The Legal Intelligencer
The Rolling Stones said it best: “Time is on my side, yes it is.” This has never been more accurate after the publication of the much-anticipated final rule updating overtime regulations, as an estimated 4.2 million workers who were previously exempt from receiving overtime pay may be eligible for overtime starting Dec. 1, 2016.
On May 18, President Obama and Department of Labor Secretary Thomas E. Perez announced the publication of the Department of Labor’s Final Rule titled “Defining and Delimiting the Exemptions for Executive, Administrative, Professional, Outside Sales and Computer Employees.” The final rule updated overtime regulations, including an update on the salary and compensation levels needed for employees to be considered exempt, (29 CFR Part 541).
The Fair Labor Standards Act
Pursuant to the Fair Labor Standards Act (FLSA), an employee is entitled to overtime of one and one-half times the employee’s regular rate of pay for hours worked over 40 in a workweek. However, certain executive, administrative, and professional employees are exempt from this rule. These employees are commonly referred to as “exempt employees.” To be considered exempt, three tests must be met: The employee must 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); the amount of salary paid must meet a minimum specified amount (salary level test); and the employee’s job duties must primarily involve executive, administrative or professional duties as defined by the regulations (duties test).
Combination of ‘Long’ and ‘Short’ Duties Test
Prior to 2004, the regulations implemented both a “long” and “short” duties test. The long test paired a lower salary requirement with a more stringent duties test—meaning that to qualify a worker could perform no more than 20 percent of their time on nonexecutive, administrative, or professional duties. The short test paired a higher salary requirement with a less rigorous duties test. In 2004, the U.S. Department of Labor (DOL) eliminated the long and short duties test, combining the less-stringent duties test with a higher salary level derived from the long duties test. The executive summary to the DOL’s final rule concluded that the 2004 modifications “had the effect of making it easier for employers to both pay employees a lower salary and not pay them overtime for time worked beyond 40 hours.” Thus, the DOL asserted that the combination of the long and short duties test in 2004 resulted in the exemption from overtime of many lower-paid workers who performed minimal executive, administrative, or professional work and “whose work was indistinguishable from their overtime-eligible colleagues.” The DOL further asserted that this resulted in the inappropriate misclassification of employees as exempt. On March 13, 2014, Obama issued a presidential memorandum directing the DOL to update its regulations, instructing the DOL to “look for ways to modernize and simplify the regulations while ensuring that the FLSA’s intended overtime protections are fully implemented.”
Increase of Minimum Standard Salary Level
Since 2004, the salary basis test was met if the employee was paid a salary of $455 a week ($23,660 annually). The final rule increases the minimum salary, effective Dec. 1. Principally, the final rule raises the minimum standard salary level for exempt employees to the 40th percentile of earnings of full-time salaried workers in the lowest-wage census region, which is currently the South. Applying this rule, the new standard salary level for exempt employees will rise from $455 per week to $913 per week (or from $23,660 annually to $47,476 annually).
Use of Other Payments
Under the new final rule, employers may, for the first time, use nondiscretionary bonuses and incentive payments (including commissions) to satisfy up to 10 percent of the standard salary level. To qualify, such payments must be made on a quarterly or more frequent basis, among other conditions set forth in the final rule.
Automatic Updates
Prior to the final rule, the last update to the overtime regulations was in 2004. In an effort to modernize the regulations and prevent a situation where wages outpace revisions to the rules, automatic updates to this minimum standard salary level will occur every three years beginning on Jan. 1, 2020. Originally, the DOL proposed annual automatic updates, but revised the automatic updates to occur every three years, in response to comments criticizing the annual update.
Revisions to the Minimum Standard Salary Level
In the 2004 update, a new highly compensated employee (HCE) exemption was established. The HCE exemption provided that certain employees were exempt from the overtime rules if they earn at least $100,000 in total annual compensation and customarily and regularly perform any one or more of the exempt duties or responsibilities of an executive, administrative or professional employee. The executive, administrative, or professional duties required by an HCE are less stringent than the duties requirement for nonHCEs. The final rule also increases the minimum salary level for employees that qualify for HCE treatment. Specifically, the final rule sets the HCE annual compensation level to the 90th percentile of earnings of full-time salaried workers nationally, which is currently $134,004. Additionally, an HCE employee must also receive $913 weekly (the remainder of the HCE salary may be paid in bonuses, commissions, or other incentive payments) and must pass one of the minimal duties tests.
The Job Duties Test Remains Unchanged
The final rule did not change the existing job duties test to qualify as an exempt employee. The DOL reasoned that the standard salary level in the final rule, along with the existing job duties tests, will effectively distinguish between overtime-eligible workers and exempt workers.
The Estimated Financial Effect
The DOL estimated that the final rule will extend the right to overtime pay to 4.2 million workers who are considered exempt. An additional 65,000 workers currently exempt under the HCE rules are estimated to become overtime eligible due to the implementation of the final rule. The DOL estimated that the average annualized direct employer cost resulting from the final rule will total $295.1 million per year. Additional transfers of income from employers to employees are estimated to average $1,189.1 million.
The Final Rule’s Effect on Litigation
Lawsuits under the FLSA have increased dramatically. The preamble to the final rule observes that the increase of wage-and-hour lawsuits from approximately 2,000 to approximately 8,000 per year has been due in part to employer confusion about which workers could be classified as exempt employees. The DOL concluded that while a reduction of litigation was not the purpose of the final rule, “we believe that reduced litigation will be one of the beneficial impacts” of the rule.
The DOL reasoned that the salary level in the final rule serves as a “clear and effective line of demarcation, thereby reducing the potential for misclassification and litigation.” In other words, the DOL stated that setting the new salary level test, along with automatic updates, will “alleviate the need for employers to apply the duties test in these types of cases, which is expected to result in decreased litigation as employers will be able to determine employee exemption status through application of the salary level test without the need to perform a duties analysis.
Of course, others criticize this reasoning. The Wage and Hour Defense Institute submitted comments to the proposed rule, saying that the rule will likely increase litigation. Specifically, the institute argued that by reclassifying millions of exempt employees as nonexempt employees, there will be a proliferation of disputes regarding issues that only apply to nonexempt employees, such as what is compensable time, the accuracy of time records, compliance with rest/meal period requirements and others, as in a letter from the Wage and Hour Defense Institute to Mary Ziegler, director of the Division of Regulations, Legislation, and Interpretation, Wage and Hour Division (Sept. 4, 2015) (https://www.regulations.gov/#!documentDetail;D=WHD-2015-0001-5585).
Additionally, the institute argued that the new salary level will create additional claims against employers who mistakenly fail to understand or apply the new salary level correctly or who fail to understand how to administer salary basis issues properly.
Conclusion
The consequences of the final rule are yet to be seen, but employers and their counsel must now make a decision for employees that were once considered exempt but no longer meet the minimum salary thresholds—either increase the worker’s salary to meet the threshold or pay overtime. The rule is effective Dec. 1, 2016, absent the U.S. Congress blocking the final rule under the Congressional Rule Act. Now is the time for all employers to re-examine their pay practices for compliance with the law.
*Reprinted with permission from the 6/29/16 issue of The Legal Intelligencer. © 2016 ALM Media Properties, LLC. Further duplication without permission is prohibited. All rights reserved.