Impact of New Overtime Regulations on Your Business: An In-Depth Analysis

By Charles E. McDonald, III
Attorney, Ogletree Deakins

The minimum salary threshold to qualify for the executive, administrative, and professional exemptions to the Fair Labor Standards Act (FLSA) will more than double on December 1, 2016, from $23,660 per year to $47,476 per year. This is the most notable—but not the only – change to the FLSA exemption requirements under the final Part 541 regulations that the U.S. Department of Labor (DOL) released on Tuesday, May 17. The final regulations also contain a provision to automatically adjust this salary amount every three years beginning on January 1, 2020.

New Minimum Salary Threshold of $47,476

Under the final regulations, the new minimum salary for the executive, administrative, and professional exemptions will increase from $455 per week, or $23,660 per year, to $913 per week, or $47,476 per year. This means that employees who do not receive the new minimum salary level when the final regulations become effective on December 1, 2016, will not qualify for any of these three exemptions from the FLSA’s overtime compensation requirements, regardless of their job duties. Nonexempt employees must be paid overtime compensation when they work more than 40 hours in a workweek, and the Obama administration estimates that the new salary threshold will make 4.2 million more employees eligible for overtime compensation if their salaries are not increased to meet the new minimum amount.

Although this new salary threshold is slightly more than double the current minimum salary level, the new standard actually is lower than the $970 per week figure that had been projected when the DOL’s Wage and Hour Division (WHD) issued its proposed Part 541 regulations in 2015. The WHD had stated in the proposed regulations that it planned to set the new threshold to correspond to the 40th percentile of weekly earnings for full-time salaried workers in the United States based on statistics maintained by the U.S. Bureau of Labor Statistics (BLS). That proposed approach was the subject of much criticism, including the fact that it did not take into account pay differentials among various regions of the country.

In the final rule, the WHD tied the salary figure to the 40th percentile of all salaried employees in the lowest-wage Census region, which is the South. This was intended to silence criticism that the proposed salary level would render too many bona fide exempt executive, administrative, and professional employees eligible for overtime. In the Executive Summary to the final regulations, the DOL estimates that at the time of the first update on January 1, 2020, the standard salary level is likely to be approximately $51,168 annually.

However, the bottom line for employers is that it still increases the threshold by more than 100 percent. Furthermore, while some businesses may be able to adjust to the changes by raising prices, other businesses—particularly many small businesses, retailers and non-profits— will be placed in a particularly challenging situation.

Timing—Effective Date of December 1, 2016

The final rule is scheduled to be published in the Federal Register on Monday, May 23, 2016, and to become effective on Thursday, December 1, 2016. The DOL was required to provide at least 60 days between the publication date and the effective date, which would have been an extremely short time period to finalize plans and implement changes following the announcement of the new rule. The December 1 effective date means that employers will have just over six months to make changes, which should make the process more manageable and should be seen as a concession to the needs of a broad spectrum of employers. However, it also represents a rejection of employer requests that such a major leap in the new threshold be phased in over time.

Of particular interest, the new rule will become effective less than one month after the presidential election. Most commentators had anticipated that the DOL would want to establish an effective date that was at least a couple of months prior to the election. In addition, the December 1 effective date is curious in that the final rule also calls for indexing the new salary threshold every three years, starting on January 1, 2020. In light of the January 1 effective date for indexing, the fact that January 1 marks the start of a new calendar quarter, and the reality that a large number of businesses budget and operate on a calendar year, it would have made more sense for the DOL to establish a January 1, 2017, effective date for the final regulations.

Inclusion of Bonuses and Incentive Pay When Calculating Salary

For the first time, employers will be able to use non-discretionary bonuses and incentive payments (including commissions) to satisfy up to 10 percent of the standard salary level, as long as those payments are made on a quarterly or more frequent basis. The DOL had stated in the proposed regulations that it was considering such a move, and it sought comments as to whether to include such a provision in the final regulations. The fact that the DOL created such a provision, specifically including commissions, and also decided to include payments made on a quarterly or more frequent basis was a small win for employers.

