If you are a business owner, and you have exempt employees, you need to pay attention because the rules for some of your exempt employees are about to change dramatically.
The U.S. Department of Labor (DOL) recently released its long-awaited Final Rule updating regulations under the Fair Labor Standards Act (FLSA) governing overtime exemptions for executive, administrative, and professional employees, commonly known as the “white collar exemptions” or “EAP exemptions.” Unless specifically exempted, employees covered by the FLSA must receive pay for hours worked in excess of 40 in a workweek at a rate of not less than one and one-half times their regular rates of pay. This is referred to as “overtime” pay.
As a practical matter, the updated regulations from the DOL will mean that the pool of employees who you will be able to treat as exempt from the overtime laws will shrink dramatically starting December 1, 2016. This will mean that you may no longer be able to claim an exemption for some of your employees. Instead, you may be required to pay these employees overtime pay. The DOL estimates 4.2 million workers will be eligible for overtime pay as a result of the Final Rule and that it will result in an increase in wages of $1.2 billion per year.\
In 2014, President Obama directed the DOL to update and modernize its regulations. On July 6, 2015, the DOL published its notice of proposed rulemaking and received more than 270,000 comments. Details regarding the changes made in the Final Rule were announced on the DOL’s website on May 17, 2016, including a video explaining the need for the change, as well as detailed “FAQs,” “fact sheets,” and guidance publications targeting some employers who will be particularly affected by the Final Rule — including non-profits, educational institutions, small businesses, and state and local governments. Below is a summary of the Final Rule.\
Salary Level Will Increase from $23,660 ($455 per week) to $47,476 ($913 per week) Beginning December 1, 2016
For EAP exempt employees, the new minimum salary level will be $47,476 per year, more than double the current salary level of $23,660. So, as of December 1, 2016, for an employee to initially qualify for one of the three most common “white collar” exemptions – executive, administrative, and professional – you will have to ask yourself one initial question: am I paying this employee at least $47,476 per year? If the answer to that question is “no,” then that employee will not qualify as an EAP exempt employee under the law, and, assuming the employee does not qualify for any of the other exemptions, the employee will lose exempt status and become eligible to receive overtime pay for any hours worked in excess of 40 hours per week.
How did the DOL arrive at the new salary level of $47,476? In its notice of proposed rulemaking, the proposed salary level was based on national data regarding the salary levels for all salaried workers, and set at the 40th percentile. The Final Rule retains the 40th percentile standard, but sets the rate based on the salary for workers in the lowest income Census region (currently, the South), instead of nationwide salary levels.
Notably, in 2004 (the last time the DOL increased the salary level for these exemptions), the DOL set the salary level at $455 per week, also using, in part, salary data from the South. But in 2004, the salary level was set at the 20th percentile. That is now raised to the 40th percentile.
The DOL states the salary level was reduced from the level identified in the proposed rule in response to public comments regarding regional variations in pay. But the new salary level still requires all employers, including those in lower salaried regions, to pay exempt workers a salary greater than the current salary level for exempt workers in both New York ($35,100) and California ($41,600), one of the major criticisms leveled at the DOL’s proposal.
It is very important to note that even if the employee is paid the required annual salary of at least $47,476, this does not end the inquiry. The salary level is only the first part of the test to determine if the employee qualifies as an EAP exempt employee. The employee will still have to be performing the types of duties required by law for one of the three exemptions in order to be considered an exempt employee.
Employers Will Be Permitted to Use Nondiscretionary Bonuses, Commissions, and Incentive Pay to Satisfy Up to 10% of Salary Level Requirement
Under current regulations, employers have not been permitted to use commissions, nondiscretionary bonuses, or other incentive payments to satisfy the salary level requirement. Rather, exempt employees have been required to meet the salary level exclusive of such compensation. Under the Final Rule, this restriction is lifted, and employers will be able to satisfy the new salary level in part through commissions, nondiscretionary bonuses, and other incentive compensation.
But there are limits to the use of such pay to meet the new salary level: only 10 percent of the salary level can be paid in the form of this incentive pay and it must be paid quarterly or more frequently (the proposed rule stated the DOL would require employers to make the payments on a monthly basis). The Final Rule, however, will permit employers to make a “catch up” payment — i.e., if the employee has not earned sufficient commissions to satisfy the salary level requirement on a quarterly basis, the employer can make up the difference without losing the exemption. The proposed rule did not permit a “catch-up” payment.
