On May 23, 2016, the U.S. Department of Labor issued updated regulations governing the white collar exemptions. The updated regulations go into effect on December 1, 2016.
The Fair Labor Standards Act (FLSA) requires that most covered employees be paid at least the federal minimum wage for all hours worked, and receive overtime pay at time and one-half the regular rate of pay for all hours worked over 40 in a workweek. However, § 13(a)(1) of the FLSA provides an exemption from both minimum wage and overtime pay for bona fide executive, administrative, professional, and outside sales employees. Section 13(a)(1) and § 13(a)(17) also exempt certain computer employees. These exemptions are generally referred to collectively as the “white collar” exemptions and include the following:
- Executive exemption.
- Administrative exemption.
- Professional exemption (learned and creative).
- Computer employee exemption.
- Outside sales exemption.
- Highly compensated employee (HCE) exemption.
Highlights of the Updated Regulations
Under current FLSA regulations, an employee must generally satisfy three tests to qualify for one of the white collar exemptions:
- The Salary Basis Test. The employee must be paid a predetermined and fixed salary that is not subject to reduction because of variations in the quality or quantity of work performed.
- The Salary Level Test. The amount of salary paid must meet a minimum specified amount.
- The Duties Test. The employee’s job duties must primarily involve those associated with exempt executive, administrative, professional, outside sales, or computer employees.
The updated regulations focus primarily on updating the salary and compensation levels in the salary level test that employees must meet to qualify for the executive, administrative, or professional employee exemption. Specifically, the updated regulations:
- Set the standard salary level at the 40th percentile of earnings of full-time salaried workers in the lowest-wage Census Region, currently the South, which is $913 per week or $47,476 annually for a full-year worker. The current salary level is $455 per week ($23,660 per year).
- Set the total annual compensation requirement for highly compensated employees (HCEs) subject to a minimal duties test to the annual equivalent of the 90th percentile of full-time salaried workers nationally, which is $134,004. The current compensation requirement is $100,000.
- Establish a mechanism for automatically updating the salary and compensation levels every three years to maintain the levels at the above percentiles.
The updated regulations also amend the salary basis test to allow employers to use nondiscretionary bonuses and incentive payments (including commissions) to satisfy up to 10 percent of the new standard salary level. Note that the regulations make no changes to the duties tests.
Steps to Take Now
If you haven’t started planning for the changes, don’t panic; but it’s time to get started. Here are some steps you can take to prepare for the changes.
Analyze the salaries of employees who may be affected by the final rule and start forecasting for increased salaries and overtime costs. Suggestions include:
- Determine which employees are exempt at an annual pay rate of less than $47,476, including up to 10 percent of nondiscretionary bonuses.
- Consider whether to raise these employees’ pay to meet the new threshold of $47,476 to maintain exempt status or budget for potential additional overtime expenses with the reclassification to nonexempt status.
- Review with your managers or exempt staff the average hours that each employee in the above group works beyond 40 hours per week, or other state hours worked requirement triggering overtime eligibility. Don’t forget to include meal and rest periods, travel time, training time, and other hidden overtime in that analysis.
- Calculate the average number of overtime hours of your current nonexempt workers on an annual basis.
- Based on these two numbers (from steps 3 and 4 above), determine the average number of hours that would be considered as overtime (over 40 hours in a workweek, or eight hours in a day for some states) for the exempt workers; the aggregate of both is an estimated average of overtime hours that the exempt worker may work if reclassified as nonexempt.
- To calculate the overtime budget, take the average hourly rate of all exempt workers at the annual rate of less than $47,476, multiply the hourly rate by 1.5, and multiply that number by the estimated average overtime hours calculated in the last step to determine the proposed overtime budget for the current exempt workers that may be reclassified as nonexempt.
Consider requiring exempt employees earning less than $47,476 per year to start tracking their weekly hours worked. Since exempt employees do not typically record their work hours, it may be difficult for them to accurately estimate the overtime hours they have worked and anticipate working in the future. Having them track their work hours will provide the employer with valuable information when it comes to budgeting.
Review your group benefits plans and your paid time off and leave policies (for example, sick and vacation) and assess how each may be impacted as they pertain to eligibility and accrual differences for exempt and nonexempt workers and how the company will best manage the transition from one accrual method to another.
Plan your communications strategy carefully. This is a great opportunity to talk with your employees about your pay strategy and what your organization values, and you can reinforce that the regulatory definitions of overtime exemption status are not important to your evaluation of each employee’s worth to your organization.
How the changes in classification status and rates of pay are communicated to employees will have a lot to do with your company culture, pay philosophy, and style of communication. Face-to-face communication is generally the ideal method when discussing compensation. Follow up with written documentation confirming your discussion with each impacted employee that shows the new classification status, rate of pay, and the overtime rate of pay that will apply. Some states already require employers to notify nonexempt employees in writing any time a change in rate of pay occurs, including California, District of Columbia, New York, and Pennsylvania.
Keep Managers in the Know
Train your management team about the changes you are making, including not just the “what,” “how,” and “when,” but also the “why” so that the company’s intentions are communicated in a way that demonstrates thoughtful consideration of the alternatives, respect for your employees, and alignment with your company’s culture and strategic objectives.
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