Digging Into the New Overtime Regulations

In 2015, the Department of Labor ("DOL") proposed substantial changes to the minimum salary level requirements, sought input on whether bonuses and incentives should be included in meeting the salary level test and considered changing the duties test to establish overtime eligibility.  Taken together, these proposed changes would have had a drastic effect on the obligation of employers to pay overtime.  On May 18, 2016, DOL issued its Final Rules and employers have until December 1, 2016 to comply.  Overall, the changes strike a middle ground as DOL declined to adopt the more restrictive California 50% duties test.  However, doubling the salary level threshold and other changes present significant economic and compliance challenges for employers.  Below is a summary of key takeaways and steps employers should consider to address these changes and ensure compliance.

Duties Test Remains the Same:  It was widely believed that DOL was leaning towards changing the test that an employer would need to satisfy to demonstrate that an employee qualified for the executive, administrative or professional exemption from overtime.  Based upon language in the proposed regulations,  DOL strongly signaled that it would change the duties test and look to adopt the more restrictive test in California where employees would have to spend at least 50 percent of their time performing exempt duties to qualify for the exemption.  However, in the final regulations, the DOL adhered to the existing test and the critical question remains whether an employee's primary duty satisfies the administrative, professional or executive definitions.

Exempt employees must earn a salary level of at least $47,476 ($913/week):  With the new regulations, the requirement that exempt employees must be paid a salary remains the same, but the minimum salary threshold will almost double to $47,476 per year.  This final number is less than the $50,444 in the proposal but still marks a substantial increase in salary requirements for exempt employees.  The DOL's final regulations also rejected requests to exclude educational and other non-profit employers from the salary increase.  To ensure compliance, employers will need to look at all of their employees currently classified as exempt who are earning less than $47,476 and assess (i) whether they remain comfortable that the duties performed satisfy the exemption requirements; and (ii) if the duties test is satisfied, whether they want to increase the salary level or whether it would be more cost effective to pay overtime to the employees.  As more employees enter the overtime eligible category, employers will have to pay special attention to employees who telework or who have flexible schedules.  While the FLSA does not mandate that these workers "punch the clock," more employees will need to track their time in a way that employers can ensure that they are not working more than 40 hours a week.  This makes training employees and managers paramount as the potential liability increases.

Salary level indexed every three years:  DOL's proposal included a provision that the salary level would be automatically indexed on an annual basis.  The final regulation calls for updating the salary level every three years.  While this represents some reprieve for employers, it leads to compliance challenges.  The new regulations ensure that employers will be re-evaluating their exempt employee population every three years when the salary level will be adjusted.  With each salary change, employers will again need to examine whether it remains confident that the duties test is satisfied, and, if so, whether the employer wants to again increase the salary level or forego exemption.  This reexamination of classifications every three years is likely to result in even more non-exempt employees over time.  Nonetheless, the salary indexing remains subject to a legal challenge as it is unclear whether the Fair Labor Standards Act gives DOL the authority to index.  

Inclusion of nondiscretionary bonuses and incentives:  For the first time, the DOL will allow employers to satisfy the salary level test with non-discretionary bonuses, commissions or other incentives as long as they are paid quarterly and do not exceed 10% of the $47,476 salary level.  The regulations also give employers the opportunity to provide a "make up" payment if due to poor sales in the quarter, for example, the anticipated commissions render the employee's quarterly salary below the new salary threshold.  This presents perhaps the most complex compliance concern.  Paying and accounting for bonuses and incentives on a quarterly basis represents a new way of operating for many employers who are used to performing this function on an annual bases.  Managers will need to be mindful of whether production bonuses or other incentives are sufficient for employees to reach the salary threshold but also not large enough to surpass the 10% limit.  This is another area for training of managers and compensation professionals.

Highly Compensated Employees: The separate exemption for "highly compensated employees" where the employee need only perform one of the exempt duties or responsibilities to satisfy the exemption, will now apply to employees whose annual salary is more than $134,004.  This is $34,000 more than the current level and $12,000 more than proposed.  This is one of the bigger surprises in the rulemaking.  While DOL claims that the large increase from the proposal is consistent with its attempt to keep this threshold at a level equal to the 90^thpercentile of earnings nationally, this is a significant increase and fewer employees will qualify for the reduced duties test.

The bottom line is that the Final Rules will have a major financial and operational impact on for-profit, non-profit and governmental employers.  The increase in the salary threshold, plus the increase in the salary level for the highly compensated exemption, means that millions of workers will now be eligible for overtime who were not previously eligible. Employers will need to make tough decisions about whether to reclassify workers, increase compensation levels and/or re-structure positions to comply with the new rules.  Employers who continue to treat employees as exempt under one of the white collar exemptions will also need to audit their workplaces to ensure that exempt employees meet the new salary level test, be prepared for the amounts to index, and train human resources and managers on how to calculate and track bonus and incentive payments.  Employers with non-exempt employees, especially those who telework or work flexible schedules, will need to closely monitor hours and reporting to make sure these workers do not inadvertently trigger overtime liability.