Employers with salaried employees earning under $47,476 annually should evaluate the impact on their organizations of major changes to employee compensation following new federal wage requirements effective December 1, 2016.
To be exempt from federal minimum wage and overtime requirements, most “white-collar” employees must meet both a compensation test and a duties test under the Fair Labor Standards Act (FLSA). These “exempt” employees are not paid more than their salary when they work more than 40 hours in a week.
This two-part test for exemption under the FLSA has not changed. What has changed is the minimum amount of salary that will be required to qualify for the exemption. Under the compensation test, an exempt white-collar employee must be paid a minimum and predetermined salary not subject to reduction because of variations in the quality or quantity of work performed. Under the duties test, the employee’s primary job duty must involve qualifying responsibilities as defined by the regulations, such as making important business decisions, supervising a department, or practicing in a scientific field.
The Wage and Hour Division of the U.S. Department of Labor (DOL) announced revisions to the compensation test to be published in the Federal Register on May 23. These long-awaited changes to the FLSA white-collar exemptions do not directly impact the duties test for exemption. The final rule issued by the DOL increases the income threshold for employers to take advantage of the “white collar exemption” to $913 a week ($47,476 a year). While the final rule is slightly more favorable for employers than the proposal issued in July 2015, this level is more than twice the current minimum salary.
It is no surprise that the DOL has raised the salary minimum above the current $455 weekly threshold, which was set in 2004 and is now below the federal poverty level for a family of four. In a statement, President Obama called the DOL’s revision, “a step in the right direction to strengthen and secure the middle class by raising Americans’ wages.” Doubling the salary minimum, however, is a difficult proposition for employers with a large proportion of workers who currently earn less than the new salaried minimum.
Under the new federal rule, any salaried employee earning less than $913 a week must be paid time-and-a half for more than 40 hours of work in a week, unless the employee is covered by another exemption. This new standard will require an evaluation of salaried compensation for employers of any size. Employers do not need to take action, however, if all of their salaried employees earn this qualifying salary as of the date the new rule is effective.
U.S. employers covered by the FLSA, which includes most businesses of any size, must comply with the rule or face potentially significant penalties through FLSA litigation and DOL investigations.The rule goes into effect on December 1, 2016, and as of that date becomes part of the generally applicable wage law, like the federal minimum wage.
Which employees must be paid the new salary?
The revised rule, “Defining and Delimiting the Exemptions for Executive, Administrative, Professional, Outside Sales, and Computer Employees,” updates the most popular overtime exemptions of the FLSA. The rule is applicable to employees working under the executive, administrative, professional, and highly compensated exemptions, often called “white collar” exemptions. The rule has limited impact on employees classified under two other white-collar exemptions, the computer professional exemption (section 13(a)(17) of the FLSA) and the outside sales exemption.
As of December 1, 2016, most exempt white-collar employees must earn $913 a week ($47,476 a year) to qualify as exempt from federal minimum wage and overtime laws. This figure represents a sizeable increase over the currently applicable levels, which have been set at $455 weekly ($23,660 annually) since 2004. Under limited circumstances, the compensation test can be met by payment on a fee basis, such as per task, if the weekly minimum earned is equivalent to the salary minimum.
Is my business impacted?
Likely, yes. This rule has broad-reaching implications, because the FLSA has no minimum number of employees for an employer to be covered. The FLSA applies to those employees who regularly engage in business transacted across state lines (including via networks, such as telephone, internet, or payment systems). It also applies to companies with $500,000 or more in annual transactions, in the unlikely event that their employees are not covered under the rule regarding interstate transactions.
Certain businesses are covered by the FLSA regardless of transactions. These include: hospitals; businesses providing residential medical or nursing care; for-profit and non-profit schools; and public agencies.
As with for-profit companies, employees of non-profit entities are subject to the FLSA if they transact business across state lines. Alternatively, the non-profit will be covered if it transacts business above the $500,000 threshold. Only activities performed by a non-profit for a “business purpose” count towards the $500,000 figure, including sales or services offered to the public by the organization, but excluding charitable activities, membership fees, dues, and most donations.
Employers with questions about whether a business is subject to the FLSA should consult with counsel to learn what impact the new rule may have on operations.
Are there any bright spots?
Following publication of the proposed rule in July 2015, the DOL received more than 300,000 comments from employers, employees, and interested parties responding to the proposal. The final rule reflects minor revisions designed to limit the impact on employers.
