After much anticipation, the Department of Labor (DOL) has issued its new regulations governing payment of overtime to salaried employees, and the new regulations may affect your company.
Employees whose salaries are less than $47,476 per year will be entitled to overtime compensation as of Dec. 1 when the new regulations take effect. In addition, the salary threshold to determine overtime eligibility will be automatically updated every three years.
Background
The Fair Labor Standards Act (FLSA) requires employees to be paid overtime compensation at a rate of not less than 1 1/2 times the employee's regular rate of pay for hours worked over 40 in a workweek without regard to the employee's total compensation. However, salaried employees who qualify for FLSA's "white-collar" exemption for bona fide executive, administrative and professional employees are not entitled to overtime if three tests are met. Employees paid on an hourly basis are entitled to overtime regardless of their compensation.
To qualify for the white-collar, or EAP, exemption, FLSA regulations state the following three conditions must be met:
DOL's final rule announced May 18 significantly increases the salary level test by setting the salary at the 40th percentile of weekly earnings of full-time salaried workers in the lowest-wage census region of the U.S., which currently is the South.
The effect of the new regulations is to increase the salary needed to qualify for the EAP exemption from the current $455 per week, equivalent to an annual salary of $23,660, to $913 per week, equivalent to an annual salary of $47,476 per year. The salary amount to qualify for the EAP exemption has increased seven times since enactment of the FLSA in 1938. The $455 per week salary level had been in effect since August 2004.
The overtime regulations are intended to further two policy objectives, according to DOL: increase employment by incentivizing employers to hire more employees rather than requiring existing employees to work longer hours and reduce overwork and its detrimental effects on the health and well-being of workers.
DOL's new overtime regulations signify the final step of an initiative announced by President Obama in March 2014 to update DOL regulations and strengthen the middle class. In July 2015, DOL proposed regulations that would have increased the salary to qualify for the EAP exemption to $970 per week, equivalent to an annual salary of $50,440. These numbers are equal, on a national basis, to the 40th percentile of earnings of full-time salaried employees, which DOL considered an appropriate point to demarcate between nonexempt and exempt employees.
DOL received more than 270,000 comments during the 60-day public comment period following publication of the proposed new overtime regulations in July 2015. One frequent criticism of the proposed DOL rule was using a national wage average failed to account for regional differences in pay rates and resulted in too great of an increase in some areas. In response to these comments, the final regulation pegged the standard salary level test at the 40th percentile of earnings of full-time salaried workers in the lowest-wage census region rather than using a national average.
Unless specifically excluded, FLSA applies to all companies with an annual dollar volume of sales or receipts of $500,000 or more. All employees of an FLSA-covered enterprise are entitled to FLSA protection unless an employee meets the criteria for an exemption. Teachers, academic administrative personnel, physicians, lawyers, judges and outside sales workers are not subject to the EAP salary level test.
In addition to requiring employers to pay the federal minimum wage and overtime for work completed in excess of 40 hours in a workweek, FLSA requires covered employers to make, keep and preserve records of employee wages, hours and other conditions of employment.
In setting a new salary level threshold for the EAP exemption, DOL stated: "[t]he Department's primary objective in this rulemaking is to ensure that the revised salary levels will continue to provide a useful and effective test for exemption."
Stating an outdated salary level test reduces the effectiveness of the salary level test, DOL considered the current annual salary level test of $23,660 to be out-of-date and problematic because the low threshold meant low-paid workers who were never intended to be within the EAP exemption were denied minimum wage and overtime protection. Some states, notably California and New York, already have adopted a higher EAP salary level test than the current federal $455 per week threshold just as several states and communities have adopted a minimum hourly wage higher than the federal $7.25 rate. In California, the current salary level test to qualify for the EAP exemption is $800 per week, and in New York the EAP salary exemption is $600 per week.
For the first time, DOL regulations allow certain bonuses paid to employees to count toward meeting the required salary to qualify for the exemption. Employers may use nondiscretionary bonuses and incentive payments, including commissions, to satisfy up to 10 percent of the required salary amount. A nondiscretionary incentive bonus tied to productivity and profitability can be included when determining whether the salary test has been met. Bonus payments must be made on a quarterly or more frequent basis to qualify.
DOL has long considered the salary level test to be the best test to determine eligibility for the EAP exemption. Unlike the duties test, the salary level test makes it immediately clear to employers and employees whether an employee passes the salary threshold. DOL has estimated 12.8 percent of employees, whom DOL believes should be entitled to minimum wage and overtime protection, have been misclassified as exempt based on the duties test. Increasing the salary level test is intended to decrease worker misclassification, according to DOL, because passage of the duties test no longer will exempt workers making less than $913 per week.
DOL did not revise its regulations governing the duties tests applicable to EAP employees that has been in effect since 2004. To qualify as an exempt executive employee, an employee must have the primary duty of managing the enterprise or managing a customarily recognized department or subdivision of the enterprise. In addition, the employee must customarily and regularly direct the work of at least two or more other full-time employees or their equivalent and have the authority to hire or fire other employees or the employee's suggestions and recommendations as to hiring, firing, advancement, promotion or other change in status of employees must be given particular weight.
To satisfy the standard duties applicable to administrative employees, an employee's primary duty must be performance of office or nonmanual work directly related to the management or general business operations of the employer or the employer's customers and the administrative employee's primary duty must include the exercise of discretion and independent judgment with respect to matters of significance.
Periodic updating
An important component of the new regulations is the provision for automatic updating of the salary level test in lieu of DOL undertaking a new rulemaking procedure each time DOL believes an adjustment is appropriate.
