The final rule updates the earnings thresholds necessary to exempt, executive, administrative and professional employees from the FLSA’s minimum wage and overtime pay requirements. Overall, the final rule will provide not only a challenge for organizations, but also an opportunity for a broader, proactive process to ensure compliance as of the January 1, 2020 effective date.
In general, the final rule:
- Raises the annual salary threshold below which workers qualify for overtime wages to $35,568 from the current level of roughly $23,600. In terms of weekly salary, this represents an increase from $455 per week to $684 per week.
- Raises the total annual compensation requirement for “highly compensated employees” from the currently enforced level of $100,000 per year to $107,432 per year.
- Allows employers to use nondiscretionary bonuses and incentive payments (including commissions) paid at least annually to satisfy up to 10% of the standard salary level, which according to the DOL is in recognition of evolving pay practices.
- Revises the special salary levels for workers in U.S. territories and the motion picture industry.
The final rule takes effect on January 1, 2020 and requires employers to pay time-and-a-half rates to workers making less than the threshold amount for all hours beyond 40 per week.
A previous version of the overtime rule, which was introduced by the Obama Administration and had a much higher threshold ($47,500 with automatic updates every three years), was scheduled to go into effect on December 1, 2016, until an injunction stopping the rule was issued on November 22, 2016. The new rule does not include automatic updates to the $35,568 threshold.
Increase of the standard salary level
Enacted in 1938, the FLSA requires employers to pay a minimum wage and overtime pay at a rate of one and one-half of the employee’s regular rate of pay for hours worked above 40 per week. Various regulations implementing this requirement were issued beginning in late 1938. The DOL established two methods for assessing whether an employee qualified for the white collar exemption – a “long” test and a “short” test. The long test combined a low minimum salary level with a rigorous duties test which limited the amount of nonexempt work an employee could do to remain exempt. The short test combined a higher minimum salary level with an easier duties test that did not restrict the amount of nonexempt work.
In 2004, the DOL eliminated the long and short test and replaced them with a “standard” duties test that did not restrict the amount of nonexempt work an exempt employee could perform. The 2004 regulations also set a minimum salary level of $455 per week and required an employee to meet three criteria in order to be exempt as an employee employed in a “bona fide executive, administrative, or professional capacity” – often called the “white collar” or “EAP” exemption. Those three criteria are:
- The employee must be paid on a salary basis,
- The employee must receive at least a minimum specified salary level, and
- The employee’s job must primarily involve executive, administrative, or professional duties as defined by the regulations (the duties test).
The new rule does not alter the standard duties test used to determine if an employee is exempt. The new rule simply increases the standard salary level to $684 per week ($35,568 for a full-year worker).
Highly compensated employees
FLSA contained a special rule for highly compensated employees who were paid total annual compensation of $100,000 or more (which must include at least $455 per week paid on a salary or fee basis). These employees are exempt from the FLSA if they customarily and regularly perform at least one of the duties of an exempt executive, administrative or professional employee. The final rule raised the salary cutoff for highly compensated employees to $107,432 or more. To be exempt as a highly compensated employee, an individual must also receive at least the new standard salary amount of $684 per week on a salary or fee basis (without regard to the payment of nondiscretionary bonuses and incentive payments).
Workers who earn at least this much may qualify for exempt status if they meet a reduced duties test as follows:
- The employee's primary duty must be office or non-manual work.
- The employee must "customarily and regularly" perform at least one of the bona fide exempt duties of an executive, administrative or professional employee.
For a detailed analysis of the application of the exempt duties of an executive, administrative or professional employee, please refer to DOL Fact Sheet #17A by clicking here.
Treatment of nondiscretionary bonuses and incentive payments
In the final rule, in recognition of evolving pay practices, the DOL permits employers to use nondiscretionary bonuses and incentive payments to satisfy up to 10 percent of the standard salary level. For employers to credit nondiscretionary bonuses and incentive payments toward a portion of the standard salary level test, they must make such payments on an annual or more frequent basis.
If an employee does not earn enough in nondiscretionary bonus or incentive payments in a given year (52-week period) to retain his or her exempt status, the DOL permits the employer to make a “catch-up” payment within one pay period of the end of the 52-week period. This payment may be up to 10 percent of the total standard salary level for the preceding 52-week period. Any such catch-up payment will count only toward the prior year’s salary amount and not toward the salary amount in the year in which it is paid.
U.S. Territories and the motion picture industry
The final rule maintains a special salary level of $380 per week for American Samoa because minimum wage rates there have remained lower than the federal minimum wage. Additionally, the DOL set a special salary level of $455 per week for employees in Puerto Rico, the U.S. Virgin Islands, Guam, and the Commonwealth of the Northern Mariana Islands.
The final rule also maintained a special “base rate” threshold for employees in the motion picture industry. Consistent with prior rulemakings, the DOL increased the required base rate proportionally to the increase in the standard salary level test, resulting in a new base rate of $1,043 per week (or a proportionate amount based on the number of days worked).
