The U.S. Department of Labor (DOL) has just proposed new overtime rules to replace those that were presented during the Obama administration, but frozen by the courts after the 2016 election. Since this new story broke, much has been written about it in the media. But most reports have buried the lead.

Overtime Generally

Overtime pay - at 1.5 times an employee's "regular rate" - must be paid to employees who work more than 40 hours in a workweek. However, an employer does not have to pay overtime to "exempt" employees. While there are a number of recognized exemptions, the most common apply to professionals, executives and administrative employees and are referred to as the "white collar" exemptions. To be properly considered as "exempt," such employees must meet several "duties" requirements (known as the "duties test") and must also receive a minimum salary.

Under the new rules, an employee would now have to be paid a salary of at least $35,308 per year ($679 per week) as an initial step in determining whether they are "exempt" under one of the white collar exemptions. The second step would be to determine if they meet the "duties test." This new minimum salary is up from the current $23,660 per year ($455 per week), but far less than the $47,476 ($913 per week) that had been proposed in 2016.

Total Compensation for the Highly Compensated Employee (HCE) Exemption

To us, the more newsworthy story is the proposal to increase the "highly compensated employee" (HCE) exemption from $100,000 to a whopping $147,414.

The $100,000 annual compensation level currently required to meet the HCE exemption has been in place since its inception in 2004. In short, an employee who is paid $100,000 or more per year and works in an office or performs non-manual work is exempt from overtime provided they meet just one factor in the "duties test." Such highly compensated employees are more easily classified as exempt because a six-figure earner is more likely to have sufficient job responsibilities to satisfy at least one factor in the "duties test." Read the DOL's basic guidance on the HCE.

In 2016, the DOL attempted to increase the HCE compensation level to $134,004, which was deemed to be the 90th percentile earnings of full-time salaried employees nationwide. Now, the DOL ends up at $147,414.

Even though the DOL estimates this leap would affect only 201,100 employees nationally, the potential economic exposure is monumental, as earners of between $100,000 and $147,414 would now be entitled to overtime.

This is especially so in major cities where $100,000 is not a terribly uncommon salary. Said another way, in New York (and nationwide), even if they meet one factor in the "duties test," an employee paid less than $147,414 annually would no longer come within the HCE, and must be paid overtime. Overtime is paid based on one and one-half times the "regular rate," which must take into account all earnings. The higher the total compensation, the higher the overtime rate. For instance, $147,413 per year ($1 less than the new proposed amount) translates to $70.87 per hour based on a 2,080 hour work year (52 weeks X 40 hours). Overtime to this employee would have to be paid at $106.31 per hour ($70.87 X 1.5). Employers are going to have to closely examine the compensation rates and duties of their currently exempt highly compensated employees to assess how this change, if it takes effect, will impact their businesses financially.

Standard Salary Level for White Collar Exemptions

As stated above, employees must pass the full "duties test" and receive a minimum salary to qualify for a white collar exemption. It is the salary component being impacted by the new rules, as the floor would be raised from $455 to $679 per week.

This change is less meaningful to New York employers. This is because New York State employers must currently pay exempt executive and administrative employees a salary that is already higher than the proposed $35,308 per year outlined above. Depending on the location and employer size, New York State's minimum salary levels range from at least $43,264 per year ($832 per week) in most of the state, to at least $58,500 per year ($1,125 per week) for NYC employers of 11 or more employees. In other words, if a New York City employee is earning a salary of at least $58,500 per year, the federal increase is a non-event because their weekly salary exceeds the proposed new federal amount.

That being said, New York does not have a standard salary level for the professional exemption, arguably the least common of the major exemptions. New York employers with exempt professionals will need to comply with the increased standard salary level should it be enacted, or else must pay these employees overtime. Pragmatically, this is not likely much of an issue as professionals (such as doctors, lawyers, CPAs and engineers) likely earn above $679 per week.

The Good News

It must be recognized that the scenario presented above for an HCE employee would occur only if the employee could not properly be classified as exempt under one of the other recognized exemptions. Thus, an individual who meets the full "duties test" and is paid more than the now-proposed $679 per week would still be exempt under federal law.

The Bad News

The law of unintended consequences comes in to play here. First, take a properly classified exempt employee (meaning they meet the "duties test") in New York who is paid a salary of $1,125 per week. Overtime is not required to be paid under either the federal or New York State overtime law.

Next, take an employee who earns $99,999 per year but meets only one criterion of the "duties test." Under the current federal law, that employee is entitled to overtime. But at $100,000, just $1 more, they are exempt from overtime. In years past, this has caused many attorneys to recommend that clients increase the compensation of employees earning near $100,000 up to that level in order to avail themselves of the HCE exemption. It is a harder sell to counsel the same client to increase the compensation by over 47% to meet what would be the new federal HCE exemption level.

The consequence? Since there will no longer be any reason to target $100,000, employers unwilling to hit the new threshold may be inclined to keep compensation levels at or below $100,000, or to increase them modestly, because overtime would be too costly. Alternatively, such "newly non-exempt" employees may see their hours cut so that employers need not pay them overtime. The reduction in hours might also lead to wage stagnation. An HCE who works 50 hours per week now for $100,000 would not be entitled to overtime. To avoid paying overtime, the employee's hours might be reduced to 40. While salary cuts might not occur, there is little incentive for an employer to pay a higher salary when fewer hours are being worked.

Conclusion

The HCE exemption has been in place for 15 years. In that time, many employers have modeled their compensation structure around the $100,000 "magic number." Even if increasing the amount is a good idea, such a dramatic increase may create problems that had not been foreseen. The new rules are still subject to change as we head into the comment period and finalization process. Hopefully, either the $100,000 will remain in place, or a more modest increase will be implemented taking these concerns into account.