The US Department of Labor (DOL) has finalized a new rule expanding the number of employees entitled to receive overtime pay for work in excess of 40 hours in a regular workweek, by doubling the salary needed for executive, administrative, and professional workers to qualify as exempt and by raising the compensation needed to qualify as a highly compensated employee.

The rule will take effect December 1, 2016 and is expected to affect at least 4.2 million full-time exempt employees.

It supposedly represents the DOL’s effort to better distinguish overtime-eligible white collar employees, whom Congress intended to protect under the Fair Labor Standards Act, from bona fide executive employees, whom it intended to exempt. The salary level required to qualify for the FLSA “white collar” exemption had now moved from $23,600 to $47,476 annually, or $913 weekly.

For highly compensated employees, the new rule raises the minimum salary from $100,000 to $134,004 annually. These numbers will be automatically updated every three years, beginning in 2020.

Background

The FLSA generally requires covered employers to pay their employees overtime pay of one and one-half times the employee’s regular rate of pay for all hours worked over 40 hours in a workweek.

But the FLSA provides a number of exemptions from this overtime requirement, including what is known as the “white collar” exemption for executive, administrative, and professional workers.

Since first issuing regulations defining the scope of these exemptions in 1938, the DOL has updated the salary level requirements seven times. For quite some time, these updates included both a “long duties test,” which limited the amount of time an exempt employee could spend on nonexempt work, and a “short duties test,” which did not contain a limit on nonexempt work but required a higher salary level than the long duties test.

The last update occurred in 2004, and it eliminated the short and long duties tests in favor of a standard duties test requiring a $23,660 annual salary for a full-time worker. It also set the highly compensated employee exemption at a minimum annual salary of $100,000.

On March 13, 2014, President Obama issued a presidential memorandum to the DOL directing it to update the regulations defining which white collar workers are protected under the FLSA.  The memorandum specifically instructed the DOL to modernize and streamline the overtime regulations. Following the President’s memorandum, the DOL published a proposal to update the overtime exemptions on July 6, 2015.

Final Rule

The DOL’s stated goal for the new rule was to rectify “the inappropriate classification of employees as EAP exempt who pass the standard duties test but would have failed the long duties test.”

In other words, the DOL believes that the 2004 update created many exempt employees whose work was indistinguishable from other nonexempt workers who were overtime-eligible.

The DOL stated that the “most appropriate line of demarcation” between workers who are EAP exempt and workers who should receive overtime is the salary level equal to 40th percentile of earnings of full-time salaried workers in the lowest-wage census region (currently the South), which resulted in a salary level of $913 per week, or $47,476 annually.

For highly compensated employees, the DOL set the salary level at the 90th percentile of earnings of full-time salaried workers nationwide, or $134,004.

In order to prevent the salary levels from becoming outdated, the DOL has included a mechanism to automatically update the threshold every three years, with the first update on January 1, 2020.

For the first time, the DOL will allow employers to count nondiscretionary bonuses, incentives, and commissions toward up to 10 percent of the required salary level for the standard exemption. These amounts must be paid on a quarterly or more frequent basis.  This portion of the rule does not apply to highly compensated employees.

Implications

The DOL estimates that this rule will cost employers $592.7 million in the first year and $194.2 million per year for the next decade. The DOL envisions higher employee earnings, with a $1,482.5 million increase in the next year and $872.9 million annually for the next decade.

We expect the rule will have other consequences that are less easily measured.  For example, the National Retail Federation predicts a “’hollowing out’ of low-level professional and administrative functions, as firms centralize their management structures to rely on a smaller number of genuine managers and professionals.”  The National Retail Federation also predicts a shift away from full-time workers to part-time, entry-level workers, creating more inequality in the workforce. The Society for Human Resource Management warns that the rule could lower employee morale if employees feel they lose professional status by becoming nonexempt.

To prepare for the effective date of the rule, employers should review and reassess the classifications of full-time employees with annual salaries under $47,476.

For each employee who is currently classified as exempt under the executive, administrative, or professional exemption, an employer must consider whether to raise the employee’s salary to at least $47,476 and maintain the exempt status, reclassify the employee as nonexempt and pay overtime as needed, or investigate other options, such as restructuring positions and job duties or considering a program to limit employees’ overtime work.

Employers will also need to reevaluate their policies and practices related to overtime and recordkeeping.

FLSA claims and lawsuits have been on the rise, and this rule is unlikely to change that trend. Employers should begin their preparations now to be ready for the rule’s December 1, 2016 effective date.

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