On May 18, 2016, the U.S. Department of Labor (DOL) released its long-anticipated revisions to the federal overtime regulations governing the so-called white-collar exemptions to the federal Fair Labor Standards Act (FLSA). Most notably, the revisions more than double the minimum salary threshold needed to qualify for the executive, administrative, and professional exemptions. The revised regulations also make other significant changes to the amounts that must be paid, including allowing employers to count nondiscretionary bonuses and commissions to satisfy a portion of the salary threshold, scheduling automatic adjustments to the salary threshold every three years, and increasing the annual salary threshold for the “highly compensated employee” exemption. Fortunately, the new regulations do not make changes to the duties tests for the white-collar exemptions. The new regulations will go into effect on December 1, 2016.

The revised regulations will directly impact many California employers. For the first time in a very long time, the federal salary threshold necessary to qualify for exemption from the FLSA’s overtime requirements will exceed the minimum salary threshold required for exempt status under California law. For many California employers, this development marks the first time that they will need to pay close attention to the federal standard to ensure they are in compliance with both California and federal law. Compliance may become more complicated as the minimum salary threshold under California law repeatedly increases over the next several years in connection with scheduled annual increases to California’s minimum wage rate, which will reach $15.00 per hour by 2022.

In this article, we summarize the final federal regulations and identify how they will impact California employers. It is important to understand that California employers must comply with both California and federal laws. Employers often mistakenly believe that this may be accomplished by simply complying with the law that is more favorable to the employee. As described below, however, California law and federal law each contain specific requirements and exceptions, and it is therefore necessary to focus on each law separately to ensure compliance.

Summary of Changes to the FLSA’s White Collar Exemption Regulations

The following key revisions to the federal white-collar exemption regulations are scheduled to take effect on December 1, 2016:

  • Increase in the Salary Threshold. The minimum salary threshold for the executive, administrative, and professional exemptions under the FLSA will increase from $455 per week, or $23,660 per year, to $913 per week, or $47,476 per year. This new threshold matches the 40th percentile of weekly earnings for full-time salaried workers in the lowest-wage national Census Region, which is the South.
  • Indexing Every Three Years. The minimum salary threshold for the white-collar exemptions will be indexed every three years, with the first change resulting from indexing to occur on January 1, 2020. The new salary threshold will be indexed to the 40th percentile of all full-time salaried workers in the lowest-wage Census Region. The DOL will post this figure and publish it in the Federal Register at least 150 days prior to the effective date of the new salary threshold, which means that employers will have approximately five months’ notice of the new minimum salary threshold when it changes every third year.
  • Inclusion of Bonuses and Incentive Pay When Calculating Salary. For the first time, employers will be able to use nondiscretionary bonuses and incentive payments (including commissions) to satisfy up to 10 percent of the standard salary level, as long as those payments are made on a quarterly or more frequent basis.
  • Highly Compensated Employee Exemption Threshold. The FLSA provides for a highly compensated employee (HCE) exemption. Besides meeting a minimal duties test, an HCE’s total annual compensation under the current (i.e., 2004) regulations must be at least $100,000, of which at least $455 per week must be in the form of a salary. Under the final regulations, the new minimum total compensation threshold will be increased to $134,004, of which at least $913 per week must be in the form of a salary. The DOL based the $134,004 figure on the 90th percentile of all salaried employees nationally and did not make any distinctions based on Census Region. The final rule also indexes the total compensation and salary level requirements for the HCE exemption every three years, consistent with the timing of the indexing of the minimum salary level for the white-collar exemptions. The total compensation level will track the 90th percentile of all employees nationally, and the minimum salary level will be the same as for the other white-collar exemptions.
  • No Change to the Duties Test. The DOL did not make changes to the duties tests for any of the exemptions in the final regulations. In the proposed regulations, the DOL had solicited comments as to whether a “percent of time” test should have been added into the regulations similar to the 50 percent “primarily engaged in” exempt duties test that exists in California.

What These Changes Mean for California Employers

California employers must comply with both federal and California wage and hour laws. In the case of exempt employees, the new federal regulations will directly impact those California employers employing exempt employees who may earn enough to be exempt under one law, but not the other. While these laws are similar, California law is generally more favorable to employees in several significant respects. For instance, under federal law, employers must pay employees overtime for all hours worked in excess of 40 hours in a workweek unless the employee meets one of the duties tests and is paid at least a minimum salary. Under California law, in contrast, nonexempt employees are entitled to daily overtime for all hours worked in excess of 8 hours per day as well as weekly overtime for hours worked in excess of 40 hours in a workweek.