The DOL’s revised regulation attempts to provide some relief to employers by allowing up to 10% of the minimum income for an exempt white-collar employee to be earned as a non-discretionary bonus, commission, or incentive compensation. Under existing rules, only the employee’s guaranteed salary counts toward the salary minimum. The new regulation allows employers to meet the minimum exempt earnings requirement by paying up to 10% of the salary minimum (about $4,747) annually in non-discretionary incentives or commissions. Effectively, salaried workers can earn as little as $42,278 annually ($821 weekly) as long as their annualized wages equal at least the $47,476 minimum. The final rule requires that these supplementary bonus payments be made at least quarterly, no later than the next pay period after the quarter ends. While this bonus provision provides some flexibility to for-profit corporations, it will not be compatible with compensation plans for most non-profits and government entities.
Importantly, the DOL did not change the duties tests for exempt white-collar workers. The rule proposed in 2015 invited comment on a California-style duties test, requiring that at least 50% of the job duties be exempt duties, but the final rule makes no revisions to the duties tests simplified by the DOL in 2004. Employers that have current and accurate job descriptions or duties analyses for their salaried workers should be able to use these descriptions to assess employee classifications going forward. Employers that have not updated job descriptions to reflect how a job is actually performed will want to revise their data before making classification decisions.
Does the rule impact high-earning employees?
White-collar employees who are paid a salary of at least $47,476 annually (including the 10% rule for incentive compensation discussed above) generally will not be impacted by the new rule. However, employers should review the status of employees who earn $100,000 to $134,004 annually to ensure that the revisions to the rules for highly compensated employees do not impact employees in this compensation band.
Highly compensated workers are subject to a reduced duties test and are exempt if they customarily and regularly perform at least one exempt duty under the executive, administrative, or professional exemptions. If a worker with an exempt duty earns sufficient annual compensation, including incentive and commission pay, the “highly compensated” exemption is applicable without further analysis. The new rule changes only the compensation rate for these workers.
Highly compensated workers must now earn a minimum of $134,004 annually ($2,577 weekly). This level is considered the 90th percentile for salaried workers nationally and is an increase over the current $100,000 annual compensation requirement. Workers earning under $134,004 in salary will have to meet the full duties test of the exemptions.
How do I comply without giving everyone a raise?
The new rule does not require that employers pay all workers who are currently salaried the new $47,476 salary minimum. The DOL’s announcement explains that the changes would grant overtime eligibility to more than 4.2 million U.S. workers if all salaried employees earning less than $47,476 annually are reclassified as non-exempt. It seems likely, however, that employers will rely on a menu of options to ensure compliance with the new regulations while minimizing operational costs.
Among options employers should consider are reclassifying salaried workers to a non-exempt hourly rate that anticipates overtime; applying a half-time overtime approach to agreed hours for non-exempt employees; using the fluctuating workweek method to minimize overtime costs; raising compensation of certain exempt employees to meet the new salary minimum; and managing overtime costs through limited hours and additional hiring. With careful planning, employers can minimize the cost of compliance with the new rule.
While compensation alternatives to a minimum salary may be attractive options, in practice they can be challenging to implement correctly. Employers should consult informed counsel before applying some of the more exotic compensation alternatives to the salaried exempt or hourly non-exempt classifications they likely use now.
Which exempt employees can be paid less than $47,476 or do not require a salary?
A limited number of white-collar jobs are exempt from overtime and are not entitled to the $913 weekly salary. Among these positions, the outside sales exemption is not impacted by the changes to the regulations, because qualifying outside sales employees have no minimum salary requirement. Employees working as doctors or lawyers are exempt from federal salary requirements and minimum wage and overtime laws.
The revisions to the regulations have minimal impact on computer professionals who meet the statutory requirements of FLSA section 13(a)(17), which requires that these employees be paid at least $27.63 an hour ($1,105 for a 40-hour week) and meet the duties test of an exempt computer systems analyst, computer programmer, software engineer, or similarly skilled IT professional. Many computer professionals, however, will also qualify as salaried exempt under the professional exemption due to their high salaries, the complex nature of their work, and their corresponding required education.
Educational institutions should pay particular attention to the new rule. Teachers are exempt from federal salary minimum and overtime laws if they have a primary responsibility of teaching, tutoring, instructing, or lecturing. Schools are not required to pay bona fide teachers the $913 weekly salary. Additionally, school administrative personnel with job duties directly related to instruction, such as principals, assistant principals, curriculum advisors, and academic counselors, are not subject to the federal salary minimum if they are paid at least the minimum salary for a teacher at the school. School administrators without a primary duty directly related to instruction, however, will be entitled to the higher salary levels set by the new rule. Schools may be able to manage costs by making these employees non-exempt and tracking hours to avoid overtime liability.
When will the salary minimum change again?
Admittedly, the current $455 salary level set by the last FLSA regulation revision in 2004 is now below market rate for most properly classified salaried jobs. The new rule has a built-in provision to revise the minimum salary automatically every three years.
