Understanding the new overtime regulations

By Marco Costa, Esq.
Senior Associate at Marco Q Rossi & Associati, LLP

 

A. INTRODUCTION    
On May 18, 2016, the Department of Labor (DoL) has issued the final version (“Final Rules”) of the Fair Labor Standards Act (FLSA) regulations regarding the salary threshold for exempt employees. FLSA provides an exemption from the overtime pay requirement for the workers employed as executive, administrative, and professional employees (“exempt white collar employees”). The FLSA also exempts from overtime highly compensated employees (“HCE’s”).


The new regulations will be effective as from December 1, 2016, and is foreseen they will significantly affect the position of thousand of employees in America. Employers may take the decision of updating the current employment agreements in order to comply with the regulations, with all the consequences that will be explained in this article.


Thus, this article provides employer with insight into how to understand, and eventually apply, the new regulations, which will affect employers of all sizes in all industries across the country.

 

B. BRIEF HISTORY OF THE SALARY SYSTEM IN THE US
In the U.S. employees are usually classified as non-exempt employees and exempt employees.


The main difference is that non exempt employees are paid the overtime, while exempt employees do not receive any overtime compensation regardless the hours worked.


Exempt employees’ salary is calculated on a hourly basis. Federal law establishes a minimum wage that cannot be reduced. As well, each single state can establish its own minimum wage than can be equal to or higher than the federal minimum wage. Naturally, employers can decide to correspond a base salary higher (but never below to) than the minimum wage established by the law. Currently, federal minimum wage is $7.25 per hour. The majority of the states have a minimum wage higher than federal one, as in California ($10 per hour) or New York ($9 per hour), while few states, like Alabama and Louisiana, follow federal law (1).


Likewise, federal law regulates the compensation of overtime, as well as is regulated in each single state. According to federal law, overtime is calculated as one and half time the base salary (not the minimum wage) per each hour worked over the ordinary eight hours per day (forty hours per week). Almost all the states follow the federal rule. Conversely, California has adopted a different system whereas overtime is calculated based on one and half time the base salary per each hour worked over the ordinary eight hours up to a maximum of twelve hours. Over the twelve hours of work, overtime is calculated doubling the base salary.


As anticipated, overtime regulations do not apply to exempt employees.    


To be considered exempt, the employee must meet three criteria (2):


(a) paid on a predetermined “salary basis” - i.e. the predetermined salary cannot be reduced because of variations in the quality or quantity of work performed (predetermined salary test);
(b) perform certain white-collar job duties (quality test);
(c) receive a minimum salary threshold - currently $455 per week or $23,660 per year (quantity test).


HCE’s are usually white-collars workers3 receiving a minimum salary threshold of  $100,000 per year.

 

C. THE FINAL RULES
The Final Rules modify only the quantity test as in sub-paragraph (c) above. The other two criteria in sub (a) and (b) remain untouched.


The new regulations increase the white-collar employee  salary threshold from $455 per week ($23,660 per year) to $913 per week ($47,476 per year). Also the annual compensation for HCE’s is increased from $100,000 per year to $134,004 per year (4).


Finally, the new regulations allow employers to use nondiscretionary bonuses and incentive payments (including commissions) to satisfy up to 10% of the new salary threshold for exempt white-collar employees.


Therefore, beginning December 1, 2016, to be considered exempt from overtime the employee must (i) perform certain white-collar duties, (ii) receive a predetermined salary that cannot be adjusted according to the quality or the quantity of the work performed, and (iii) be paid a minimum salary of $47,474 or $134,000 per year (if considered a HCE’s).

 

D. PRACTICAL CONSEQUENCES
In order to comply with the new regulations, employers will have to chose between (i) increasing the salary threshold for those exempt employees currently earning less than $47,476 or $134,004, or (ii) avoiding increasing the salary and reclassify workers as non exempt employees.


Potentially, both the scenarios bear some significant consequences.


