For the first time in over a decade, the Department of Labor (Department) proposed updates yesterday to the federal Fair Labor Standards Act (FLSA) white collar overtime regulations. These changes will impact businesses throughout the United States. The Department estimates that, in the first year, 4.6 million workers will be entitled to overtime protection because of these changes—specifically, the increase in the salary level threshold.

Background

The FLSA establishes, among other things, minimum wage and overtime laws for workers in the United States. Non-exempt workers are entitled to minimum wage and overtime; whereas, exempt workers are paid a salary and not entitled to overtime protections. As explained in the proposed regulations, “[t]he exemption was premised on the belief that exempted workers earned salaries well above the minimum wage and enjoyed other privileges, including above-average fringe benefits, greater job security, and better opportunities for advancement, setting them apart from workers entitled to overtime pay.” There are various ways that a worker may qualify as exempt from overtime requirements and the proposed regulations, very simply, reduce the number of workers who can qualify as exempt.

An employee must meet certain tests to qualify for the white collar exemption. In particular, an employee must generally:

• be paid a predetermined and fixed salary that is not subject to reduction because of variations in the quality or quantity of work performed (salary basis test), and the amount must be more than a certain minimum amount identified by the Department (salary level test); and
• primarily perform bona fide executive, administrative or professional duties, as identified by the Department regulations (duties test).

If the Proposed Rules Are Adopted, What Will Change?

The Salary Level for Exempt Employees Will Be Changed.

Currently, the minimum salary level required for an exemption for an executive, administrative or professional employee is $455 per week ($23,660 annually). This means that, if an employee makes at least $455 per week, the determination of whether an employee is exempt depends on whether the employee otherwise meets the salary basis test and the duties test.

The new regulations propose to increase the minimum amount of pay and set the standard salary level to the 40th percentile of weekly earnings for full-time salaried workers. Using 2013 data provided by the Bureau of Labor Statistics, that amount would be increased to $921 per week ($47,892 annually). The Department estimates that the 2016 level will be approximately $970 per week ($50,040 annually).

To ensure the salary level does not, again, become outdated—since the last time the salary level requirement was updated was in 2004—the Department is proposing that the salary and compensation levels be automatically updated annually. The salary level will remain a threshold question when determining the applicability of an exemption and, even if a worker meets the salary basis test and the duties test, the employee will not be considered exempt if he/she does not have a salary above the new minimum salary level. More specifically, a worker who is exempt today and makes $24,000 annually will not be exempt when these regulations are finalized (assuming they are finalized as-is) unless his/her salary is at or over the 40th percentile (e.g., projected to be $50,040 in 2016) for full-time salaried workers.

The current standard of $455 per week, or $23,660 annually, falls below the poverty line for a family of four. The Department stated in its Frequently Asked Questions that the 40th percentile salary level “minimizes the risk that employees legally entitled to overtime will be subject to misclassification based solely on the salaries they receive, without excluding from exemption an unacceptably high number of employees who meet the duties test.”

The Department is seeking guidance as to whether nondiscretionary bonuses or incentive payments (e.g., tied to productivity or profitability) should be included in the calculation of the salary level. In particular, the Department is considering whether it should permit the nondiscretionary bonuses or incentive payments to account for 10 percent of the standard weekly salary level or, whether it should consider a lower amount, a higher amount, or not permit it to apply at all. “[T]he Department envisions that in order for employers to be permitted to credit such compensation towards the weekly salary requirement employees would need to receive bonus payments monthly or more frequently. For similar reasons, the Department is not considering employers to make a yearly catch-up payment.”

The Salary Level for Highly Compensated Employees Will Be Changed.

In addition to the change to the salary level for exempt employees, there is another proposed change relating to the level of compensation necessary to qualify as a highly compensated employee. The highly compensated employee exemption currently applies only to employees who have a guaranteed total annual compensation of at least $100,000 and who “customarily and regularly” perform one or more of the exempt duties of an administrative, executive or professional employee, and are not engaged in manual work.

The assumption is that the high salary is a strong indicator that an employee is properly classified as exempt; therefore, the other tests are relaxed when determining whether an employee is properly classified. Just as the Department proposes increasing the salary level for all employees to qualify for an exemption, the Department also has proposed increasing the salary level for highly compensated employees to qualify for an exemption. The Department proposes that the level be set at the 90th percentile ($122,148 total annual compensation) for the highly compensated employee. Under the proposed regulations, the total annual compensation may continue to take into account commission payments, nondiscretionary bonuses, and other nondiscretionary compensation. However, it does not include board, lodging, or other payments for medical insurance, payments for life insurance, contributions to retirement plans and the cost of other fringe benefits.

There Are No Proposed Changes to the Duties Test.

There are no proposed changes to the duties test, which is one of the tests that must be met for a worker to be classified as exempt. Rather, the Department is seeking comments on whether the tests, which were last updated in 2004, are working properly. The expectation is that setting the salary level threshold at the 40th percentile will eliminate the need for “a more robust duties test to ensure proper application of the exemption.”

How Will This Impact My Business?

Right now these are just proposed regulations. Nothing is changing today, but big changes are on the horizon. The Department explained that, in 2013, there were 144.2 million workers in the U.S., of whom the Department estimated 43 million are white collar salaried employees. Of those, 21.4 million may potentially be affected by the proposed rule; whereas, a subset of workers who meet different exemption tests (e.g., physicians, teachers, judges, outside sales workers, etc.) may not be impacted by the change. In the first year of implementing the regulations, the Department estimates that 4.6 million exempt workers will be directly affected as they fall between the current $455 weekly salary level but less than the 40th percentile ($921) proposed by the Department and, accordingly, will need to be reclassified as non-exempt. With automatic updating of the salary levels, this amount is expected to increase to 5.1 to 5.6 million workers within 10 years. In addition, an estimated 36,000 workers will be impacted by the change to the highly compensated employees salary level—originally set at $100,000 and, now, set to increase to the 90th percentile ($122,148).

Companies will need to audit their workforce to determine if employees will need to be reclassified when the final rules go into effect. Legal counsel should be involved to appropriately preserve privileges and to properly evaluate the classifications. While the proposed regulations focus primarily on updating the salary level, there must still be an analysis of the duties required to be performed to qualify for the various exemptions. The Department reaffirmed that “we have always recognized that the salary level test works in tandem with the duties test.” Accordingly, it is important to remember that job titles and descriptions alone do not determine exempt status but, rather, analyze exactly what employees actually do on a day-to-day basis to properly establish an exemption.

Keep in mind that the proposed rules are not final and may still be modified when the final regulations are issued. For those workers who are ultimately re-classified to non-exempt, companies will need to develop methods to track their hours so that overtime and minimum wages can be paid. Certain states may also have their own regulations that may be impacted, if the new FLSA regulations are adopted.

What’s Next?

If you want more information, here is a Fact Sheet published by the Department regarding the proposed changes to the regulations.

We are currently in the notice-and-comment period of the proposed rule. Comments can be submitted to the Department electronically through the Federal eRulemaking Portal for 60 days following the publication of the proposed rulemaking issued today. The Department identified in the proposed regulations specific areas it is seeking comments, but an individual or organization may choose to comment on any areas. The Department will ultimately base its decisions on these comments, as well as its own analysis and other data gathered.

When the final rule is published in the Federal Register, the effective date of the new regulations will be identified. Snell & Wilmer will continue to update you as there are further developments.