The U.S. Department of Labor (DOL) recently issued final regulations updating the overtime pay rules that govern the so-called “white collar” exemptions for executive, administrative, and professional (EAP) employees and for certain highly compensated employees (HCEs). These new rules update and implement the overtime pay requirements of the federal Fair Labor Standards Act (FLSA). The major changes adopted in the final rules relate to increasing the salary thresholds for exempt status, thereby making many more employees eligible for overtime pay. The final regulations also change the rules for counting certain bonuses and incentive pay toward satisfaction of the salary thresholds.
Key Action Items
- Employers should review the questions and answers to familiarize themselves with the FLSA’s overtime rules as well as the changes brought about by these final regulations.
- Review the employer implications section below to become familiar with potential issues and consider rewards and workforce strategy options.
- Employers should consider the potential implications for benefits plans.
The changes are generally effective December 1, 2016.
What is the Fair Labor Standards Act (FLSA)?
The FLSA is a federal law that establishes minimum wage, overtime pay, recordkeeping, and child labor standards affecting full-time and part-time workers in the private sector and in federal, state, and local governments.
Most workers are entitled to the overtime pay protections under the FLSA unless they meet a series of “tests” and are therefore deemed to be exempt. To qualify for exemption, workers must be paid on a salary basis meeting a minimum weekly salary threshold and perform certain job duties classified as executive, administrative, professional, outside-sales or computer-related (also known as white-collar exemptions). There are separate guidelines for determining whether highly compensated employees (HCEs) are exempt from the FLSA’s overtime pay protections as well.
Employees in jobs that do not meet both the minimum salary and the job duties tests are considered non-exempt must receive overtime pay at one and one-half times their regular rate of pay for every hour worked over 40 during the workweek (or more than eight hours in a day in some states).
It is important to note that the words “salaried” and “exempt” are often used interchangeably by many human resources (HR) professionals. While it is true that exempt employees generally need to be paid on a salaried basis, it is not true that all employees paid on a salaried basis are exempt from overtime pay under the FLSA.
2016 final regulations Q&A
What are the new salary thresholds?
Effective December 1, 2016, the standard salary level for an employee to be exempt will be set at the 40th percentile of earnings of full-time salaried workers in the lowest-wage census region (currently the South), which is $913 per week ($47,476 annually).
Additionally, the total annual compensation requirement for purposes of the HCE exemption has been increased to the equivalent of the 90th percentile of full-time salaried workers nationally, or from the current $100,000 level to $134,004 a year. To qualify for this overtime pay exemption, such employees must also be paid a standard weekly salary of at least $913 per week.
It is important to note that exemptions from the minimum salary requirement for learned professionals have not changed. Professions such as teachers, doctors and lawyers are still not subject to the minimum salary requirements.
Are employers allowed to count compensation other than regular pay in determining whether an employee meets the standard salary threshold?
Yes, to some extent. The final rules allow up to 10% of the minimum salary threshold for non-HCE employees to be met by nondiscretionary bonuses, incentive pay, and commissions. However, the final rules require that such amounts must be paid at least quarterly to qualify for inclusion.
Also note that if an employee does not earn enough in nondiscretionary bonuses and incentive payments in a particular quarter to retain his or her exempt status, the final rules permit a “catch-up” payment at the end of the quarter. Under the rules, the employer has one pay period to make up for the shortfall (up to 10% of the standard salary level for the preceding 13 week period). Any such catch-up payment will count only toward attaining the prior quarter’s salary amount and not toward the salary amount in the quarter in which it is paid. Note that if the employer chooses not to make the catch-up payment, the employee would be entitled to overtime pay for any hours worked in excess of 40 during any week in the previous quarter.
Are employers allowed to count compensation other than regular pay in determining whether an employee meets the HCE threshold?
Yes. As was the case in the past, employers can continue to include nondiscretionary bonus payments, incentive pay and commissions when calculating the total annual compensation limit under the HCE exemption. However, employers must be certain that the standard salary level test that is part of the HCE exemption is first met. In other words, HCEs must be paid at least $913 per week to satisfy the standard salary level threshold and bonus payments, incentive pay or commissions can’t be included when calculating this weekly limit.
Going forward, will the standard salary and HCE compensation thresholds increase on a regular basis?
