Today the U.S. Department of Labor (“DOL”) announced the publication of its final regulations radically overhauling the minimum salary necessary for an employee to qualify for overtime exemptions under the Fair Labor Standards Act (“FLSA”). The final rule applies to employees classified as FLSA exempt pursuant to the executive, administrative, or professional exemptions only. Although the minimum salary is not as high, initially, as DOL had originally proposed last July, the final regulations more than double the minimum salary necessary to qualify for an exemption from the current $455 per week ($23,660 per year) to $913 per week ($47,476 per year). This minimum salary threshold will be subject to adjustment every three years, with the first adjustment becoming effective on January 1, 2020, based on a measure of inflation and wage fluctuation using the 40th percentile of average weekly wage earners for full-time salaried employees in the lowest income Census region (currently the South) from the Bureau of Labor Statistics (“BLS”). This represents a departure from the proposed regulation, which planned for adjustment in the minimum salary every year and used the national average in the 40th percentile, rather than the average in the lowest Census region of the country.
As we expected, with this announcement employers will have a very short period of time to begin complying. The final regulation takes effect on December 1, 2016, which is a month earlier than most employment attorneys expected. Although Congress will have an opportunity to review and potentially strike down or change the law during a 60-day congressional review period, it would require a super-majority sufficient to override a veto by President Obama in the middle of a presidential election cycle where every member of the House and more than one third of the Senate are up for re-election, too. In short, we expect these regulations to take effect on schedule. As we cautioned last July, employers should act quickly to meet with employment counsel and stakeholders throughout their organizations to determine how the regulations will affect their workplace. Finally, there is at least one silver lining here. For employers who perhaps have overlooked some misclassified workers, the new regulation will give employers cover as they work with their employment counsel to re-evaluate classifications and make changes necessary to achieve compliance.
Summary of Key Changes
Under current FLSA rules, in order to qualify for the typical exemption from the FLSA’s mandated minimum wage and overtime requirements, an employee generally must satisfy both the minimum salary test and the applicable duties test. Although we talk about this requirement as though it consists of two tests, DOL really considers these requirements to consist of three tests: (1) that the employee is paid the minimum weekly pay to qualify for the exemption, (2) that this pay is paid on a salary basis, and (3) that the employee performs the requisite duties to qualify for a specified exemption. For example, under the current law, in order to qualify for an executive exemption, the employer must show that an employee has a minimum salary of $455 per week and that the employee (1) has a primary duty of managing, (2) customarily and regularly directs the work of two or more full-time equivalent employees, and (3) has the authority to hire and fire or to make recommendations concerning ultimate employment decisions that are given particular weight. The duties test differs for each type of FLSA exemption. The same salary test applies to executive, administrative, and professional exemptions. The outside sales exemption has no minimum salary test and is not affected by the new regulation.
Noting that a salary of $455 per week is below the current federal poverty level for a family of four, DOL has taken the position that a salary of $455 per week is simply too low to justify exempt status. The last time DOL increased the minimum salary threshold was in 2004. If the original 1975 salary test were adjusted to account for national wage inflation, today’s salary test would be $1,083 per week.
DOL’s final regulation re-establishes the minimum salary necessary to qualify for an executive, administrative, and professional exemption every three years using BLS data for the 40th percentile of average weekly wage earners for full-time salaried employees in the lowest income Census region (currently the South). Based on today’s announcement of the final regulations, the minimum salary to qualify for any of these exemptions will be $913 per week during the first three years of compliance, effective December 2, 2016, and subject to adjustment every three years thereafter with the first adjustment scheduled for January 1, 2020. Using current data, DOL projects that when the minimum salary threshold receives its first subsequent adjustment on January 1, 2020, the minimum salary by that time will be about $51,000 per year.
In its proposed rule, DOL requested comments on whether it should allow employers to include other components of compensation in order to meet the minimum salary test. For example, DOL asked whether bonuses and incentive pay should be included in an employee’s minimum salary calculation. Under the old FLSA regulations, only an employee’s base salary could be considered for the $455 minimum salary test, excluding employers from considering bonus or incentive pay in order to satisfy the test. Breaking with nearly a half-century of regulatory precedent, in its final rule DOL chose to allow employers to count an employee’s non-discretionary bonuses or incentive payments (including commissions) toward satisfying up to 10% of the minimum salary test, provided that such bonuses or incentive compensation are paid to an employee on at least a quarterly or more frequent basis. For the first time, this will allow employers who pay nondiscretionary bonuses based on productivity, profitability or commission to take at least a partial credit toward fulfillment of the minimum salary test.
