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Fair Labor Standards Act Exemptions from Overtime Redefined
By: Net at Work Team
FLSA changes in December 2016 will mean that many employees treated as exempt from overtime will now be eligible due to new wage test guidelines. How will your organization respond?
Although the FLSA ensures minimum wage and overtime pay protections for most employees covered by the Act, some workers, including bona fide executive, administrative, and professional (“EAP”) employees, are exempt from those protections. Since 1940, the Department’s regulations have generally required each of three tests to be met for the FLSA’s EAP exemption to apply: (1) 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”); (2) the amount of salary paid must meet a minimum specified amount (“salary level test”); and (3) the employee’s job duties must primarily involve executive, administrative, or professional duties as defined by the regulations (“duties test”). The Department last updated these regulations in 2004, when it set the weekly salary level at $455 ($23,660 annually) and made other changes to the regulations, including collapsing the short and long duties tests into a single standard duties test and introducing a new exemption for highly compensated employees.
With the Rule effective December 1st, 2016, the salary and compensation levels needed for EAP workers have been updated. Specifically,
Sets the standard salary level 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 or $47,476 annually for a full-year worker;
Sets the total annual compensation requirement for highly compensated employees (HCE) subject to a minimal duties test to the annual equivalent of the 90th percentile of full-time salaried workers nationally, which is $134,004; and
Establishes a mechanism for automatically updating the salary and compensation levels every three years to maintain the levels at the above percentiles and to ensure that they continue to provide useful and effective tests for exemption.
Additionally, the Final Rule amends the salary basis test to allow employers to use nondiscretionary bonuses and incentive payments (including commissions) to satisfy up to 10 percent of the new standard salary level. The Final Rule makes no changes to the duties tests.
According to the US Department of Labor, Wage and Hour Division, without intervening action by their employers, it extends the right to overtime pay to an estimated 4.2 million workers who are currently exempt. It also strengthens existing overtime protections for 5.7 million additional white collar salaried workers and 3.2 million salaried blue collar workers whose entitlement to overtime pay will no longer rely on the application of the duties test.
Possible Responses and Effects
These changes will affect employers’ HR and Payroll departments in a number of ways. Certainly the most obvious is the potential economic effect of raising employee wages to meet the new salary level test. However, there are other considerations to be made as well, depending on the employer’s response. Exempt status contributes to overtime calculations and wages, but it also often has an impact on time and attendance reporting, benefit eligibility and time off plans. Moreover, employee morale and engagement is often tied to exempt status especially if exempt employees don’t ‘punch a timeclock’ like their non-exempt co-workers. So what are the possible response employers can consider?
It is possible that after an analysis, employees classified as executive, administrative, and professional or highly compensated meet the new salary guidelines. Keep in mind that changes to the new rule allow employers to satisfy up to 10% of the new salary level with at least quarterly nondiscretionary bonuses and commissions. In the short term, this may be a solution. A careful analysis of employee wages, as well as duties, will be required to confirm this conclusion. It is not uncommon for employees to meet the salary test and fail the duties test leading to DOL fines for the employer. Employers should also be aware that a new provision of the rule mandates review of the salary level test amounts every three years, so they may just be putting off the inevitable.
Raise Wages for EAP Employees to Meet the New Salary Guidelines
Identifying employees who are below the salary guidelines and raising their wages to meet the salary test may seem like the easiest response. However, there are a number of considerations. Depending how far the employees are from the new salary requirements and how many employees need the wage raise, the cost could be prohibitive. Moreover, there are other factors to be taken into consideration:
Employee morale – Although employers typically discourage discussion of wages among employees, raises ‘out of the blue’ can make other employees resentful, especially if there is not an increase in duties and responsibilities,
Raising wages can cause salary grade compression as more employees approach the salary grade ceiling. Meeting the salary requirement may actually ‘redline’ the employee putting them outside of their salary grade and making them ineligible for additional wage growth.
Salary grades themselves may need to be reconfigured to reflect the new ranges, thereby making all positions in the grade eligible for the wages up to and including the new test salary.
Reclassify the Employee as Non-Exempt and Pay Overtime as Required
A more cost effective response may be to make the positions in question non-exempt from overtime either as an hourly or salaried non-exempt position. Although this approach may make sense from a financial perspective, and will probably be the most popular response, there are a number of potential impacts to consider. New non-exempt employees will need to be trained to use your time and attendance system. They may or may not be accustomed to close scrutiny of their hours by supervisors who will want to keep overtime to a minimum. There is often a morale issue attached with the flexibility of exempt workers not ‘punch a clock’. How will that be addressed?
Additionally, if the new non-exempt workers are classified as hourly, how does that effect their eligibility for benefits? Paid Time Off plans? Eligibility for bonuses? HR and Payroll policies and procedures may need to be adjusted for the changed status of the employees in question, especially if they stand to lose benefits enjoyed as exempt employees. Moreover, an analysis will need to be made if the reclassification has a disparate impact on a particular protected class of employee.
As mentioned above, positions could be reclassified as salaried non-exempt and mitigate some of the potential policy and employee morale effects. However, salaried non-exempt positions still require the employee to clock their time so that overtime may be assessed and paid as required. If anything, managing overtime for salaried non-exempt is more complicated than straight hourly non-exempt. There still needs to be training and acceptance by the employee of the new conditions of employment. There may be review of duties and even need for additional positions to be created to reduce overtime payments.
In addition to the direct cost of employee wages, employers need to also consider the indirect impact of wages. They include:
FICA (Employer portion of Social Security and Medicare Tax)
State and Federal Unemployment
Employer paid state disability taxes
Employee benefit costs attached to salary
401(k) matching contribution,
Life Insurance Premium,
Health Reimbursement Account matching, etc.
Time and attendance administration
Additional processing time for timesheet approvers and payroll
Employers have a great deal of work to do to prepare for the rule change in December. There is no ‘cookie cutter’ or ‘one-size-fits-all’ approach to this issue. Employers need to carefully analyze compliance requirements, cost, pay structure, policies and procedures and strategies for communicating the changes to employees.
To assist our clients, Net at Work is preparing a ‘survival kit’ of tools for Sage HRMS users. The tools will assist employers in the main areas of work to be done: Analysis of current employees; current Job, EEO and Pay Grade rules in place; and monitoring employees for compliance. The toolkit will include resources custom Crystal reports, alerts, dashboard to help you stay compliant.
For more Information
Over the course of the next few months we will be presenting free webinars on the legal aspects and background of the FLSA rule change as well as using the FLSA Survival Kit. We hope that you can join us.