The impact of the new federal overtime regulations is made more complicated when the impact of California’s new minimum wage law is taken into consideration. In order for an employee to be exempt under one of the white-collar exemptions under California law, the employee must, as under federal law, meet both a duties and a salary test. The minimum salary threshold for the exemption under California law is based on the state’s minimum wage law and requires that the exempt employee be paid a salary that is at least twice the state minimum hourly wage rate based upon full-time employment. “Full-time employment” is defined as 40 hours of work per week. The current minimum salary required for an exempt employee under California law is $41,600 annually, or $800 weekly and $3,466.67 monthly. For an employer that employs 26 or more employees, the annual minimum salary requirement for exempt employees will be:

Click here to view the table.

For an employer that employs 25 or fewer employees, the minimum wage increase progression is delayed by one year and starts on January 1, 2018. Accordingly, the minimum salary thresholds for exempt employees for employers with 25 or fewer employees, the weekly, monthly, and annual minimum salary requirements will be the same as above, however, they will be effective one year later and start on January 1, 2018. 

Under these scheduled increases, California’s minimum salary threshold for employees of employers with 26 or more employees will not meet or exceed the new federal minimum salary threshold of $913 per week or $47,476 per year until January of 2019. Employers with exempt employees who earn a sufficient salary to meet one, but not both, state and federal exemptions, will need to determine how best to manage this situation. The likely available options include, among others, (1) increasing the exempt employee’s salary to meet both exemptions; (2) reclassifying the exempt employee as a nonexempt employee; or (3) maintaining the employee’s exempt status under California law and treating the employee as nonexempt under federal law.

Each option presents significant challenges for businesses. Customary business requirements may not enable an employer to simply increase salaries, particularly when the likely impact of corresponding upward salary pressure from higher-paid employees, who may demand salary increases when lower-paid employees receive raises, is taken into consideration. Reclassifying exempt employees as nonexempt employees also presents many employee management challenges for businesses. Not only must an employer now ensure compliance with the various minimum labor standards that apply to nonexempt employees—such as overtime, meal and rest periods, and recordkeeping requirements—but experience shows that employees who are reclassified from exempt to nonexempt status often perceive such a change as a demotion in status, as they are now forced to “punch a clock.” Employers seeking to take the third option and treat an employee as exempt for purposes of California law but nonexempt for purposes of federal law will likely encounter significant obstacles to ensuring compliance. While such employees would not be entitled to daily overtime, meal and rest periods, or other minimum labor standards required under California law, such employees would still be entitled to overtime for all hours worked over 40 hours per week and the employer would have additional recordkeeping obligations under federal law.

Under federal law, there are some professional exemptions that do not require a minimum salary threshold. Specifically, the federal salary level and salary basis requirements do not apply to teachers, lawyers, or doctors (“bona fide practitioners of law or medicine”). Accordingly, for those positions, California employers may continue to treat teachers, lawyers, and doctors as exempt employees under federal law without having to increase their salaries to meet the new federal threshold. Unlike under federal law, however, each of these professional occupations continue to be subject to the California salary basis requirement so they will still need to be paid at least the minimum “salary” required by California law.

California law also has more restrictive duties requirements than federal law. Accordingly, California employers cannot simply assume that exempt employees who meet the higher federal salary threshold and federal duties test will also satisfy the California duties test for exempt employees.

The new regulations will also create a difference between California law and federal law with respect to what may be included in meeting the minimum salary threshold. While the new federal regulation will permit employers to count nondiscretionary bonuses and commissions to satisfy up to 10 percent of the minimum salary threshold, California law does not allow California employers to include such payments in calculating minimum salaries.

The new regulations present an opportunity for California employers to reexamine whether their employees meet the duties tests for the federal and California exemptions. In those instances where an employee may not meet the duties or salary tests, and the employer concludes that the employee should be reclassified, the implementation of the new regulations may provide an appropriate occasion for a California employer to reclassify the employee to ensure or improve compliance.

Conclusion

California employers should become informed about the timeline for these new minimum salary threshold increases under federal and California law and identify which of their workers will be impacted by the changes. For those employees whose exempt status may be affected by the increases, employers should develop strategic plans as to how such employees will be classified. For employees whom the employer seeks to maintain in an exempt status, it will be important to identify what salary increases will be necessary to preserve the exemption under both federal and state laws. For those employees for whom the employer decides reclassification is warranted, attention must be paid to determining when and how to best accomplish the reclassification and how to ensure compliance with the various minimum labor standards to which nonexempt employees are entitled, such as overtime, meal and rest periods, and recordkeeping.