apply.

The DOL’s Final Rule includes major changes in two key areas.

Minimum Salary Level for White Collar Exemptions

At present, to qualify for one of the white collar exemptions, an employee must be paid a guaranteed salary or fee of at least $455 per week. The Final Rule increases the minimum salary level from $455 per week ($23,660 for a full-year worker) to $913 per week ($47,476 for a full-year worker), the 40th percentile of weekly earnings for full-time salaried workers in the lowest-wage Census Region (currently the South). Absent employer action, the DOL estimates more than 4 million EAP employees will become newly entitled to overtime because of the increase in the salary level.

For the first time, employers will be permitted to factor nondiscretionary bonuses, incentive payments and commissions to satisfy up to 10 percent of the EAP salary test requirement. However, to credit such payments, the employer must make the payments on a quarterly or more frequent basis. Also, if the bonus is discretionary, meaning the decision to award the bonus and the payment amount is at the employer’s discretion and not according to any pre-announced standard, the employer cannot use the bonus to satisfy part of the EAP salary level test. Finally, employers also may make a “catch-up” payment in the event that an employee doesn't receive enough in nondiscretionary bonuses and incentive payments (including commissions) in a given quarter to remain exempt. The employer has one pay period to make up for the shortfall (up to 10 percent of the minimum salary level for the preceding 13 week period), and the catch-up payment will count only toward the prior quarter’s salary amount—not toward the salary amount in the quarter in which it was paid.

The Final Rule also includes a mechanism for automatically updating the salary level every three years using census data. The DOL’s stated purpose is to ensure that the salary level test remains a “meaningful test for distinguishing between bona fide executive, administrative, and professional workers who are not entitled to overtime and overtime-protected white collar workers.” See FAQ, Automatic Updating, No. 1. Notably, the proposed regulations published in June 2015 would have required annual updates, which employers argued would have been administratively burdensome. With this change, the first update will not take effect until January 1, 2020. The DOL will publish the updated rate on its website and in the Federal Register at least 150 days before the new rate takes effect.

Minimum Annual Compensation Level for Highly Compensated Employees

The HCE exemption was introduced in the DOL’s 2004 amendments to the exemption regulations. Under the current HCE exemption, employees who earn total annual compensation—which may include salary, commissions, and nondiscretionary bonuses—of at least $100,000, and whose base salary is at least the minimum for other exempt employees, are exempt if they customarily and regularly perform at least one of the duties or responsibilities enumerated in the white collar exemptions tests.

The minimum annual compensation level for the HCE exemption has remained at $100,000 since 2004. The DOL found that since the HCE exemption was introduced in 2004, the percentage of employees who earn at least $100,000 in total annual compensation has increased to 17%.

Under the Final Rule, the new annual compensation level for highly compensated employees will be increased to the 90th percentile of annual wages of all full-time salaried workers. The 90th percentile annual compensation level in the Final Rule is $134,004, which is approximately $12,000 more than what the DOL had projected in June 2015. According to the DOL, an estimated 65,000 currently exempt workers who earn at least $100,000 but less than the 90th percentile of earnings of full-time salaried workers, and who otherwise meet the highly compensated employee duties test, may become eligible for minimum wage and overtime protection with this change.

In contrast to the EAP salary level, which is based on the lowest-wage Census Region, the HCE salary level is based on national census data.

In order to prevent the salary level from becoming outdated, the Final Rule adopts the same mechanisms for updating and publishing the salary level as described above, with the first update to take effect on January 1, 2020.

III. THE DUTIES REQUIREMENTS FOR EXEMPTION ARE UNCHANGED

To qualify for exempt status, employees must meet certain requirements as to their job duties. Employers have to establish that the employee’s “primary duty” is performing exempt work for an exemption to apply.

In the proposed regulations, the DOL stated that it was “concerned that employees in lower-level management positions may be classified as exempt and thus ineligible for overtime pay even though they are spending a significant amount of their work time performing nonexempt work.” The DOL sought comments on whether there should be changes made to the duties test. Specifically, the DOL sought input on whether employees should be required to spend a minimum amount of time performing work that is their primary duty to qualify for an EAP exemption, similar to what is required under California law. In addition, the DOL sought comments on whether the concurrent duties regulation for executive employees is working appropriately.

Faced with strong opposition from the employer community, the DOL ultimately chose not to make any changes to the duties test in the Final Rule.

IV. STEPS EMPLOYERS SHOULD TAKE

The DOL estimates that 4.2 million workers will become overtime-eligible as a result of the Final Rule. Employers may wish to consider the following steps before the Final Regulations become effective on December 1, 2016.

  • Identify the salary levels of employees in your workforce currently classified as exempt under the white collar exemptions to determine whether they meet the DOL’s $913 a week minimum threshold. Be mindful of job-sharing or other part-time exempt arrangements in which a currently exempt employee may be earning less than $913, because the Final Rule does not allow for proration.
  • If an employee’s salary comes close to the threshold for EAP status, evaluate whether the employee receives non-discretionary bonuses or commissions on a quarterly or more frequent basis. The Final Rule includes a new provision that allows employers to count such non-discretionary incentive payments toward the minimum EAP salary level up to a certain limit.
  • Determine whether to adjust the salaries of or reclassify as non-exempt employees who fall below the minimum salary threshold.
  • Review job duties for exempt positions. While the Final Rule does not alter the duties tests for the EAP and HCE exemptions, the DOL estimates that there are 732,000 salaried workers in the United States making between $455 and $913 a week who do not meet the duties test and are already overtime eligible, but their employers do not recognize them as such.
  • If employees are reclassified from exempt to non-exempt, determine an appropriate hourly rate. Employers are not required to establish an hourly rate by simply dividing an employee’s weekly salary by 40 hours and paying for all additional hours at the overtime rate. Such an approach could dramatically increase compensation costs. Instead, an employer could estimate the number of overtime hours an employee is expected to work and calculate an hourly rate that will match the employee’s current compensation level. Assuming the estimate of overtime hours is accurate, this would not impact compensation costs. In certain states, employers also have the option to pay employees using the fluctuating workweek method, which can considerably reduce the amount of overtime pay an employee receives. However, specific requirements must be met in order to use the fluctuating workweek method and it is not permitted in all states.
  • Consider whether current policies and practices regarding approval for and monitoring of overtime hours are adequate to prevent unintended and avoidable increases in labor costs.
  • Develop an action plan to implement any changes, including appropriate communications to reclassified employees about timekeeping and meal and rest break requirements.