Now is probably a good time for employers to audit their exempt classifications. Last week, the United States Department of Labor (“DOL”) finally unveiled its long-awaited changes to federal overtime laws. Most noteworthy among the changes, the DOL is more than doubling the minimum salary necessary to meet the so-called “white collar” exemptions. Whereas current law requires employees to, among other things, earn about $23,000 per year to be exempt from overtime pay, employees will need to earn more than double that amount by December 1, 2016 to retain the exempt classification.
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The new law will impact millions of workers across the country who are currently classified as exempt but will no longer meet the new standard absent a bump in pay. The change will most significantly impact employers in states that follow the federal exemption laws. But it will also impact, at least temporarily, employers in states that already have laws requiring higher pay for exempt employees.
The Current Exempt Requirements
Under the Fair Labor Standards Act (“FLSA”), employers must pay 1.5 times their regular rate of pay for every hour worked in excess of forty hours per workweek. That law does not apply to all employees, however. Some employees are deemed exempt from the overtime requirements. The most common exempt classification are the “white collar” exemptions (executive, administrative, and professional). To be classified as exempt under one of these exemptions, employees must meet certain criteria relating to the nature of the work they perform (the “duties test”) and earn a minimum salary of at least $455 per week, which translates to $23,660 annually.
The New Exempt Requirements
As stated above, the minimum salary threshold will effectively double under the new regulation. Effective December 1, 2016, employees will have to earn $955 per week, which translates to $47,476 annually, to be properly classified as exempt. According to the DOL, the new threshold represents the 40th percentile of earnings of full-time salaried workers in the lowest wage Census Region, which is currently the South. While it could have been worse—the DOL’s proposed changes issued last summer initially placed the new minimum above $50,000 per year—the DOL estimates that more than 4 million employees are currently classified as exempt nationwide while earning less than the new threshold.
In addition to doubling the salary threshold on the white collar exemptions, the new law will increase the salary necessary to retain the “highly compensated employee” exemption. The HCE exemption currently applies to employees who earn at least $100,000 annually and “customarily and regularly” perform one or more of the exempt duties performed by employees who qualify for one of the white collar exemptions. Under the new law, these same employees will need to earn at least $134,004 annually, which the DOL declares is the annual equivalent of the 90th percentile of full-time salaried employees nationally.
To account for inflation and cost-of-living increases, the new law also establishes a mechanism for automatically updating the salary and compensation levels described above every three years. According to the DOL, doing so will ensure that the minimum salary thresholds remain at the above percentiles.
While exacting much more demanding salary standards, the new law does offer one piece of good news for employers. Specifically, employers will now be able to use nondiscretionary bonuses and incentive payments such as commissions to satisfy up to 10 percent of the salary rule. Finally, unlike some of the proposed changes issued during the DOL’s lengthy process of arriving at this law, the new rules will not make any changes to the duties test.
What Employers Should Do
As stated above, the new law will impact employers in different ways depending on what state or states they operate in. Many states, such as Florida, Georgia, and Texas, do not have independent state laws relating to overtime and exempt classifications. Employers in these states follow the FLSA’s requirements. That means many employers in these states are classifying employees as exempt while paying them as little as $23,660 per year. These employers will have to decide whether to increase these employees’ salaries (by more than double in some cases) or reclassify them as non-exempt. If they take the latter approach, employers will have to begin monitoring these employees’ hours and pay them overtime when they exceed forty hours per workweek. Employer costs will increase under either approach, sometimes dramatically.
Other approaches carry different drawbacks. For example, employers could ensure that reclassified employees do not exceed forty hours worked in a week, but that would impact overall productivity. Employers could also consider reclassifying employees while also cutting their salary so that any extra overtime pay earned would bring their total compensation in line with what they are currently earning. This approach, however, could damage employee morale and lead many employees to seek other jobs. No matter which route works best for a given employer, difficult decisions will need to be made.
Other states such as New York and California have their own exemption laws that are in large part more employee friendly than the FLSA. For example, in New York, employees must earn at least $656.25 per week (roughly $34,000 per year) to be classified as exempt. Typically, where both state and federal laws govern the employer-employee relationship, the law that offers more protection to employees will apply. Employers in these states therefore currently pay little attention to the FLSA and instead ensure they are complying with state law. That will change under the new law as no state currently has a minimum salary threshold above the federal minimum that will take effect on December 1.
So, while these employers will now have to ensure exempt employees earn the federal minimum salary, they will still have to monitor the respective state laws’ duties test to the extent it is more employee friendly than the FLSA’s test. These employers will also have to monitor possible changes to state laws that will cause the state’s minimum salary threshold to rise back above the federal minimum. Finally, in the handful of states that also mandate meal and rest breaks for non-exempt employees, such as Illinois, Nevada, and New York, employers will have to juggle the different state law standards for exemption classifications applicable to meal and rest breaks, and those federal law exemption standards applicable to overtime pay. This could result in certain employees being classified as exempt for one purpose but not the other.
In the end, the new law is well-intended but is both frustrating, costly, and potentially confusing for employers. Between now and December 1, employers should audit their exempt classifications and consult with legal counsel to determine the best approach for their business and ensure they are in compliance with all applicable federal and state laws.