On May 23, 2016, the U.S. Department of Labor (DOL) published its long awaited Final Rule updating the Fair Labor Standards Act’s (FLSA) regulations relating to the “white collar” executive, administrative and professional exemptions from overtime compensation (29 C.F.R. Part 541). The Final Rule is not effective until December 1, 2016.  Once implemented, the Final Rule means that employees paid on a salary basis earning less than $47,476 per year can no longer be treated as exempt employees, and will now be entitled to overtime compensation for hours worked in excess of 40 per week.

In order for employees to fall within the FLSA’s white collar exemptions and not be entitled to overtime pay, employees must (1) be paid on a salary basis, (2) be paid more than the threshold amount set by the DOL; and (3) perform duties that are primarily executive, administrative or professional, as defined by the regulations. Although the Final Rule does not change the duties test, it significantly increases the salary level required for the exemptions and adds additional types of compensation that may be included in certain employees’ salaries to reach the newly-updated threshold. Employers should keep in mind that an employee must meet both the salary test and duties test to be considered exempt from overtime pay obligations. This new rule only modifies the salary portion of the test, but does not in any way modify the duties test.

For the first time since 2004, the salary level threshold was increased – indeed, more than doubled - from $455 per week ($23,660 per year) to $913 per week ($47,476 per year). The calculation is based upon the 40th percentile of weekly earnings of full-time, salaried workers in the lowest-wage U.S. Census Region (currently the South). For highly-compensated employees, the amount was increased from $100,000 per year to $134,004 per year, which is based upon the annual earnings for the 90th percentile of earnings of full-time, salaried workers across the nation. The DOL estimates that approximately 4.2 million workers will join the over 22.5 million workers currently entitled to receive overtime compensation. Automatic updates will be made to the threshold amounts every three years starting January 1, 2020, at which time the white collar salary threshold is expected to exceed $50,000, so employers should budget for these increases.

The Final Rule also includes a new provision allowing up to 10 percent of non-highly compensated employees’ salaries to be comprised of non-discretionary bonuses, incentive payments and commissions. These payments must be made at least quarterly, and employers are permitted to make a quarterly “catch­up” payment when an employee’s actual salary plus bonus, incentive payment or commission does not reach the required threshold. Employers, therefore, may consider structuring some employees’ compensation arrangements to include these forms of compensation in order to reach the newly-increased exemption threshold.

Employers can respond to the increased threshold by (1) increasing salaries of employees who meet the duties and salary basis tests in order to maintain their exempt status or paying those employees overtime in lieu of raising salaries; (2) reducing or eliminating overtime hours; (3) reducing the amount of pay allocated to base salary (not below minimum wage), and adding pay to account for overtime for hours worked over 40 in a workweek, to hold total weekly pay constant; (4) restructuring compensation arrangements; or (5) using some combination of these responses.

The changes will have a notable effect upon businesses that cannot afford to raise salaries, including small businesses and non-profits. If salaries cannot be raised for currently-exempt employees, employers will need to reclassify such employees as non-exempt, but may choose to restrict their hours to 40 hours per week or otherwise manage overtime to minimize cost. Reclassification may be viewed as a demotion by reclassified employees, who will now have to track their hours, and could result in higher employee turnover rates. The need to track hours may also require employers to reexamine telecommuting and mobile device policies, and other flexible work arrangements, as they apply to non-exempt workers. Despite these potential downsides, however, employers now have a unique opportunity to study their workforce and correct any potentially-improper misclassifications which may otherwise raise a red flag with the DOL. Accordingly, employers should ensure that positions classified as exempt that already meet the salary threshold also comply with the duties test.

In order to make appropriate changes, employers will need to identify all current exempt positions with compensation below $50,000 and determine whether compensation can be increased above the new salary threshold, or whether to reclassify such positions as non-exempt. For employees who may need to be reclassified, employers should determine the tasks they perform and begin to track how many hours they usually work. In order to assess the impact and cost of any changes, employers will need to obtain a good understanding of the number of hours these employees work per week. It may be that the employees do not work more than 40 hours per week and, thus, their salaries can remain the same, and the employees may simply be reclassified as non-exempt. However, if these employees work overtime, employers should consider whether tasks can be assigned to other employees, including managers and others who are exempt, and consider the option of hiring part-time or temporary employees to reduce and spread out such employees’ workloads. Employers must also develop an employee communications plan, required by the DOL, announcing the new regulations and the changes they have necessitated.