On May 18, after more than a year of speculation and debate, the U.S. Department of Labor (the DOL) released a controversial Final Rule updating regulations under the federal Fair Labor Standards Act (the FLSA) governing the “white collar” overtime exemption for executive, administrative, and professional employees.
Most notably, as further discussed below, the Final Rule more than doubles the salary threshold for claiming exemption from overtime, from $23,366 annually to $47,476. The Final Rule will go into effect on Dec. 1, giving employers just six short months to analyze and implement any changes necessary to comply with the new regulations.
Who is covered under the FLSA?
For background, the FLSA applies to any business or entity with annual sales or business in excess of $500,000 (“enterprise coverage”) or to any individual employee engaged in interstate commerce or the production of goods for interstate commerce (“individual coverage”).
Because the definition of engaging in interstate commerce is incredibly broad, many individual employees in the state of Washington are covered under the FLSA even while working for small businesses or non-profits that may not be covered under the enterprise coverage. For example, if an employee makes interstate telephone calls, ships products or materials to another state, or uses a credit card for an out of state purchases, that employee may be engaging in interstate commerce, and would thereby be subject to the FLSA.
What is the Overtime Exemption?
The FLSA establishes minimum wage and overtime payment requirements, which may apply to employers in addition to state laws. The Final Rule does not change the Washington State overtime exemption laws; however, most every employer in the state of Washington is required to comply with both the state and federal wage and overtime laws.
Under the FLSA, employers are authorized to categorize certain employees as “exempt” from overtime requirements, meaning that they are not eligible for overtime pay if they work in excess of 40 hours per week. The most common exemption category is referred to as the “White Collar” exemption, which applies to workers in administrative, executive, and professional capacities.
To qualify for a White Collar exemption, workers must satisfy both a “salary-basis” test and a “duties” test. The salary-basis test sets a minimum weekly salary that must be paid to a worker in order to qualify for exemption from overtime pay; currently that weekly minimum salary is $455 per week.
Under the FLSA, the employer has the ultimate responsibility to determine whether or not a worker properly satisfies both prongs of the White Collar exemption test; failure to properly classify workers as exempt or non-exempt may lead to liability for unpaid overtime wages and penalties under the FLSA. The Final Rule does not change the duties test, but significantly increases the minimum salary for the salary-basis test.
Salary level doubles on Dec. 1
As mentioned, the Final Rule more than doubles the salary requirement for the salary-basis test for the White Collar exemption, increasing the minimum salary from $455 per week ($23,660 annually) to $913 per week ($47,476 annually).
The new threshold sets the salary-basis test at the 40th percentile of weekly earnings for full-time workers in the lowest-wage Census Region (currently the South). The Final Rule will also require, for the first time in the history of the FLSA, that the threshold salary adjust automatically every three years, consistent with the 40th percentile of weekly earning for workers in the lowest-wage Census Region.
While the new salary levels will be effective Dec. 1, the three-year adjustments will begin Jan. 1, 2020. The DOL estimates that the 2020 adjustment will increase the salary level to $51,168 and anticipates publishing the rate change beginning August 1, 2019.
What else does the Final Rule change?
The Final Rule will allow employers to use nondiscretionary bonuses, incentive payments, and commissions to satisfy up to 10 percent of the salary basis test for the White Collar exemption. Under current regulations, employers have been prohibited from factoring commissions, nondiscretionary bonuses, or other incentive payments in the calculation to satisfy the salary level requirement for the White Collar exemption. Under the Final Rule, this restriction is lifted, however, only 10 percent of the salary level can be paid in the form of this incentive pay and such incentive pay must be paid quarterly.
The Final Rule also increased the salary basis threshold for Highly Compensated Employees (HCE) from $100,000 per year to $134,004. The salary level for HCEs, unlike the standard salary level, is based on nationwide data for full-time workers, and set at the 90th percentile.
No changes to the duties test
The Final Rule did not adopt any changes to the duties tests for the White Collar exemption, which is a relief to many employers. The DOL sought comments from the public on whether such changes to the duties test should be made, but decided not to adopt any changes at this time. However, in light of trend setting regulations adopted in other states, including requirements that exempt employees be required to spend no less than 50 percent of their time on exempt tasks, we anticipate changes to the duties test will be forthcoming.
What steps do employers need to take before Dec. 1?
The DOL estimates that approximately 4.2 million additional workers will be eligible for overtime compensation as a result of the Final Rule. In addition, the DOL anticipates the new regulations will result in an increase in wages of $1.2 billion per year.
Local employers will be impacted by the new regulations, and should pay close attention to the new regulations. We anticipate many employers will discover that employees formerly classified as exempt from the overtime laws will now be eligible for overtime pay (unless employers implement changes in compensation structure).
Generally, it is a good idea to review exemptions annually for compliance with the salary-basis and duties tests. Employers should conduct internal audits as soon as possible to identify workers who fall below the new salary threshold and make changes to the compensation structure prior to Dec. 1. Due to the automatic salary increase adopted by the Final Rule beginning in 2020, employers should also be sure to conduct internal audits for the salary-basis test at least every three years to ensure continued compliance with the Final Rule.
If an internal audit identifies workers that are classified as exempt, but will now fall under the new salary threshold, employers must take steps to comply with the new regulations before Dec. 1, or risk penalties. Potential options for compliance include:
• Increase employee salaries to the new salary level and continuing to treat employees as exempt (assuming they satisfy the duties requirements);
• Reclassify employees as non-exempt and pay overtime for hours worked over 40
• Reduce employee hours to avoid overtime work.
The changes to the FLSA White Collar exemption salary-basis test adopted by the Final Rule are unprecedented and will have significant impact on many local businesses, including non-profits. Although the DOL provides guidance and fact sheets regarding compliance with the Final Rule on its website, employers are encouraged to consult with a labor and employment attorney to assist with navigating the new regulations and assuring compliance to avoid potential penalties.
Julie Norton and Erin McCool are labor and employment attorneys at Ogden Murphy Wallace, providing management advice and guidance to local businesses, municipalities, and non-profits.