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Final white collar overtime rule carries a few surprises

By Pamela Wolf, J.D.

The Labor Department has released its highly anticipated final rule on the FLSA exemption for executive, administrative, professional, outside sales, and computer employees—the so-called “white collar” or “EAP” overtime exemption—making some significant changes to the proposed version of the regulation. While some of these changes are within the range of what stakeholders anticipated, others are surprising. The changes are effective December 1, 2016.

Bonuses and incentives. The first surprise is that while the final rule, like the proposed rule, makes no changes to the “duties tests” used to determine whether the white collar exemption applies, it amends the salary basis test so that employers may use nondiscretionary bonuses and incentive payments (including commissions) to satisfy up to 10 percent of the new standard salary level—a move not included in the proposed regulation, although comments were solicited.

Lowest-wage Census Region. The final rule also adjusts downward the weekly salary threshold below which overtime must be paid from the proposed $970 to $913 a week, or stated annually, from $50,440, as projected for 2016, to $47,476—a move that was hoped for, if not anticipated. More surprising is that while the proposed rule set this salary threshold at the 40th percentile of full-time salaried workers nationally, the final rule sets it at the 40th percentile of full-time salaries in the lowest-wage Census Region, which is currently the South. This change was in response to concerns that the “one-size-fits-all” approach of the proposed rule did not take into account the lower salaries paid in some areas of the country, particularly in the South.

HCE exemption. The final rule also increases the pay required for Part 541’s “highly compensated employee” (HCE) exemption to apply from the proposed $122,148 to $134,004—a move not unexpected since it was hoped that the final version would narrow the group of employees who would become overtime-eligible, and the upward adjustment does that.

Three-year adjustments. A final surprising move, however, is that while the proposed rule would have adjusted both exemption thresholds annually, with requests for comments, based on a CPI or percentile basis, the final rule makes automatic adjustments every three years based on the standard salary level at the 40th percentile of full-time salaried workers in the lowest-wage Census region and the HCE total annual compensation at the 90th percentile of full-time salaried workers nationally. The DOL made this change in response to concerns about the burdens associated with updating the salary level on an annual basis. The first adjustment will occur on January 1, 2020.

Proposal drew much controversy. The DOL published its proposed overtime rule in the Federal Register on July 6, 2015. It immediately attracted controversy that led to Congressional hearings and even proposed legislation that would negate any final rule. Republican lawmakers on March 18 unveiled legislation that would require the Labor Secretary to nullify the proposed rule. Introduced by Senator Tim Scott (R-S.C.) (S. 2707) and Representative Tim Walberg (R-Mich.) (H.R. 4773), the measure would also require the Secretary to conduct a specified economic analysis on employers before promulgating any substantially similar rule.

Most recently, on May 11, the Senate Committee on Small Business and Entrepreneurship held a hearing on the anticipated final rule. At the hearing, “An Examination of the Administration’s Overtime Rule and the Rising Costs of Doing Business,” Littler Mendelson attorney Tammy D. McCutchen, who previously served as the DOL’s Wage and Hour Administrator from 2001 to 2004, pointed out that when the proposed rule was first published in July 2015, using its methodology would result in a threshold salary level of $921 per week or $47,892 annually, before the overtime exemption would apply—a level just slightly higher than he final rule’s $47,476 threshold. McCutchen had suggested that the DOL would be unable to justify anything greater than a threshold of just $35,000.

The final version of the rule came after input from 270,000 public comments and extensive outreach meetings with employers, business associations, small businesses, workers, worker advocates, non-profit organizations, educational institutions, and state and local government representatives, according to a White House fact sheet.

Making more workers eligible for overtime. The final rule sets the white collar exemption’s salary floor substantially higher than the $455 a week ($23,660 annually) currently set under FLSA regulations and also increases the floor for the HCE exemption substantially from its current $100,000 a year. These adjustments are expected to extend overtime protections to 4.2 million more American workers who are currently ineligible for overtime pay under federal law and are projected to boost wages for workers by $12 billion over the next 10 years, with average annual wage increases of $1.2 billion, according to the White House fact sheet.

Why the changes? The Labor Department said that it is updating the regulations to ensure that the FLSA’s intended overtime protections are fully implemented and to simplify the identification of overtime-eligible workers. The changes are aimed at making the white collar exemption easier for employers and workers to understand and apply. The updates will also help ensure that going forward, “the regulations continue to appropriately separate workers who are entitled to overtime protections and those who may be exempt.”

