Following the U.S. Department of Labor’s (“DOL”) announcement last year of sweeping proposed changes to the “white-collar” exemptions under the Fair Labor Standards Act (“FLSA”) (i.e., professional, administrative, executive, computer professionals and outside sales), on May 18, 2016, the DOL published the much-awaited Final Rule, which more than doubles the annual salary threshold for exempt status to $47,476. The White House estimates that the new minimum salary will expand eligibility for overtime pay to an additional 4.2 million workers.

The effective date of the Final Rule is December 1, 2016. While mostly uncomplicated as a matter of law, employers should be prepared for the significant business and employee relations issues raised by the new rules. The next six months provide valuable time to plan strategically.

Key Provisions of the New Overtime Rules

By way of background, in order to be classified as exempt, the following three tests must be met: (1) minimum salary test, (2) salary basis test and (3) duties test. The significant changes and non-changes to these tests are as follows:

Minimum Guaranteed Salary

The minimum guaranteed salary level will be more than doubled, from $455 per week (the equivalent of $23,660 per year) to $913 per week, which equates to $47,476 annually for a full-year worker. This figure represents the 40th percentile of earnings of full-time salaried workers in the lowest-wage Census region.

Automatic Update Mechanism

The DOL has established a mechanism for automatically updating the minimum guaranteed salary and compensation levels every three years to maintain the percentile levels to the 40th percentile of full-time salaried workers in the lowest-wage Census region. This adjustment will begin on January 1, 2020, when the minimum salary level is estimated to reach $51,168 per year.

Highly-Compensated Employee Exemption

The “highly compensated employee” (“HCE”) exemption, which enables employers to meet a simpler “duties” test as long as a higher minimum guaranteed compensation threshold is met, will be increased from $100,000 to $134,004 for a full-year worker, which is the annualized value of the 90th percentile of weekly earnings of full-time salaried workers nationally.

Salary Basis Test; Use of Non-Discretionary Bonuses

The salary basis test means that exempt employees must be paid on a salaried, not hourly, basis, with deductions prohibited except in very narrow circumstances. The DOL has made one key (and welcome) change to this test: Employers will now be permitted to include non-discretionary bonuses, incentive payments or commissions to satisfy up to 10 percent of the substantially higher minimum salary level, as long as payments are made at least quarterly.

Duties Test; Sector-Specific Guidance

Currently, the “primary duty” test for exempt status is qualitative and not quantitative. Under the Final Rule, primary duty continues to mean the main, principal or most important duty.

By the questions it asked in the proposed regulations, the DOL suggested that it might adopt a quantitative approach, as is the case under California law. Ultimately, the DOL did not make the change, and the Final Rule still applies a qualitative approach to the primary duty analysis.

However, the DOL developed guidance documents for non-profits and institutions of higher education, as well as a general overview to illustrate the application of the Final Rule to certain sectors and to discuss the substantive duties test more generally.

Even though the DOL has not changed the duties test, now may be an opportune time for employers to evaluate positions to ensure they satisfy the duties test, which tends to be the most-litigated issue in a challenge of an employee’s classification. Employers should be thoughtful about how they collect and analyze the data. The collection and analysis of the data under attorney-client privilege may help minimize the risk that good-faith efforts will be used against the employer. Although beyond the scope of this Alert, the privilege issues are deceptively complex.

What This Means for Employers

Wage-and-hour compliance remains a paramount concern for employers, and noncompliance with the FLSA and its regulations can result in significant liability, along with potentially negative impacts on publicity, morale and recruitment efforts.

The key question that employers will likely need to decide with exempt employees currently earning below the new minimum salary is whether to raise their salaries to retain their exempt status or to convert them to non-exempt status. The DOL recognizes that “numerous options for compliance” exist. Some of the business and employee relations issues that employers should consider are discussed here.

It is important to note that employees get the benefit of federal or state law, whichever is more favorable. This is particularly significant for employees in California.