Employers Need to Prepare For The Increase to the Salary Threshold for Exemptions to Overtime

April 11, 2016

5273To address what some consider to be low paid managers missing out on overtime earnings when they work more than 40 hours in a week, the Obama Administration through the U.S. Department of Labor (DOL) has proposed to significantly increase the salary threshold for the executive, administrative, and professional exemptions to overtime.  The latest word from DOL is that implementing changes in the regulations will be finalized by July 2016 and will take effect 60 days later sometime around September 2016.

Under current regulations, to qualify for the executive, administrative, or professional exemption from overtime an employee must be paid on a salary basis, meet certain duties, and be paid at least $455 per week ($23,660 per year for a full-year worker).  The anticipated changes to the regulations will set the initial, standard salary level for the EAP exemption at a point equal to the 40th percentile of earnings for full-time salaried workers. Based on the latest statistics available, DOL projects that for 2016, the 40th percentile weekly wage in the final rule will be $970 per week, or $50,440 per year for a full-time worker. In other words, unless an employee is earning more than $50,440 per year, he or she must treated as an hourly worker and must be paid overtime.  (To qualify for a different exemption for highly compensated employees (HCE), an employee will have to earn at least $122,148 per year.)

To prevent the salary levels from becoming outdated, DOL’s proposed regulations include a mechanism to automatically update the salary and compensation thresholds on an annual basis using either a fixed percentile of wages or the consumer price index for urban consumers (CPI-U).  Depending on the nation’s economic performance, this could result in automatic annual pay increases for exempt employees.

The impact of a change to the salary threshold will be dramatic.  DOL estimates that 21.4 million are currently exempt EAP workers under existing rules and projects that these proposed changes, if adopted, would affect an estimated 4.6 million currently exempt workers.  Absent some intervening action by their employers, these employees would become entitled to overtime if the proposed rules take effect.  Similarly, an estimated 36,000 currently exempt workers who earn at least $100,000 but less than the 90th earnings percentile ($122,148) per year and who meet the HCE duties test also may become eligible for minimum wage and overtime protection.  As the rates are adjusted, more employees will be affected.

The effect would be greater for small to mid-sized companies in smaller cities and rural areas that simply cannot afford to raise salaries to meet the new exemption or pay overtime.  Although the intent of the new rules is to force companies to make such changes, the more likely outcome is for employers to shift salaried workers paid less than the new minimum salary threshold to hourly rates that approximate their former salaries, and control costs by restricting overtime.  These new rules will also discourage moving hourly workers into salaried management positions, which will deprive such workers of valuable experience and upward mobility.

Salaried, nonexempt pay will also remain a viable option to employers interested in controlling overtime expense in states where the practice is permitted.  This allows an employer to pay a nonexempt employee a guaranteed salary for all hours worked, plus an overtime premium of an additional ½ the regular rate for each overtime hour.  This method is desirable where an employer wants to contain costs by discouraging employees from shifting work from regular hours to overtime, since the employee’s effective rate of earnings per hour actually declines the more overtime hours are worked.  If either of these methods is adopted, the employer will, of course, be required to make and preserve records of hours worked for these employees.

The proposed salary level increase will raise other management issues as well.  It will be necessary to maintain records of hours worked for more employees, and some with managerial responsibilities may chafe at being required to clock in and out.  And overtime can be hard to control.  For example, a nonexempt employee who checks his or her work e-mail outside of normal working hours may be due overtime for that activity.  It is nearly impossible to prevent an employee possessing a smart phone from checking work e-mail without locking them out of the system after hours.  The change also may affect employee eligibility for benefits such as health insurance, since many employers provide more or better benefits to salaried, exempt workers than they do to nonexempt, hourly employees.

Because of the impending imposition of the new salary requirement and short implementation period, employers should evaluate and review the status of all currently salaried employees in advance to determine whether they still qualify for the overtime exemption under the new salary level.  This will make the transition a lot easier and will give employers more time to make adjustments as needed to ensure compliance.