DOL wanted to include a mechanism in the new regulation to automatically increase the salary level threshold to keep pace with inflation and increases in earnings. DOL initially had proposed the salary level be adjusted annually to equal the 40th percentile of weekly earnings of full-time salaried workers nationally. The final rule calls for updating the salary level test every three years to keep it at the 40th percentile of weekly wages of full-time nonhourly employees in wherever the lowest-wage census region is at that time.
Per the new regulation, the salary threshold to qualify for the EAP exemption will be updated beginning Jan. 1, 2020, and every three years thereafter based on data from the Current Population Survey as published by the Bureau of Labor Statistics.
Who is affected?
FLSA covers 132.8 million workers in the U.S and, by DOL's calculations, 22.5 million workers potentially are affected by the new regulations.
DOL has estimated 4,163,000 workers whose current salaries are greater than $455 per week but less than $913 per week will receive overtime compensation resulting from the increase in the salary level test during the first year of its application (assuming their weekly earnings do not increase to meet the new salary threshold). These currently are exempt workers based on the current salary test. Of these, 55.6 percent are females, 44.3 percent are males, and 31.3 percent of the affected workers are between the ages of 25 and 34.
Far more workers in the South (1.7 million) will be affected compared with 900,000 affected workers in the Midwest and 800,000 in the Northeast and West. The states with the most affected workers, in descending order, are California, Texas, Florida, New York, Illinois, Pennsylvania, Georgia, North Carolina, Ohio and New Jersey.
Additionally, DOL estimates there are 732,000 white-collar, salaried workers making between $455 and $913 per week who do not meet the duties test and, therefore, already are overtime-eligible but do not receive overtime pay because they have been misclassified as overtime exempt based on the duties test. With the adoption of the new rules, these workers' eligibility for overtime pay will be clear based on the salary level test; for them, misclassification under the duties test becomes irrelevant because they no longer will meet the salary level test and, therefore, will be entitled to overtime compensation as a result of the increase in the salary level test.
DOL also asserts another 8.9 million salaried workers who earn between $455 and $913 per week will have overtime protection strengthened. Although these workers may not work more than 40 hours per week, DOL states these workers were previously vulnerable to misclassification through misapplication of the duties test but now will be automatically protected based on the salary level test if they work more than 40 hours.
In 10 years, with automatic updating of the salary level test, DOL estimates 5 million workers will be affected by the new overtime regulations.
What about the construction industry?
There are 7.41 million workers in the construction industry who are subject to FLSA; 800,000 of these workers potentially are affected by the new overtime rules. DOL estimates 130,000 construction industry workers (16 percent of the potentially affected population) will be affected.
For construction trades and extraction workers, DOL data indicates there are an estimated 58,500 first-line supervisors and managers covered by the final rule who earn at least $455 but less than $913 per week; 19.9 percent of these workers usually work more than 40 hours per week, and DOL estimates 19 percent are misclassified as exempt based on the duties test.
If you currently have employees whom you have considered exempt and whose salaries are greater than $455 per week but less than $913 per week, those employees no longer will be exempt under the new salary level test as of Dec. 1. You may have salaried project managers, assistant project managers, estimators, superintendents and office management personnel who previously met the EAP exempt criteria and were paid a salary greater than $455 per week. If an employee's annual salary plus perhaps a nondiscretionary bonus paid no less frequently than quarterly does not equal at least $47,476 as of Dec. 1, that individual is to be paid overtime. Job titles are irrelevant.
What are the options?
To comply with the new rules, you can:
In comments submitted to DOL in response to the proposed rules, the Associated General Contractors (AGC) reported it had conducted a survey in which 74 percent of construction contractors surveyed responded they would likely reclassify some or all the affected exempt workers as nonexempt hourly status at their current salaries. It is difficult to see how such an approach would be beneficial given that only salaried employees are potentially eligible for the EAP exemption. The AGC survey also showed more than 60 percent of respondents expected the proposed rule to result in the institution of policies and practices to ensure affected employees do not work more than 40 hours per week.
The National Association of Home Builders (NAHB) in its submission to DOL estimated more than 110,000 construction supervisors no longer would be eligible for the EAP exemption and would become overtime-eligible under the proposed new rule. NAHB submitted data to DOL indicating 50 percent or more first-line construction supervisors in Arkansas, Mississippi, New Mexico and Tennessee would be affected by DOL's proposed rule. However, when issuing its final rule, DOL reported 55 percent of first-line supervisors of construction trades and extraction workers in the South earn above the final rule's salary threshold.
Highly compensated employees
The current federal overtime regulations contain another exemption, known as the HCE exemption, for highly compensated employees who do not satisfy the EAP standard duties tests. The HCE exemption applies to full-time salaried employees whose primary duty includes performing office work or nonmanual work and whose salary, under the current regulation also set in 2004, is at least $100,000. These employees are not subject to the standard duties test but instead need only meet a less stringent duties test because DOL believes highly paid employees are much more likely to be properly classified as exempt.
Per the new DOL regulations, the HCE annual compensation level is set at the 90th percentile of weekly wages of full-time salaried workers nationally, which currently is $134,004. DOL estimates 65,000 workers are affected by the increase in the HCE exemption.
What should you do?
Unless Congress reverses the new DOL overtime regulations, which is unlikely, you should prepare to comply with the new regulations when planning personnel management, budgets and job estimates as of Dec. 1 and expect further adjustments every three years thereafter.
If you currently rely extensively on exempt salaried employees who frequently work more than 40 hours per week, you will want to be sure their compensation meets the new salary level test or establish procedures to minimize their overtime work. Although the industries that will be most affected by the new overtime regulations are the retail, food service, hospitality and leisure industries, construction contractors also will be affected and can expect compliance with the overtime rules to be included in wage and hour audits of contractors conducted by federal and state labor agencies.
Stephen M. Phillips is a partner with Atlanta-based law firm Hendrick, Phillips, Salzman & Flatt.
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