On May 18, 2016, the U.S. Department of Labor (DOL) announced its long-awaited regulatory change to the salary threshold in the Fair Labor Standards Act (FLSA). The final rule will have a sweeping effect on employers across the country from both a financial and operational standpoint, and may require them to make broad changes to the workplace. Most significantly, for the first time since 2004, the minimum salary threshold for determining whether certain classes of employees are exempt from overtime has increased from $23,660 per year (or $455 per week) to $47,476 per year (or $912 per week). Given that this more than doubles the threshold level, the DOL anticipates overtime benefits will be extended to more than 4 million people and an estimated 35 percent of employees previously exempt from overtime may now be entitled to such benefit based solely on their salary. Because the effective date of this new regulation is December 1, 2016, employers have some time to prepare and adjust their policies and practices.

Exemptions Generally

While the FLSA requires overtime payment for hours worked in excess of 40 hours per week, it also provides an exemption from overtime requirements for employees who meet the requirements for certain so-called white collar (executive, administrative and professional) and computer-related exemptions. The FLSA also has a "highly compensated individual" exemption, which many states do not have, and allows for a more relaxed application of the job duties test based on the higher salary. In connection with that exemption, under the new regulation, an individual must now be paid $134,004 (up from $100,000) to satisfy the salary threshold.

The exemption analysis is generally a two-pronged test requiring an individual to both be (a) paid a certain minimum salary and (b) meet certain tests regarding job duties. The job duties test is specific to each exemption, but generally involves demonstrable independence, discretion, and/or advanced skills to justify the exemption. Unless employees meet both criteria, salaried employees still must be paid overtime if working more than 40 hours in a week.

Because the salary threshold had historically been relatively low, the main question for determining exempt status had previously been whether the job duties test was met. By more than doubling the minimum, the final rule now requires a more stringent review of the economic and business realities of maintaining certain positions as exempt, even if otherwise qualifying under the respective duties tests. Now, unless employees make at least $47,476 (or $134,000, for highly compensated employees), employers will likely be on the hook for overtime even if those employees' jobs otherwise qualify under white collar or highly compensated individual job tests. This is a significant change and may result in many positions being reclassified as non-exempt and subject to overtime (and other) protections. For example, in many states (such as California), the exempt nature of a position does not just extend to overtime but also to meal or rest periods and record keeping requirements. Accordingly, by now reclassifying employees as non-exempt, employers may have additional responsibilities such as to provide breaks to employees who previously were exempted from such requirements. Employers must also be careful to ensure compliance with both state and federal laws covering these employees.

Calculation Of The Salary Threshold

To help offset the increased salary threshold, the DOL has provided some relief to employers by, for the first time, allowing them to use nondiscretionary bonuses and incentive payments to satisfy up to 10 percent of the standard salary level, provided these payments are made on a quarterly or more frequent basis. Previously, the DOL required the entire salary level to be satisfied proportionally in each work week.

Nondiscretionary bonuses and incentive payments are generally defined as forms of compensation promised to employees to induce them to work more efficiently or to remain with the company. These may include individual or group production bonuses, bonuses for quality and accuracy of work, and commission payments. Being able to include a portion of this form of compensation in determining the minimum threshold could help to defray some of the increased salary costs, but the minimum is still a substantial increase over the prior rule.

More specifically, if an employer applies a non-discretionary bonus or incentive pay towards the salary threshold, at least 90% of the salary ($822 per week) must be paid as a salary, while up to 10% of the salary ($91 per week) may be satisfied with non-discretionary bonuses or incentive payments. If an employee does not earn enough of a non-discretionary bonus or incentive payment in a given quarter to meet the standard salary level, the DOL is allowing an employer to make a “catch-up” payment no later than the next pay period after the end of the quarter. Any such “catch-up” payment counts only toward the prior quarter’s salary.

Nondiscretionary bonuses and incentive payments may also be counted toward the $134,004 total annual compensation minimum for highly compensated employees, but only so long as the employer pays at least the full standard salary level of $913 per week. If an employee’s total compensation in a given annual period fails to meet the $134,004 threshold, the DOL is also allowing an employer to make a "catch-up" payment within one month of the end of the annual period. Any such catch-up payment counts only toward the prior year’s total annual compensation. If such a catch-up payment is not made within the timeframe allotted, the exemption is lost for the prior quarter and the overtime premium must be paid.

What To Do

Given the increase in the salary threshold, employers have a range of options to ensure compliance. Specifically, employers may (a) raise salaries to maintain the exemption, (b) pay current salaries but now include payment of overtime for hours worked in excess of 40 hours in a given workweek, (c) adjust/reduce wages to reallocate it between regular wages and overtime so that the total amount paid is relatively the same,(d) reorganize workloads, spread/eliminate work hours, and/or adjust schedules, and (e) consider whether employees could be exempt under state law but then paid overtime for hours over 40 in a workweek. If an employer chooses to pay current salaries with overtime after 40 hours, the employer will need to ensure it has a method in place for the employees to track and record their hours.

Under the new regulations, the DOL will also automatically update the salary threshold every three years, beginning on January 1, 2020. Each update will raise the standard threshold to the 40th percentile of full-time salaried workers in the lowest-wage Census region, which the DOL currently estimates to be $51,168 in 2020. The highly compensated threshold will increase to the 90th percentile of full-time salaried workers nationally, which the DOL estimates to be $147,524 in 2020. The DOL expects to post new salary levels on August 1, 2019.

As if the above is not enough to put employers on edge, the new overtime rule is in line with a mounting national trend to increase wages for lower paid workers. Already in 2016, two of the largest marketplaces – New York and California – passed legislation to increase the states' minimum wage to $15.00 per hour. Parts of New York will reach $15.00 per hour as early as December 31, 2018, while California will incrementally increase the minimum wage over the next several years. These types of changes may then have a ripple effect and directly or indirectly impact other wage obligations that employers may have under applicable state laws. Increases in the minimum wage combined with the new overtime rules will increase labor costs for many employers and confront them with tough decisions regarding the composition, scope, and location of their workforce. Therefore, it will be important for employers to face and prepare for the effect of the new overtime rule and any other wage related legislation in effect or on the horizon.