In 2014, President Obama directed the Department of Labor to update the rules governing which white-collar workers qualify as exempt from the overtime requirements of the federal Fair Labor Standards Act (FLSA).  In 2015, the DOL released a proposed update that would have limited overtime exemptions to employees making roughly $50,000 or more.  After a period of vigorous public comment, the DOL issued its final rule on May 18, 2016.  The final rule does not stray far from the DOL’s initial proposal, but dials down a few key provisions, including the salary threshold increase.  It becomes effective December 1, 2016, giving employers little more than six months to get their payrolls in order.

The White-Collar Overtime Exemptions

An employer must satisfy three tests before classifying employees as exempt from overtime under the administrative, executive, or professional (EAP) exemptions.  First, the employee must earn a predetermined and fixed salary that does not vary based on the quantity or quality of work.  Second, that salary must exceed a minimum level set by the DOL.  Third, the employee must primarily perform certain executive, administrative, or professional duties.  These standards are known as the salary basis test, the salary level test, and the duties test.  A less-stringent duties test is available for “highly-compensated” employees. 

Of the three tests for EAP exemption, the DOL’s new rule changes only the salary level test.  Accordingly, exemption categories that do not necessarily incorporate the salary level test, such as bona fide teachers, academic administrative personnel, outside sales employees, employees practicing law or medicine, employees exempt under the Motor Carrier Act exemption, and certain exempt computer employees, will be unaffected by the new rule.

Final Changes to the Salary Level Test

Under the current salary level test, an employee must be paid a salary of at least $455 per week ($23,660 per year).  This number has been updated seven times since 1938, most recently in 2004.  The final rule raises the salary level test again, this time pegging it at $913 per week ($47,476 per year), which is the 40th percentile of weekly earnings for full-time salaried workers in the lowest-wage U.S. Census Region.  This is a bit lower than the DOL’s initial prediction of $970 per week ($50,440 per year).  And while existing regulations require the salary level test to be satisfied entirely by the employee’s guaranteed salary, the new rule allows employers to count non-discretionary bonuses and incentive payments (including commissions) that are paid quarterly or more frequently toward up to 10 percent of the salary threshold.

The final rule makes a similar change to the exemption for “highly-compensated” employees.  To meet that exemption currently, an employee’s annual compensation (including all forms of compensation, not merely annual salary) must be $100,000 or higher, the employee’s primary duties must include office or non-manual work, and the employee must perform at least one qualifying executive, administrative, or professional duty.  The final rule raises the compensation level for a highly-compensated employee to $134,004,  the 90th percentile of full-time salaried workers’ earnings nationally.  Note that highly compensated employees will also need to satisfy the new salary level test to qualify for the exemption.  

Finally, both of these new pay thresholds will increase automatically every three years to keep pace with the earnings percentiles listed above.  The proposed rule contemplated a yearly update.

Employers Must Weigh Their Options

With the new salary level for exemption clear, employers must determine how to address workers who are currently properly classified as exempt EAP employees under the duties and salary basis tests, but make less than $47,476 per year.  If an employee typically works significantly more than 40 hours per week, the most cost-efficient option might be to raise his or her salary to meet the new threshold.  Employees who occasionally work significant overtime may be suited to a “fluctuating workweek” or “day rate” arrangement, which, when implemented appropriately, allows employers to pay employees a reduced overtime premium for hours over 40 per week, if certain other conditions are met.  Employees who rarely work over 40 hours per week can be kept on their existing salaries or converted to an hourly rate, but in either case employers must track their hours and pay overtime after 40 hours of work per week.  Note that the new rule does not require employers to maintain base pay for workers converting to non-exempt status. Employers who convert a salaried employee to hourly can adjust the employee’s hourly rate so that total compensation does not increase once overtime is factored in.    

The DOL’s increased salary threshold will significantly impact the workforce structure for many companies.  There is no one-size-fits-all response to the new rule, or to FLSA compliance in general.  Now may be a good time to review all exemption classifications to make sure they are compliant.