Although employers are no doubt going to experience some sticker shock from the increase in minimum salary, they can breathe a sigh of relief that nothing in DOL’s final rule increases the federal minimum wage, and DOL has made no change to the duties tests necessary to qualify for the exemption.
Although the process of implementing new wage and hour regulations has often been painstakingly slow, this Administration worked swiftly to finalize the new regulations and make them effective before President Obama is scheduled to leave office. Employers should not wait to see how Congress responds to the final regulations before they begin assessing how the regulations will affect their organizations. How employees are classified (exempt versus non-exempt) often goes to the bottom line budgetary structure of any organization. Employers should gather stakeholders throughout their organizations and work in conjunction with their employment counsel now to evaluate how this substantial change to the minimum salary test will affect staffing, policy, compensation, benefits, production, supervision, customer contracts, and budgets.
The last new law to substantially affect how employers classify their employees was the Affordable Care Act (“ACA”), which implicated how employers classify full and part-time employees. In the wake of the ACA, many employers acted swiftly to preserve the status quo of their underlying budgetary assumptions (i.e. re-defining their part-time classifications to include only those employees who work under 30 hours per week, on average) without first considering how such a change would affect multiple layers of their organization. We expect employers will respond similarly to the final FLSA exemption regulation, exploring primarily those solutions that preserve the status quo in the middle of a calendar year budget cycle.
By DOL’s own estimates, the final regulations will cost employers $1.2 billion in the first year of compliance, alone, and $12 billion over the next 10 years. Still, we think DOL’s suggestion that the final regulation will dramatically increase wages misses the mark. Sure, employees with compensation within 5% or so of the new minimum salary may see an increase, but we think the vast majority of employers are more likely to comply using more budget-neutral solutions, of which there are many, such as reducing pay, splitting full-time jobs into part-time jobs, re-assigning exempt functions, outsourcing, or simply paying formerly exempt employees on an hourly basis. Note that some state laws may further restrict the availability of some of these options.
Converting a previously salaried exempt employee to an hourly non-exempt employee is no simple task. Exempt employees typically do not track and report hours worked on time cards and also typically work at least some, if not a substantial amount of overtime. Formerly exempt employees may need to be trained on how to track and report their working time. Employers may need to create new systems for collecting time and preserving these payroll records. Also, employers who choose to comply by converting a salaried exempt employee to an hourly non-exempt employee using a budget-neutral approach will have to take into account the expected overtime hours worked by that employee and revise down that employee’s effective hourly rate. For example, if an exempt employee works, on average, two hours of overtime per week, the employer may have to convert that employee to an hourly rate that is about 10% less than a strict translation of salary to hourly in order to maintain a budget-neutral conversion.
Employers should also consider using the fixed salary for a fluctuating workweek strategy, a permissible DOL-approved method of paying both salary and overtime to non-exempt employees who regularly work variable overtime hours. Before setting out to implement this creative compliance option, be sure to discuss this method with your employment counsel and payroll provider.
In addition to the budgetary risks associated with overtime, employers will face challenges with employee retention, tracking, and management of hours worked, and cultural changes. Employees frequently consider exempt classification to be a reflection of their status within or importance to an organization. Often, an employer’s fringe benefit programs will similarly reflect this status or importance by granting exempt employees greater schedule flexibility, vacation, sick leave, or similar benefits, and more employee-level discretion over how those benefits are used. Each of these considerations must be part of your organization’s plan of action in anticipation of the December 1, 2016 compliance deadline.
Finally, employers with union contracts or operations in a heavily unionized industry now have to consider what effect this final regulation will have on their union avoidance strategy. We expect the final regulations will force many employers to convert front-line supervisors and team leaders into hourly employees. Depending on the nature of the work, this conversion could create a whole new class of potential union members. Be sure to work with your labor attorney to review the effect of the regulation and your compliance strategy on any current collective bargaining agreement or potential union organizing effort.
The final regulation will not be published in the Federal Register until May 23, 2016; however, a pre-publication copy of the final regulation is available here.
Please contact your Maynard Cooper & Gale, P.C. labor and employment attorney to discuss your organization’s response to the final regulations.
 Under the current law, highly compensated employees—those making at least $100,000 in annual compensation including at least $455 per week in salary—are exempt from the minimum wage and overtime rules so long as they regularly and customarily perform at least one of the duties necessary to qualify under a white collar exemption. Under the final rule released today, DOL has increased this highly compensated employee exemption to a salary of $134,004 per year indexed to the 90th percentile of average weekly wages for full-time salaried employees, nationally, as reported by BLS.