The Final New Overtime Rule is Finally Here

On May 18, 2016, the U.S. Department of Labor released the final rule raising the minimum salary an employee must make to be exempt from overtime and, by that act, making many more salaried employees eligible for overtime compensation. The rule may be found here. The changes to the old rule are few and not surprising as they closely track the proposed rule published last July. The most significant change is, as expected, an increase in the amount an employer must pay for an employee to qualify for exempt status. It increases from the current $455 per week to $913 per week – that’s an increase of just over 100% from $23,600 annually to $47,476 annually. The new salary minimum will be effective December 1, 2016.

Background

Under the Fair Labor Standards Act, an employee is entitled to overtime premium pay of one-and-one-half times their regular rate of pay after working 40 hours in a week, unless an exemption applies. If an exemption applies, the employee is said to be “exempt” and is not entitled to overtime pay no matter how many hours they work in a week. An exemption applies if the employee is salaried and the position meets the requirements of the executive duties test, the administrative duties test, or the professional duties test.

But even if the employee is salaried and the position satisfies one of the three duties tests, the exemption does not apply if the employee is paid less than $455 per week, or $23,660 on an annualized basis. Such a low-paid, salaried employee is entitled to overtime pay after 40 hours.

For an explanation of the salary basis test, see here. For discussion of the executive duties test, see here, the administrative duties test, see here and here, and the professional duties tests, see here and here.

Some History

March 2014: President Obama Calls for the Overtime Regulations to Be Updated

In March 2014, President Obama directed the U.S. Secretary of Labor to modernize and simplify the federal Fair Labor Standards Act regulations. The President was particularly concerned that the minimum required salary for exemption from overtime, known as the salary threshold, had not kept up with inflation. In 1975 the salary threshold was $250 per week. The next time the salary threshold was raised was in 2004, when it went to $455 per week. There it has stayed since 2004. The President noted that in 2014, $455 per week was below the poverty line for a family of four, and well below 1975 levels when adjusted for inflation. In 2014, only 12 percent of salaried workers fell below the minimum salary threshold (the 12^th percentile) – compared with 18 percent in 2004 and 65 percent in 1975 (the 18^th and 65^th percentiles).  The President did not tell DOL how to revise the regulations, but it was clear that he wanted to bring more employees out of exempt status and to give them the benefits of overtime compensation. And that is exactly what the new overtime regulations do.

July 2015: DOL Issues Proposed New Overtime Regulations

The Department of Labor (DOL) issued proposed regulations in July 2015, suggesting a raise to the 40^th percentile of full-time salaried workers – which was $921 per week or $47,892 per year based on data from 2013, and expected to be $970 per week or $50,440 per year in 2016. DOL also proposed that the minimum salary be automatically increased on an annual basis. Finally, DOL proposed a change in the minimum salary required for an employee to be exempt under the highly-compensated employee test from $100,000 to $122,148 annually. DOL left open the possibility that it would revise one or more of the exempt duties tests in the final rule, showing particular interest in limiting the amount of time an exempt employee could spend on nonexempt duties. As required by the federal Administrative Procedures Act, DOL asked for comments on its proposed rule. The comment period closed in September 2015.

The Final Rule

The final rule deviates from the proposed rule only in detail. In a nutshell, the final rule

• raises the minimum salary necessary for an employee to be exempt from overtime from the current $455 per week ($23,660 annually) to $913 per week ($47,476 annually);
• raises the minimum salary necessary for an employee to be exempt from overtime as a highly-compensated employee from $100,000 annually to $134,004 annually;
• provides for automatic updating of the salary thresholds every three years;
• allows employers to include nondiscretionary bonuses in an amount up to 10% of the minimum salary level;
• makes no changes to the duties tests; and
• makes no changes to any of the other rules regarding compensable time and overtime.

The final rule is effective December 1, 2016.

Minimum Salary Threshold of $913 Per Week

The new threshold of $913 per week represents the 40^th percentile of earnings for a full-time (35 hours per week), full-year, salaried worker in the fourth-quarter of 2015. In the preamble to the final rule, DOL reiterated its conviction that a standard salary level at the 40^th percentile will be a “bright line” that adequately distinguishes between employees whose positions are likely to meet the duties test requirements and those whose positions are likely not to do so.

