According to the U.S. Department of Labor (DOL), the Final Overtime Rule, which is effective on December 1, 2016, simplifies the regulations to make them easier for employees and employers to understand and apply. Really? This simplification will likely not make it easier for employers to comply with the Fair Labor Standards Act – rather, it simply converts approximately 4.2 million workers to an overtime eligible status. Although the DOL estimates that employers will need only one hour to get up to speed on the changes, the time and effort employers will expend analyzing the impact their bottom lines, dealing with employee relations fallout, and repeating the process every three years as the salary basis increases over time will take far exceed that one hour estimate.

Scope of the Final Overtime Rule

The Rule applies to the executive, administrative, and professional (EAP) exemptions only. The DOL’s guidance related to the Rule reminds employers that to be exempt from overtime an employee must be paid on a salary basis not subject to reduction based on quality or quantity of work (salary basis test), and the employee’s primary job duties must involve the type of work associated with the EAP exemptions (duties test).

As many employers who have been sued under the FLSA know, misclassifying employees under any of the FLSA’s exemptions is a very costly mistake for employers. Employers should not blindly raise currently exempt employees’ salaries to maintain the exempt status without first making sure that those employees’ duties also meet one of the duties tests. In other words, this is the perfect opportunity to “fix” misclassification problems of those currently exempt employees who may be misclassified.

Changes to the Salary Basis Test

As we now know, the salary basis will increase from $455 to $955 per workweek ($23,660 to $47,476 annualized). But, it will not stay at that rate for long because the salary basis is set to automatically update every three years. Effective on January 1, 2020, the date of the first increase, the salary basis is expected to rise to $51,168.

First Time Use of Non-Discretionary Bonuses to Meet the Salary Basis Test

For the first time ever, employers may use non-discretionary bonuses and incentive payments, including commissions, to meet the salary basis test. The use of such variable compensation is limited to 10 percent of the salary basis level (up to $91.30 per workweek), and it must be paid to the exempt employee on a quarterly or more frequent basis. Surprisingly, the Rule also allows employers to make a “catch up” payment at the end of the quarter if the amount of variable compensation paid to the employee does not equal $91.30 per workweek. The inherent risk of improperly handling the “catch up” payment is loss of the exemption. That is, if an employer wrongly calculates or untimely makes the catch up payment, it will not be in compliance with the salary basis test. Employers should carefully consider whether the administrative costs and the risks of improperly applying the catch up payment are worth it.

Changes to the Highly Compensated Employee Exemption Threshold

Currently, among other requirements, the Highly Compensated Employee exemption (HCE) requires that an employee earn a total annual compensation of $100,000 or more, which includes at least $455 per week paid on a salary basis. The Final Overtime Rule sets the threshold at $134,004 (up from the proposed $122,148), which includes at least $913 per week paid on a salary basis. The HCE threshold is also set to automatically update every three years. January 1, 2020, is the anticipated date of the first increase. Employers should take note that the “catch up” contribution does not apply to the HCE exemption.

No Changes to the Duties Tests

Why? The DOL has stated that by raising the salary level, the number of workers for whom employers must apply the duties test is reduced, thus simplifying the exemptions under the FLSA. The DOL also expects that changes to the salary basis will effectively mark the difference between which employees are truly exempt and those that are non-exempt.

What Should Employers Do Now?

Start planning. The DOL gave employers about 200 days to determine how the Rule will impact their businesses. Whether the DOL will begin enforcement of the Rule immediately is unknown, however, on December 1, 2016, employers should be prepared to comply.

The annual cost of one hour of overtime for an employee currently making $40,000 is $1,500. How much will the final Rule cost overall? How many employees will be affected? Should the employees’ salaries be increased to remain exempt, or it is more cost effective to absorb the additional overtime cost? How will benefits be affected? Some employers provide greater paid time off benefits to exempt employees – will those benefits be reduced or “grandfathered?” The answers to these and many more questions may be different for each exempt employee based on the role of the employee, the employee’s current annual salary, and the number of hours the employee typically works. And, it goes without saying that timely communication with employees is critical so that employees know the “what” and the “why” about their reclassification.

Some of the factors to consider when reclassifying employees under the new Rule:

  • Costs to absorb and manage overtime
  • Employee relations and morale concerns, such as loss of flexibility in the workplace
  • Compression of wages
  • Possible blurred lines between the manager and the staff
  • Shifting of workloads to other exempt employees to control costs
  • Impact on service and whether reclassified employees will continue to perform all of their job duties
  • Whether benefits will change for employees moving from exempt to nonexempt
  • Whether eligibility for bonus or other incentives will change
  • Whether reclassified employees will be eligible for travel time pay