Salary Level for Highly Compensated Employees Will Increase from $100,000 Per Year to $134,004
The salary level for highly compensated employees (HCEs) — who are required to satisfy a more relaxed duties test — is also getting a hefty increase, and, in time, may outpace increases to the standard exempt salary level. The salary level for HCEs, unlike the standard salary level, is based on nationwide data for full-time workers and set at the 90th percentile. This change is consistent with the proposed regulations. The proposed regulations identified the salary level for HCEs as $122,148, but that was based on 2013 data; 2015 fourth quarter data from the Bureau of Labor Statistics identifies $134,004 as the 90th percentile.
If you are an Illinois employer, however, please note that Illinois does not recognize this exemption.
The DOL Will Update the Salary Level Every Three Years, Beginning 2020
Historically, many years pass between increases to the salary level — the last increase occurring 12 years ago, and the increase before that took more than 25 years. Now, for the first time in the history of the FLSA, adjustments to the salary level will occur automatically every three years and will not require specific rulemaking.
The new three-year increases will be set at the 40th percentile for the lowest wage Census region for the standard salary level and the 90th percentile for salaried workers nationally for HCE employees. The DOL will publish the new rates 150 days before the effective date.
While the new salary levels will be effective December 1, 2016, the three-year adjustments will occur on January 1, beginning in 2020. The rates, therefore, will be published beginning August 1, 2019. The DOL estimates that the salary level will increase to $51,168 at the time of the first adjustment in 2020.
The proposed rule, consistent with the Final Rule, called for automatic increases. But the proposed rule indicated annual increases would be required. The Final Rule abandons this, giving employers more time between changes to prepare.
No Changes to the Duties Tests
The Final Rule does not contain any changes to the duties tests for the white collar exemptions, a relief to many employers.
While the DOL had not proposed any specific language modifying the duties test, it sought comments from the public on whether such changes should be made, including whether to adopt the California rule that exempt employees must spend more than 50 percent of their time performing exempt work. This would have narrowed the exemptions, particularly for exempt employees who perform non-exempt duties concurrently with exempt duties.
Non-Enforcement Policy for Providers of Medicaid-Funded Services for Individuals with Intellectual or Developmental Disabilities in Residential Homes and Facilities with 15 or Fewer Beds
The DOL also announced that it is publishing in the Federal Register a time-limited non-enforcement policy for providers of Medicaid-funded services for individuals with intellectual or developmental disabilities in residential homes and facilities with 15 or fewer beds. From December 1, 2016, to March 17, 2019, the Department will not enforce the updated salary threshold of $913 per week for employers covered by this non-enforcement policy. However, this DOL non-enforcement period may not serve as a bar to civil litigation.
Alternatives for Compliance
The DOL fact sheets and guidance documents identify several obvious alternative steps employers can take to comply with the new rule:
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increasing employee salaries to the new salary level and continuing to treat employees as exempt (assuming they satisfy the duties requirements);
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reclassifying employees as non-exempt and paying overtime for hours worked over 40; and
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reducing employee hours to avoid overtime work (and thus, overtime pay).
Buried in the guidance, the DOL also concedes employers could reclassify employees and set their wages at a rate so that the total amount paid to the employee remains the same. But this alternative is clearly not one the DOL or the President hopes employers will take, as that would thwart the DOL’s prediction that the new rule will “boost wages for workers by $12 billion over the next 10 years.”
The DOL also does not address in its posted materials the potential for employees to earn lower wages if their hours are reduced or the possibility that employers may reduce benefits or other compensation to off-set increases to the salary level.
Potential Challenges to Final Rule
Under the Congressional Review Act, Congress will have 60 session days to review the Final Rule. But even if Congress were to disapprove the Final Rule, the President would surely veto any such vote.
In March 2016, the “Protecting Workplace Advancement and Opportunity Act” was introduced, which would nullify the Final Rule and bar the DOL from issuing any future rule with automatic increases to the salary level without separate rulemaking. The future of that legislation will likely depend on the next election. Given the highly-speculative nature of any deferring action, employers should begin preparations for compliance with the Final Rule now.
Conclusion
Because of the rule changes discussed above, many of the employees who are currently considered exempt, will no longer qualify for this exempt status. As a result, many of these employees may have to be reclassified as non-exempt and be paid overtime for all hours worked in excess of 40 hours per week.
Now is a good time to conduct an audit of your workforce to determine which employees may no longer qualify as exempt come December 1, 2016.
If you have any questions, you can reach out to James Botana at botanaj@jacksonlewis.com with any questions in English or Spanish.