DOL did make one change in response to comments it received. A number of commenters expressed concern about the fairness of setting the minimum salary threshold based on a nationwide average. The commenters believed that it unduly disadvantaged employers in a lower-wage region or a lower-wage industry. The final salary threshold is therefore set at the 40^th percentile of earnings all full-time salaried workers in the lowest-wage census region, which at this time is the South Census Region.  

The rule setting forth the new minimum salary threshold will be found at 29 CFR § 541.600 effective December 1, 2016.

New! Inclusion of Nondiscretionary Bonuses in the Minimum Salary

One additional change will affect public employers who use longevity pay plans. The new rule for the first time allows nondiscretionary bonuses and commissions to be included – to a limited extent – in the calculation of an employee’s minimum salary. In the final rule, DOL limits the amount of nondiscretionary bonuses and commission that may be used to satisfy the minimum salary threshold to ten percent of the minimum required salary, currently $91.30 per week or $4,747.60 annually, provided that the bonus or commission is paid quarterly or more frequently.

What is a nondiscretionary bonus?

To better understand what this new provision offers local government employers, let’s first discuss what counts as a nondiscretionary bonus. The distinction between discretionary bonuses and nondiscretionary bonuses is explained at 29 CFR § 778.211. A discretionary bonus is one which may be given or not in the sole judgment of the employer. It is up to the manager to decide to which employees and in what amount to award a bonus. A nondiscretionary bonus, in contrast, is one which accrues to the employee automatically as a function of policy or ordinance. Bonuses that DOL considers nondiscretionary are:

• bonuses which are announced to employees to induce them to work more steadily or more rapidly or more efficiently or to remain with the organization;
• attendance bonuses;
• individual or group production bonuses;
• bonuses for quality and accuracy of work;
• bonuses contingent upon the employee’s continuing in employment until the time the payment is to be made (longevity pay, for example).

Among public employers, longevity pay is the most frequently used form of nondiscretionary bonus. Public employers have traditionally paid longevity bonuses once a year. To make use of longevity payments in meeting the salary threshold for exempt status, those employers will have to change their practices and make longevity payments on either a weekly or a quarterly basis. A once-a-year payment may not be in calculating compliance with the salary threshold. Relatively few public employers, award nondiscretionary merit bonuses based on meeting productivity metrics and there are few public-sector positions that involve commission-based compensation.

How Will the Inclusion of Nondiscretionary Bonuses Work in Practice?

Effective beginning December 1, 2016, and continuing until the next update of the minimum salary threshold on January 1, 2020 (on which, see below), the amount of nondiscretionary bonus payments that may be credited toward the salary minimum for exemption will be $91.30 per week ($4,747.60 annually) (that is, 10% of the salary threshold). Employers using nondiscretionary bonuses to meet the salary threshold will need to double-check that employees for whom they are claiming exempt status on this basis are in fact being paid the required minimum salary. As a practical matter, employers will need to do this on a quarterly basis, as DOL is allowing employers to make a “catch-up” payment to bring an employees within the required salary level within one pay period of the end of a quarter. DOL explains how this will work in the preamble to the final rule:

1. Each pay period an employer must pay the exempt salaried employee at least $821.70 (that is, 90 percent of the minimum salary threshold.
2. At the end of the quarter, if the sum of the salary paid plus the nondiscretionary bonuses and incentive payments paid does not equal $11,869 (that is, the standard salary level multiplied by the 13 weeks of the quarter), the employer is allowed one pay period to make up for shortfall.
3. The shortfall cannot exceed $91.30 per week or $1,186.90 for the quarter, which is 10 percent of the minimum salary threshold.
4. Any catch up payment counts toward only the prior quarter’s salary amount. It will not count toward the salary amount in the quarter in which it ends up actually being paid.

An Additional Clarification

The inclusion of nondiscretionary bonuses in the minimum salary threshold does not change any other aspect of the salary basis or salary threshold tests. As has always been the case under the FLSA, discretionary bonuses, employer contributions to health, disability and life insurance and employer contributions to LGERS and the North Carolina 401(k) Plan may not be included in the calculation of whether an employee’s salary meets the minimum salary threshold.