The final rule provides a mechanism for automatically updating the standard salary and HCE total compensation limits every three years, beginning on January 1, 2020. As indicated above, the standard salary level increases will be determined based on the 40th percentile of earnings of full-time salaried workers in the lowest-wage census region at the time of the update and HCE compensation will be determined based on the 90th percentile of full-time salaried workers nationally at the time of the update. The DOL will post the new levels at least 150 days in advance of any change so employers have adequate time to make the necessary adjustments.
Do the special rules for computer and outside sales employees continue to apply?
Yes, the final regulations made no changes to either of these exceptions except that the minimum standard salary to qualify for the computer employee exemption, for an employee who is paid on a salaried basis, is increased to be consistent with the new standard salary threshold for other employees. However, for employees who are compensated on an hourly basis, the minimum pay rate to qualify for the computer employee exemption remains unchanged at $27.63 per hour.
Are certain types of organizations exempted from these rules?
No, the FLSA does not provide any special exemptions. However, the Department of Labor has acknowledged that these changes may prove more problematic for higher education, non-profit and governmental organizations and has issued guidance regarding these types of organizations’ specific practices.
Links to this guidance may be found below:
Do employers still need to be concerned with state overtime laws?
Yes, the recent changes brought about by the new final regulations apply only for purposes of federal law, and if a state establishes a higher standard than the provisions of the FLSA to qualify for an overtime pay exemption, the higher standard applies in that state. As a result, employers should also be mindful of how these new rules interact with any state wage and hour laws, especially those that have traditionally been stricter than the federal requirements with respect to overtime eligibility.
Also, certain states (e.g. California) have different job duties tests that are more favorable to employees, which would continue to apply. In addition, some states require a notification period be met prior to any pay change, which may mean determining and communicating pay changes based on the new FLSA regulations prior to the December 1, 2016 effective date.
What impact will these new overtime rules have on rewards?
Any reward plan that is tied to exemption status and/or pay type (hourly, salaried) should be reviewed in light of changes to overtime exemption status, salary or compensation level, and other pay-based changes made in response to the new FLSA rules. Examples of such rewards may include incentive plans, paid-time-off, etc. Employers should analyze, understand and implement adjustments as needed in these affected programs.
How should employers prepare for these changes?
With any type of change, we recommend employers make changes guided by their legal counsel and in support of the organization’s human resources and rewards strategies. As employers prepare to comply with the new regulations, we recommend a three-step process:
- Identify those currently exempt jobs where all employees are not paid at least the new minimum salary threshold and also identify programs specific to non-exempt employees. It is possible that you will have jobs within which some employees’ salaries are now above and some are below the new salary threshold.
- Analyze and select the best approach for each job to comply with the law, while also taking into consideration important business needs. Options may include (but are not limited to):
- Raising pay of exempt employees to meet the new threshold
- Re-classifying employees to non-exempt, maintaining their level of pay and paying overtime
- Re-classifying employees to non-exempt, then adjusting pay levels down to accommodate the additional overtime that is now due
- Re-classifying employees to non-exempt, and maintaining pay levels by prohibiting overtime
- Re-designing and eliminating jobs to absorb additional costs
Decisions may also be driven by the indirect impact of these new FLSA rules on employee benefits (e.g., health coverage eligibility), 401(k) contributions, employer taxes and premium pay offered to non-exempt employees.
- Implement changes to pay, job responsibilities, related compensation programs and operations.
- Implementation will involve updates to HRIS and payroll systems. It may involve training for both managers and employees on the requirements of non-exempt employees, including any state laws related to overtime pay and meal breaks, as there may be employees who have never had to track their time, and vice versa, managers who have never had to manage non-exempt employees.
Finally, compliance with the changes brought about by this new final rule will impact pay, cost of employment, job design and employee expectations. Communication will be a key component for success. Stay tuned for more publications about how you can implement and communicate these changes within your organization, and how they may impact your benefit and retirement programs.
This post was co-written with my Willis Towers Watson colleagues:
- Puneet Arora, Regulatory Advisor for Retirement and Executive Compensation
- Stephen Douglas, Senior Legislative and Regulatory Advisor
- Rich Gisonny, Senior Regulatory Adviser
- Laura Rickey, Senior Consultant for Talent and Rewards
- Lindsay Wiggins, Consultant for Talent and Rewards