Strategies for Compliance, Other Considerations, and Impact Modeling
There are obvious strategies for ensuring compliance with the changing regulations. An organization can identify affected employees and either increase their pay to meet the new $35,568 threshold in annual salary, or decide to pay any overtime that would be incurred. The former option assumes that the employee meets the duties tests for one of the exemption categories.
Strategies for Compliance
Below are a list of potential strategies to consider for compliance with the final rule. This is not meant to be exhaustive, and a number of these strategies may be employed at the same time.
|Increase the base salary for employees who truly perform exempt duties and are currently paid below the standard salary level.||The financial impact of this option could vary greatly, and this could cause internal equity concerns as employee pay moves closer to their supervisor’s pay.|
|Reclassify identified employees as nonexempt and pay overtime as necessary.||Similar to the strategy above, the financial impact of this option can vary quite a bit. However, this option requires assumptions regarding overtime worked, therefore making the financial modeling less accurate. It’s also likely that many jobs will include both nonexempt and exempt employees in this option. This may cause fairness concerns. Finally, employees may feel a loss of status as they move from exempt to nonexempt.|
|Reclassify employees as nonexempt and reduce hourly rate to maintain total annual compensation.||Theoretically, this option is cost neutral, but damage to employee engagement is a concern. In addition to the loss of status mentioned above, employees could also realize lower total compensation if they do not work the overtime necessary to match their previous salary.|
|Review all reward programs and determine if any financial increases can be offset by decreases elsewhere in the reward programs.||At a high level, it’s possible that an organization can reduce expenses in other reward categories to help offset increases in salary and/or overtime. At a more granular level, there may be special pay programs (e.g., shift differential pay) that are overused by the organization and could be reduced with minimum employee engagement impact.|
|Review the structure of the workforce and work processes.||This is a broad strategy that could include a number of paths such as innovating/automating work or demanding increased productivity to reduce hours. An organization can also review scheduling practices and even consider hiring additional employees to help reduce necessary overtime. If done well, these types of strategies can result in improved employee engagement and more efficient work processes.|
The best approach for an organization is likely to be a tailored combination of the strategies above and depends on the goals and approach of the unique organization.
A number of reward or other organizational programs may impact employees moving from exempt to nonexempt status. They may now be eligible for shift differentials and other premium pay items. Their paid time accruals, benefit eligibility or bonus targets may change as well. Employers should review both the eligibility and compensation definitions in their benefit plans to fully understand how those programs are impacted by any changes to an employee’s exempt status.
As with any change management effort, effective and timely communication will be vital. Managers and employees alike must be informed about the changes, the reasoning behind them and how they’ll be impacted individually. This communications effort should begin as soon as possible. It’s also important to remember that even if exempt employees who are reclassified as nonexempt will earn more with overtime, they may feel a loss of status when they move to nonexempt and must now track time.
Management and employee training will be necessary as a number of employees may be moving from exempt to nonexempt, and managers may be managing nonexempt employees for the first time. Employees and managers both will need to learn timekeeping and what constitutes hours worked under FLSA. The implications for telecommuting and answering emails or calls at night are significant. Managers may also need to deal with unauthorized overtime worked by employees.
From a compensation administration perspective, it is recommended that organizations consider the minimum of their grade ranges for alignment with the threshold level. Even if each individual employee in a given range is paid above the threshold, having a range minimum below puts the organization at risk for non-compliance should someone be brought in at the minimum level.
In order to make informed decisions in response to the final FLSA rule, a comprehensive modeling file must be created and utilized. If this file is built to take advantage of variables and includes inputs beyond employee job title and salary, it can be a powerful tool as the organization compares various courses of action.
Pulling It All Together
Employers may want to consider the following steps as part of their strategic and methodical approach:
|Step||Description & Comments|
|Plan an overall project approach.||Identify the project steps and begin by considering the organization’s strategy, culture, and objectives for this project.|
|Develop an inventory of jobs and employees impacted.||Starting with an employee census, begin a modeling file of all employees, and identify the employees and roles that will be directly impacted by the final rule.|
|Discuss options for treatment of these employees.||Discuss the options and potential implications for various approaches to compliance. Build out the modeling file to allow for real-time financial impact based on the selected scenarios.|
|Determine impact on any other pay or benefit programs.||Consider all reward and organizational programs that may be impacted by FLSA exemption. These may include paid time off, variable pay programs and developmental opportunities.|
|Estimate the financial implications.||Incorporate any of the other impacted reward programs.|
|Decide on a final approach.||Based on discussion around the results of the previous steps, determine a course of action.|
|Build the internal systems.||Determine, with payroll and/or information systems what changes have to be made in job codes, time off accruals, benefit tracking, or any other HR system that links to exemption status.|
|Communicate to and train managers and affected employees.||Communicate the changes taking place in January, and begin training managers and employees on timekeeping and policy/scheduling considerations.|
|Continue to assess the situation.||The situation will need to be monitored as new employees are hired and current employees receive pay raises or transfer jobs.|