The provision allowing the use of nondiscretionary bonuses and commissions in up to 10% of the amount of the minimum salary threshold will be found at 29 CFR § 541.602(a)(3 effective December 1. 2016.

The Highly Compensated Employee Salary Threshold

DOL also increased the minimum salary necessary for a position to qualify as exempt under the special highly-compensated employee exemption from $100,000 to $134,004 annually. The new threshold is set at the 90 percentile of earnings of all full-time employees nationally for the last quarter of 2015.

Currently, employees can be exempt if they are paid $100,000 annually and perform just one of the exempt duties of the executive, administrative or professional duties tests. The idea behind the highly-compensated employee exemption is that the very high salary threshold offsets this exemption’s minimal duties test. The current highly-compensated exemption allows for compensation in excess of $455 per week to be in the form of nondiscretionary bonuses or commissions and allows employers to make a final “catch-up” payment to bring the employee’s salary up to $100,000 per year within one month after the end of the year.

As before, employers making use of the highly-compensated employee exemption will be able to use nondiscretionary bonuses and commissions in any amount in calculating the minimum salary, provided that the employee makes at least $913 per week (in other words, the ten percent limitation applicable to the standard salary threshold does not apply here). Employers will also be allowed to make a final “catch-up” payment to bring the employee’s salary up to $134,004 by the end of January of the following year.

The new minimum salary threshold for highly compensated employee will be found at 29 CFR § 541.601 effective December 1, 2016.

Automatically Updating the Minimum Salary Threshold

In the past, the minimum salary threshold has been updated sporadically. DOL is now instituting a regular, automatic update to 1) ensure the salary threshold maintains its effectiveness as a bright line rule to distinguish between exempt and nonexempt positions and 2) make changes to the threshold more predictable for employers. DOL will now update the minimum salary threshold every three years. The first update will be effective on January 1, 2020. It will be based on the 40^th percentile of earnings of full-time salaried employees in the lowest-wage census region. DOL projects that the threshold will be $984 per week ($51,168 annually) beginning in 2020. For employees for whom employers are seeking an exemption under the highly-compensated employee test, the salary threshold will be set at the 90^th percentile of earnings of full-time, salaried employees nationally. DOL projects that the highly compensated employee salary threshold will be $147,524 beginning in 2020.

DOL will publish the updated salary thresholds in the Federal Register at least 150 days before the effective date (in other words, the notice of the January 1, 2020 update should be published in the Federal Register no later than August 4, 2019). It will also post information about the updated thresholds on its website.

The new rule providing for automatic updating will be at 29 CFR § 541.607 effective December 1, 2016.

The Duties Tests Have Not Been Revised

In the proposed rule, DOL floated the possibility of revising the executive, administrative and professional duties tests. The Department expressed concern that the current tests allow exempt employees to performing a disproportionate amount of nonexempt work along with their exempt work. The new rule does not include any changes to the duties tests.

Overtime Provisions That Will Not Change

The new rule will have a significant impact on public employers, turning many employees who are currently exempt from overtime into nonexempt employees. These newly nonexempt employees will now need to be compensated at one-and-one-half times their regular rate of pay whenever they work more than 40 hours in a workweek. The new rule will not, however, change any of the other FLSA provisions relating to overtime:

• Public employers may continue to use compensatory time-off or “comp time” in lieu of cash overtime. On comp time, see here.
• Public employers may still use the 28-day work cycle of the 207(k) exempt for paying overtime to law enforcement officers and firefighters. On the 207(k) exemption, see here.
• The fluctuating workweek will continue to be available as a method of paying overtime to those employees who sometimes work fewer than 40 hours per week and sometimes work more than 40 hours per week. On the fluctuating workweek method, see here.
• Small employers who have fewer than five law enforcement officers on the payroll in any workweek or fewer than five firefighters on the payroll in any workweek continue to be exempt from paying overtime to those officers and firefighters in those workweeks.
• The rules governing what time is compensable and what is not remain the same.

For those interested in learning more about the new overtime rule, including how the revised rule will effect public employers and what options public employers have for dealing with the challenges the new rule poses to their budgets, please join me for the School of Government’s webinar, The New (and Final) FLSA Overtime Regulations, on June 4, 2016 at 10 a.m. Registration is $125 per site (for an unlimited number of participants) and may be found here.

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