New Wage and Hour Regulations Will Make It Harder to Claim Overtime Exemption

New regulations from the Department of Labor will require employers to increase salary levels or pay overtime to millions of employees who are presently ineligible for such premium payments. Under the Fair Labor Standards Act (FLSA), employees are entitled to be paid a minimum wage and overtime at one-and-one-half of the employee’s regular rate of pay for hours worked in excess of 40 in a week . . . unless the employee is exempt. The broadest and most popular minimum wage and overtime exceptions are the so-called “white collar” exemptions that include the executive, administrative and professional exemptions. In order to fall under one of these white collar exemptions, the employee in question must usually satisfy three tests: the duties test, the salary basis test, and the minimum compensation test.

It is the last of these – the minimum compensation test – at which the new federal regulations take aim. These new regulations, released by the government in final form on May 18, 2016, and effective December 1, 2016, double the current minimum compensation requirements. As a result, it is estimated by the Department of Labor that over 4.2 million employees now classified as exempt will become non-exempt. The best way to understand where employers are going with these new regulations is to review where the employers are now under the current regulations.

An employee typically falls within a “white collar” exemption if he or she performs duties consistent with the exemption, is paid on a salary basis (which means, at its core, that the employee’s weekly wages are not subject to reduction based upon the quality or quantity of the work performed), and is paid at least a minimum amount each week. That minimum amount is currently $455 per week, which annualizes to $23,660. Employees paid that amount or more may be exempt under one of the white collar exemptions. Employees paid less generally cannot be exempt, even if they perform exempt duties and are paid on a salary basis. The current minimum has not changed since 2004, which was the last time the Department of Labor authored significant changes to the exemption regulations.

The new regulations do not change the duties test or the salary basis requirement. However, they significantly increase the minimum amount an employee must be paid to claim a white collar exemption. As of December 1, 2016, exempt employees must be paid a minimum of $913 per week, or $47,476 annually. If they are paid less, they generally cannot be classified as exempt under one of the white collar exemptions. Not only have these new regulations raised the minimum salary, but they include an escalator which assures that the minimum salary will be raised periodically. The minimum salary is indexed to the weekly earnings paid to the 40th percentile of full-time non-hourly workers in the lowest-wage Census region (which is currently the South). The escalator provision provides for increases to the minimum salary every three years, based on the index. Thus, on January 1, 2020, the minimum salary will be adjusted, and then every three years thereafter.

There is some minor relief afforded to employers by these new regulations. Specifically, up to ten percent of the minimum salary may be satisfied by the payment of nondiscretionary bonuses, incentives and commissions, if they are paid quarterly or more frequently. Moreover, if, at the end of a quarter, an employee has not received an amount equal to 13 times the minimum weekly salary, the employer may elect to make one final payment sufficient to meet the minimum salary requirements. That payment must be made by the payday closest to the end of the quarter.

The new regulations also change the compensation requirements for the highly compensated employee exemption. The highly compensated employee exemption relaxes the duties test for employees. Normally, an employee’s “primary duty” must be work of an exempt nature for the exemption to apply. However, the highly compensated employee exemption requires only that the employee in question perform some exempt work. The catch is that the employee must be paid at least $100,000 annually. Under the new regulations, the minimum compensation required to be a highly compensated employee will be $134,000, effective December 1, 2016. That number, too, will be indexed and adjusted every three years. The regulations permit a final “catch up” payment during the last pay period or within one month of the compensation year which can be used to push the total compensation beyond the applicable minimum amount.

Particularly for low level managers, first line supervisors, and entry-level administrators and professionals, it is expected that the new minimum compensation level will result in employees who are now exempt becoming non-exempt. That means their employers will either need to increase salaries or track those employees’ time and pay overtime for hours worked in excess of 40 in the workweek. Congress is considering a bill that would block the implementation of these new regulations, but it is widely expected that any such law would be vetoed by President Barack Obama.

This means employers need to review their workforces and identify which employees may need to be converted from exempt to non-exempt, or paid more to maintain the exemption. It may be cheaper to increase an employee’s salary rather than pay them overtime; conversely, it may be cheaper to maintain (or reduce salaries) and pay overtime, particularly in those cases where it is not expected that the employee will work much overtime.

Such a review, while a burden in many respects, may also be an opportunity for employers to correct improper classifications that have lingered in their organizations for years. As a practical matter, it is difficult to reclassify an exempt employee as non-exempt without risking significant liability. For example, an employee who is reclassified to non-exempt may ask hard questions of the employer (“Why are you doing this now?”) and, generally, cannot effectively waive FLSA claims without court or Department of Labor approval. However, the new regulations may offer both employer and employee a satisfactory rationale for reclassification, allowing both sides to move forward.

While the December 1, 2016, effective date for the new regulations gives employers a half-year to implement necessary changes, the challenges they will most certainly present should be addressed without undue delay.