The weekly salary requirement for the new regulation is tied to the 40th percentile of full-time salaried workers in the lowest U.S. region by income census (currently the South). The dollar figure of the salary requirement will be adjusted every three years to remain at this benchmark.
As critics have noted, the new regulation itself will cause the level of the 40th percentile of salaries to rise. Presumably all salaried workers will be at the $47,476 floor by the beginning of 2020 when the next adjustment is made, inevitably raising the 40th percentile level higher.
Can I take a wait-and-see approach?
The Wage and Hour Division of the DOL under the Obama administration has made implementation of the higher salary minimum its primary priority. In March 2014, President Obama directed the Secretary of Labor to propose revisions to the FLSA. Since then, the DOL has focused on introducing an ambitious but unassailable change to the FLSA regulations. The rule is published with the May 23, 2016, release of the Federal Register and is expected to be effective on December 1, 2016. The rule is not retroactive, so there is no legal requirement to bring compensation into compliance until December 1.
A bill to prevent implementation of the regulations, the Protecting Workplace Advancement and Opportunity Act, has been introduced by Republican members of the House (HB 4773, and related SB 2707), but remains in committee and is considered unlikely to pass in this election year. The DOL’s final rule removed some of the more ambitious facets of the proposed rule, in part, to avoid legal challenges to the DOL’s authority to implement the rule.
In all likelihood, the regulations will take effect. Employers should plan now to be in compliance as of December 1, 2016.
Do my employees meet the duties tests for exemption?
In responding to the revised regulations regarding compensation, employers should also seize the opportunity to revisit whether their exempt employees meet the applicable duties test under an FLSA exemption. A company-wide evaluation of exempt and non-exempt categories is an opportunity to correct potential errors. An informed opinion of counsel regarding proper classification may also provide additional defenses to an employer in the event of legal challenge to an employee’s proper classification.
Employers should assess carefully whether certain well-paid workers whose actual job duties do not qualify for an exemption should be reclassified as non-exempt in the transition. Frequently misclassified roles in computer systems support, sales, accounting, administration, and other areas should be audited to identify those workers who may earn above the new salary minimum but perform non-exempt roles. These workers will more easily transition to the appropriate non-exempt status if they do so in step with their colleagues.
What are my next steps?
The six-month period before implementation of the new regulations will pass quickly. The revision of the white-collar exemptions inevitably will be an administrative and financial burden for companies of all sizes. Broadly, employers will evaluate how to treat impacted positions, prepare appropriate documentation, and communicate the changes to employees. Within this process, there are numerous complexities.
Employees earning significantly below the new salary minimum are likely to be transitioned to non-exempt status this year, with corresponding burdens in tracking and reporting work hours. Employers must maintain an accurate daily count of hours worked by non-exempt employees. This additional recordkeeping involves tracking the newly non-exempt workers through existing time systems or implementing new time records. The DOL estimates that these and other administrative burdens of the new regulations will cost U.S. businesses $295 million annually.
Employers reclassifying employees as non-exempt can minimize disruption to operations and impact on morale through careful planning and communications. Managers and professionals are likely to consider reclassification a demotion. Tailoring a compensation and benefits package appealing to these workers is essential to maintaining the support of this large and important part of the workforce. Employers should move quickly to establish plans for auditing impacted jobs, tailoring compensation packages, and communicating changes to workers well in advance.
Employers used to relying on these formerly exempt employees with remote access to email and computer systems will also have to limit after-hours use of devices to minimize overtime burdens. Similarly, this new group of non-exempt employees who travel for their jobs will be required to wrestle with compensation policies for non-exempt travel time.
Further, remaining competitive for skilled workers in a tight job market may require loosening restrictions on non-exempt employees’ benefits, such as accrual of paid leave, profit-sharing, and access to favorable medical plans. Employers are advised to consider not only the immediate impact on wages, but to prepare policies, procedures, and benefits plans for a new group of educated, skilled non-exempt workers. Policies can also be revised to provide defenses to salaried misclassification claims, such as adding documentation that the salary covers all hours of work, a handbook disclaimer regarding improper deductions from salary, and limiting opportunities for after-hours work by exempt employees.
Finally, state laws, including those of California, may have more stringent requirements than the FLSA. Employers are advised to make sure they are complying with applicable state law to the extent that it is more favorable to employees than the FLSA.
By December 1 when the new regulations are effective, employers should have planned and completed revision of all documents and systems and communicated the changes in a clear and positive manner to all impacted employees.
The revised FLSA regulations will have a far-reaching impact on U.S. businesses. Employers should prepare now to be ready for implementation by the December 1, 2016, deadline.