From a practical standpoint, employers will need to become comfortable with how this new provision will work. Since it applies to 10 percent of the salary level, this means that up to $91.30 in non-discretionary bonus and incentive payments per week, or $4,747.60 in non-discretionary bonus and incentive payments per year paid no less frequently than on a quarterly basis, can count toward meeting the $47,476 threshold. This also means that even if the employer can make use of the full 10 percent, the employee still will need to receive a salary of at least $821.70 per week, or $42,728.40 per year.

The regulations also allow employers to make a catch-up payment at the end of a quarter to make up any shortfall in the non-discretionary 10 percent portion of the salary amount. If, by the last pay period of the quarter, the sum of the employee’s actual weekly salary, plus received non-discretionary bonus, incentive, and commission payments, does not equal $11,869 (*i.e.*, 13 times the weekly minimum of $913), an employer may make one final payment to reach the $11,869 level no later than the next pay period after the end of the quarter. Any such final payment made after the end of the 13-week period may count only toward the prior quarter’s salary amount and not toward the salary amount in the quarter it was paid. Employers, however, cannot count such payments toward the minimum salary requirements for the highly compensated employee exemption.

Indexing Every Three Years Starting January 1, 2020

The new minimum salary threshold for the executive, administrative, and professional exemptions will be indexed every three years, with the first change resulting from indexing to occur on January 1, 2020. The new salary threshold will be indexed to the 40th percentile of all salaried workers in whatever is the lowest-wage Census region. The DOL will post this figure and publish it in the Federal Register at least 150 days prior to the effective date, which means that employers will have approximately five months’ notice of the new minimum salary threshold.

In the proposed regulations, the WHD stated that it was planning to index the salary level annually, so the shift to three-year indexing should be of consolation to employers. The DOL’s decision to engage in indexing every three years, instead of every one year, may have been made for strategic reasons, as any courtroom efforts to enjoin or invalidate the indexing portion of the final regulations likely could be resolved within three years without affecting the remainder of the regulations.

Total Compensation Requirement for the HCE Exemption Increases to $134,004

In addition to the executive, administrative, and professional exemptions, another exemption in Part 541 is the highly compensated employee (HCE) exemption. Besides meeting a minimal duties test, an HCE’s total annual compensation under the current (*i.e.*, 2004) regulations must be at least $100,000, of which at least $455 per week must be in the form of a salary. Under the final regulations, the new minimum total compensation threshold is $134,004, of which at least $913 per week must be in the form of a salary.

The DOL based the $134,004 figure on the 90th percentile of all salaried employees nationally and did not make any distinctions based on Census region. This is exactly what the DOL had proposed doing in the final regulations. Interestingly, the 90th percentile would annualize to $134,004 based on fourth quarter statistics for 2015. However, the 90th percentile figure actually decreased in the first quarter of 2016 and now would annualize to $131,196 using first quarter of 2016 figures. Thus, the new HCE number is arguably inflated.

HCE Total Compensation and Salary Level Indexing

The final rule also indexes the total compensation and salary level requirements for the HCE exemption every three years, consistent with the timing of the indexing of the minimum salary level for the executive, administrative, and professional exemptions. The total compensation level will track the 90th percentile of all employees nationally, and the salary level will be the same as for the other three exemptions.

No Changes to the Duties Test

The DOL did not make changes to the duties tests for any of the exemptions in the final regulations. In the proposed regulations, the DOL had solicited comments as to whether a percent of time test should have been added into the regulations similar to the test that exists in California. Employers should be pleased that the DOL heeded the comments and did not make any such changes to the duties tests or requirements to qualify for the exemptions.

Next Steps

In conjunction with the release of the final regulations, the DOL has created a final rule webpage, which includes a number of fact sheets and guidance papers. Likely in anticipation of a harsh pushback by certain groups of employers that will be hardest hit by the dramatic increase in the salary level, the DOL has included specific fact sheets and guidance for non-profit organizations, higher education institutions, and state and local governments.
The final regulations will be published in the Federal Register on Monday, May 23, 2016. A pre-publication of the regulations was made available on May 18, 2016.

Although the final regulations may be subject to challenges in Congress and in the courts, employers should not assume that any of these challenges will result in a delay of the December 1 effective date. Accordingly, employers need to start developing and finalizing their compliance and communications plans now, with implementation occurring no later than December 1.

About Chuck

This article was drafted by the attorneys of Ogletree Deakins, a labor and employment law firm representing management, and is reprinted with permission. This information should not be relied upon as legal advice.