On May 18, 2016, the U.S. Department of Labor (“DOL”) released its long-expected Final Rule, making certain significant changes to the executive, administrative, and professional (“EAP”) and highly compensated executive (“HCE”) exemptions from overtime under the federal Fair Labor Standards Act, which are the so-called white collar exemptions. Although the Final Rule is not effective until December 1, 2016, employers should start preparing now for the overtime pay rule changes. Outlined below are the most significant takeaways from the DOL’s Final Rule announcement:

  • Doubling of Minimum Salary for EAP Exemptions. The minimum salary threshold to qualify for the EAP exemptions will increase from $23,660 ($455 per week) to $47,476 ($913 per week). Even if employees are paid salaries of more than $47,476, they still must meet the duties and other tests to satisfy the particular exemption. According to the DOL, the Final Rule will impact 4.2 million workers who meet the EAP duties and other tests but are currently paid less than $47,476.  
  • Increase of the Minimum Salary for the HCE Exemption. The Final Rule increases the annual compensation level above which certain white collar workers may be exempt from overtime from $100,000 to $134,004. Although the HCE duties test is not as stringent as the EAP’s version, a worker still must customarily and regularly perform at least one of the duties of an exempt executive, administrative, or professional employee, as identified under the EAP tests, to be exempt under the HCE exemption.  
  • Automatic Adjustments to the Minimum Salary Every Three Years. The Final Rule provides for adjusting the minimum salaries for the EAP and HCE exemptions every three years, starting on January 1, 2020. The EAP minimum salary will be based on the annualized weekly earnings of the 40th percentile of full-time salaried workers in the lowest-wage U.S. Census region, which is currently the South. The HCE minimum salary will be benchmarked to the annualized weekly earnings of the 90th percentile of full-time salaried workers nationally.  
  • Certain Nonsalary Pay May Be Used to Meet Salary Thresholds. The Final Rule provides employers some leeway to include certain nondiscretionary bonuses, incentive pay and commissions in employee compensation to meet the EAP salary threshold. Such payments must be made on a quarterly basis, and collectively they cannot exceed 10% of the salary threshold. The Final Rule also allows employers to make quarterly catch-up payments to meet the EAP salary threshold. HCEs must receive at least the full standard salary amount each pay period (i.e., $913 per week) on a salary or fee basis, without regard to the payment of nondiscretionary bonuses, incentive payments or commissions. However, employers may rely on nondiscretionary bonuses, incentive pay and/or commissions to fulfill the remainder of the total annual compensation level for HCEs.  
  • No Changes to the Existing “Duties” Tests. The Final Rule is also significant for the change it did not make. The Final Rule does not modify the existing duties tests under the EAP or HCE exemptions. Many business groups feared that any changes to the duties tests would increase the burden on employers exponentially. The DOL has responded to those concerns by not changing the duties tests.

How to Prepare for the Final Rule

The Final Rule’s effective date of December 1, 2016, gives employers ample lead time to prepare for the changes. Employers should immediately start gathering and analyzing information about employees classified as exempt—their compensation, hours worked, and their job duties and functions, particularly with respect to those jobs classified as exempt but paid less than the new minimum salary thresholds. This analysis is vital for compliance with the new overtime rules. It may also alert management to employees who are improperly classified as exempt because they do not satisfy the applicable duties test. The new rules give employers an opportunity to proactively reassess their classifications and make adjustments.

Having taken these steps, management will then be in a position to consider which of three general approaches makes the most sense in terms of controlling payroll and administrative burdens related to employees whose salaries are below the new minimum. These general approaches can be summarized as follows:

  • Increase the employee’s salary to the new minimum. As long as the employee is properly classified as exempt, this approach will minimize disruption and simply maintain the status quo. It should be considered for employees who are paid close to the new minimum, particularly those in high-income locations (e.g., New York City, Boston and Los Angeles) or high-income positions.  
  • Do nothing to an employee’s current salary and forfeit the overtime exemption but control the amount of overtime the employee works. This approach requires caution but works best when the employee’s weekly hours are relatively stable and are consistently at or less than 40 per week. Note that if a salaried, nonexempt employee works more than 40 hours in any given week, the employer will have to recalculate the employee’s regular hourly rate and pay overtime for those hours. Employers will have to consider carefully whether such employees are accustomed to working “off the clock” or telecommuting and determine how to track or limit this “extra” work time.   
  • Convert the employee from salaried to hourly paid, creating overtime eligibility but at a reduced hourly rate that takes into account the hours per week the employee normally works. This approach is best (if not mandatory) for employees whose duties may not qualify them as exempt and who routinely work more than 40 hours per week. Done correctly, this approach can practically neutralize the fiscal effect of the new regulations. However, this approach will increase the administrative burden on employers, as they must track the time worked by such employees. In addition, employers must be mindful of the psychological impact of this change, as employees often associate a salaried, nonexempt position as indicative of a management-track job and greater status within the organization. 

Each of these approaches has certain advantages and drawbacks. Many employers will find it necessary to utilize a hybrid of the various approaches to minimize costs and disruption. By being proactive and preparing now, management will be ready to ease into the rule changes on December 1.