Update as of November 22, 2016:
The new overtime rules have been temporarily suspended. A federal judge in Texas issued a nationwide injunction against an Obama administration regulation expanding the number of workers who would be eligible for time-and-a-half overtime pay. The new overtime limit appears likely to survive in some form, but the increase in the salary limit could potentially be below the $47,476 threshold originally discussed in this article. Please stay tuned for more information on this topic until the judge issues a final ruling on the merits and new regulation is available. However, caution should be taken that if the injunction is lifted without modification of the rule, it is possible that there could be limited time to implement the changes noted below so we recommend that you be familiar with them and have an implementation plan in place.
The deadline for the Department of Labor’s (DOL’s) new final overtime rule was scheduled to take effect on December 1, 2016. While CFOs at most large U.S. companies have been working overtime themselves to prepare for the changes, many small and midsize firms haven’t been as quick to react.
Current Overtime Rule
The Fair Labor Standards Act (FLSA) is the federal law that controls overtime pay. It requires employers to pay employees 1.5 times their regular pay rate for overtime above 40 hours a week, unless specifically exempted. The FLSA “white collar” exemptions exclude from the federal overtime rules certain executive, administrative and professional (EAP) employees and outside salespeople.
The DOL requires each of the following three tests to be met for employees to be covered by the EAP exemption and, therefore, ineligible for overtime pay:
1. Salary basis test. The employee must be paid a predetermined and fixed salary that isn’t subject to reduction because of variations in the quality or quantity of work performed.
2. Salary level test. The amount of salary paid must meet a minimum specified amount. Currently, this figure is $455 per week for EAP employees. (This is the equivalent of $23,660 annually for a full-year employee.)
3. Duties test. The employee’s job duties must primarily involve executive, administrative or professional duties as defined by the DOL regulations. In addition, the regulations include a relaxed duties test for certain highly compensated employees (HCEs) who receive total annual compensation of $100,000 or more and are paid at least $455 per week under current levels.
The DOL released updated guidance in May that makes significant changes to the overtime regs. Prior to those changes, the DOL regulations on overtime pay — which date back to 1940 — hadn’t been updated since 2004.
New Overtime Rule
The new final rule makes several significant changes related to overtime pay. Here are the highlights:
Salary level test. The standard salary level used to determine whether EAP employees are exempt from overtime will increase from $455 per week ($23,660 per year) to $913 per week ($47,476 per year) for full-time workers.
Employers aren’t necessarily in compliance with the new standard salary level threshold if an employee’s pay meets the $47,476 annual threshold. An employee’s eligibility to receive overtime is determined on a weekly basis. What’s more, this limit will be adjusted every three years, beginning January 1, 2020.
Bonuses and incentive payments. For the first time ever, employers will be permitted to use nondiscretionary bonuses and incentive payments (including commissions) to satisfy up to 10% of the standard salary level. These payments may include, for example, nondiscretionary incentive bonuses tied to productivity and profitability. For employers to credit nondiscretionary bonuses and incentive payments toward a portion of the standard salary level test, payments must be made at least on a quarterly basis, although employers can still make “catch-up” payments.
HCEs. The total annual compensation threshold for an HCE will increase from $100,000 to $134,004. The final rule makes no changes to the requirement that HCEs receive at least the full standard salary amount each pay period on a salary or fee basis without regard to nondiscretionary bonuses and incentive payments.
Thus, if employees earn at least $913 per week and pass the standard duties test for an EAP employee, they won’t be affected by the increase in the annual threshold. If they pass only the relaxed duties test for an HCE, the employer must raise the compensation to the new $134,004 threshold to retain the exempt status.
While HCEs must receive 100% of the $913 weekly threshold on a salary or fee basis, nondiscretionary bonuses and incentive payments (including commissions) may be used to satisfy the remainder of the $134,004 total annual compensation requirement.
Duties test. The final rule doesn’t make any changes to the existing EAP job duty requirements to qualify for exemption from overtime.
Outside salespeople. These employees aren’t subject to the salary basis or salary level requirements. Therefore, they aren’t affected by the rule changes.
Salaries for nonexempt employees. “Salaried status” and “exempt status” are separate concepts. So, employees entitled to overtime pay may still be paid on a salary basis as long as they receive overtime pay for working over 40 hours in a workweek.
Seasonal employers. A seasonal employer must comply with these rules during the period the employer is open for business. For example, if a seasonal employer is open during eight months of the year, the employer must guarantee that at least $913 per week is paid to an employee during that eight-month period for the employee to be exempt from overtime.
Job classifications. Employees with the same job classification don’t all have to be classified as either eligible or exempt from overtime. The determination is made on an employee-by-employee basis.
Compliance Options for Employers
Faced with the fast-approaching implementation date, employers have several options to comply with the new rule:
1. Increase salaries of employees who are paid near the salary level threshold to maintain their exempt status (assuming they also meet the EAP duties test). The DOL says that this option works best for employees who have salaries close to the new salary level and regularly work overtime. But it may be only a short-term fix, because the salary level threshold will be increased again, beginning in 2020.
2. Pay overtime in addition to the employee’s current salary when necessary. Employers can also continue to pay their newly overtime-eligible employees the same salary and pay them overtime whenever they work more than 40 hours in a week.
The DOL says that this approach may be preferable for companies with employees who work 40 hours or fewer in a typical workweek, but they have occasional spikes that require overtime. Thus, the employer can plan and budget for the extra pay. The DOL also notes that there’s no requirement to convert employees from salaried to hourly for overtime pay calculations.
3. Limit workers’ hours to 40 hours per week. Under this option, employers must ensure that workload distribution, time and staffing levels are managed appropriately for EAP workers earning below the salary threshold. Employers might hire additional workers to achieve this goal.
There’s no “wrong” or “right” answer for employers. The optimal approach for your company will depend on the particular facts and circumstances. It also will require a balancing act between meeting the company’s needs and being fair to employees. Employers already operating on slim profit margins may seek to cut costs in other ways, including making better use of technology.
At the very least, employers need to review how they manage payroll before December 1. For instance, you may want workers who never had to “punch in” in the past to start reporting their hours worked. Employers will need to think about the nuts-and-bolts of how they want employees to track their time.
The time to address the new final overtime rule is growing short. Is your company ready? If not, consult with your financial and legal advisors to ensure you’ll be in full compliance when the rule goes into effect. These outside professionals can help analyze your payroll systems and determine the best approach for your company.