In the first scenario, customary business requirements may not enable an employer to simply increase the salaries because of the impact that this would have on other higher-paid employees, who may demand salary increases when lower-paid employees receive raises.          

Reclassifying exempt employees as non exempt employees, as in the second scenario, may present other challenges for the employers, who now should ensure compliance with the various minimum labor standards applying to non exempt employees (overtime, meal and rest periods, paid leaves, etc.). Besides that, experience shows that employees who are reclassified often perceive such change as a demotion is status.

Most importantly then, employer may face some doubts regarding whether it would be more convenient increasing the salary threshold or reclassifying the worker from exempt to non exempt employee. Below, we have drafted three examples to illustrate the point:

Example 1. Let’s assume that the exempt employee is paid a fixed salary of $455/weekly (currently, the minimum threshold), that is $8.12 per hour, and usually works ten hours per day. As things currently stand, such employee is not entitled to overtime. However, if the exempt employee should keep receiving the same salary after December 1, 2016, he or she would be considered as non exempt employee and would be entitled for overtime. By applying the most common overtime calculation rule (one and half the base salary for each hour worked beyond forty hours a week), the total compensation for ordinary work and overtime would be:

$455/weekly + [(1.5 x $8.12) x 10] = 455 + 121.80 = $576.80/weekly.

Here, the total compensation would be lower than the new salary threshold of $913/weekly for exempt employees.

Example 2. Same scenario as in example 1, but employee has a fixed salary of $672/weekly, that is $12/hourly. Thus, we would have:

$672 + [(1.5 x 12) x 10] = 672 + 180 = $852/weekly.

Once again, here the total compensation would be lower than the new salary threshold of $913/weekly for exempt employees.

Example 3. Same scenario as above, but this time the employee has a fixed salary of $840/weekly, corresponding to $15 per hour. Thus, the result would be:

$840 + [(1.5 x 15) x 10] = 840 + 225 = $1.065/weekly.

Now the total compensation would be higher than the new salary threshold of $913/weekly for exempt employees. In this scenario, reclassifying the employee in order to avoid labor costs could be  detrimental to the employer.

In addition, the Final Rule could present other challenges. For example, employers would need to revisit their retirement plans to confirm whether overtime pay is eligible to contributions, including matching contributions; if so, employers should plan ahead for increased contributions beginning December 1, 2016.

Finally, another aspect to keep in consideration in the possibility for employers to count  up to 10% of nondiscretionary bonuses. The Final Rules do not define “nondiscretionary bonuses”. However, another part of the FLSA defines as discretionary such bonus that is not already agreed with the employer and subject to his discretion. Therefore, it is reasonable to assume that non discretionary bonus will mean such bonus that is already included in the compensation agreement and cannot be modified by the employer.

 

E. CONCLUSIONS
The new regulations issued by the DoL significantly affect the labor market in the U.S., specifically for exempt employees (white-collars and HCE’s).
Employers have time until December 1, 2016, to revise and adjust their employment agreements. Considering the issues illustrated above, time could not be sufficient enough. Therefore, it is paramount to act now.    
Below, we have prepared an action plan each employers should follow in order to be in compliance when the deadline is passed.

  1. Identify all the exempt employees and, for each of them, review the basis of the exemption.
  2. Once the review is done, determine which changes are to be made for each affected exempt employee.
  3. Establish, if necessary, a time-keeping system that, by December 1, 2016, will allow tracking the hours worked by all employees earning less than $47,476 per year.

 

Notes

  1. Besides the minimum wage in question, there is also a different minimum wage specific for tipped employees.
  2. Like for the minimum wage, each state can establish different more favorable rules for the determination of the category of exempt employees ribadito.
  3. Usually HCE’s are those workers that customarily and not occasionally perform certain white-collar duties such as executives, etc.
  4. The Final Rules also provide that such thresholds are automatically adjusted every three years.