White collar exemption tests. In a fact sheet for private employers, the Labor Department underscored that generally, to claim the white collar exemption under the final regulations, individuals must satisfy three criteria, or tests, to be exempt from overtime:

  1. They must be paid on a salary basis not subject to reduction based on quality or quantity of work (salary basis test) rather than, for example, on an hourly basis;
  2. Their salary must meet a minimum salary level, which as of December 1, 2016, will be $913 per week, which is equivalent to $47,476 annually for a full-year worker (salary level test); and
  3. The employee’s primary job duty must involve the kind of work associated with exempt executive, administrative, or professional employees (standard duties test).

Standard salary level. The final rule sets the standard salary level at the 40th percentile of weekly earnings of full-time salaried workers in the lowest-wage Census Region (currently the South). This salary level addresses the DOL’s conclusion that the salary level set in 2004, when the regulations were last updated, was too low given the department’s elimination of the more rigorous long duties test.

For many decades, the long duties test, which limited the amount of time an exempt employee could spend on nonexempt duties and was paired with a lower salary level, existed in tandem with a short duties test, which did not contain a specific limit on the amount of nonexempt work and was paired with a salary level that was about 130 to 180 percent of the long test salary level, the DOL explained. In 2004, the DOL eliminated the long and short duties tests, and the new standard duties test was created based on the short duties test and was paired with a salary test based on the long test.

The effect of the 2004 regulation’s pairing of a standard duties test based on the short duties test (for higher paid employees) with a salary test based on the long test (for lower paid employees) was to exempt from overtime many lower paid workers who performed few EAP duties and whose work was otherwise indistinguishable from their overtime-eligible colleagues, according to the DOL. As a result, there has been inappropriate classification of employees as EAP-exempt who pass the standard duties test but who would have failed the long duties test.

The Labor Department said that the final rule’s salary level represents “the most appropriate line of demarcation between overtime-protected employees and employees who may be EAP exempt, and works appropriately with the current duties test, which does not limit non-EAP work.”

American Samoa and motion picture industry. The DOL also noted that it is also updating the special salary level for employees in American Samoa (to $767 per week) and the special “base rate” for employees in the motion picture industry (to $1,397 per week).

HCE annual compensation requirement. The final rule sets the HCE total annual compensation level equal to the 90th percentile of earnings of full-time salaried workers nationally ($134,004 annually). For the HCE exemption to apply, an employee must also receive at least the new standard salary amount of $913 per week on a salary or fee basis, and also pass a minimal duties test. The DOL said that the HCE annual compensation level set by the final rule “brings this threshold more in line with the level established in 2004 and will avoid the unintended exemption of large numbers of employees in high-wage areas who are clearly not performing EAP duties.”

Automatic updating. The final rule uses a mechanism to automatically update the standard salary level requirement every three years to make sure that it will remain a “meaningful test for distinguishing between overtime-protected white collar workers and bona fide EAP workers who may not be entitled to overtime pay and to provide predictability and more graduated salary changes for employers,” according to the DOL. The updates will maintain a threshold equal to the 40th percentile of weekly earnings of full-time salaried workers in the lowest-wage Census Region. The final rule also automatically updates the HCE compensation level to maintain the threshold equal to the 90th percentile of annual earnings of full-time salaried workers nationally. Likewise, that final regulation will automatically update the special salary level test for employees in American Samoa and the base rate test for motion picture industry employees.

All updated rates will be published in the Federal Register at least 150 days before their effective date, and posted on the Wage and Hour Division’s website.

Nondiscretionary bonuses and incentive payments. Under the final rule, for the first time employers will be able to use nondiscretionary bonuses and incentive payments—including commissions—to satisfy up to 10 percent of the standard salary level. These payments include, for example, nondiscretionary incentive bonuses linked to productivity and profitability. However, in order to credit nondiscretionary bonuses and incentive payments toward a portion of the standard salary level test, the final rule requires that the payments must be paid on a quarterly or more frequent basis and lets the employer make a “catch-up” payment.

The requirement that HCEs must receive at least the full standard salary amount each pay period on a salary or fee basis without regard to the payment of nondiscretionary bonuses and incentive payments is continued in the final rule. The rule also continues to permit nondiscretionary bonuses and incentive payments—including commissions—to count toward the total annual compensation requirement. Permitting employers to use nondiscretionary bonuses and incentive payments to satisfy the standard salary amount for HCEs is not appropriate, according to the DOL, because employers are already permitted to fulfill almost two-thirds of the total annual compensation requirement with commissions, nondiscretionary bonuses, and other forms of nondiscretionary deferred compensation.

Duties tests. The final rule does not alter any of the existing job duty requirements to qualify for exemption. The DOL anticipates that the standard salary level set in the final rule, along with the automatic updating, will work effectively with the duties test to distinguish between overtime-eligible workers and those who may be exempt. Because of the change to the salary level, the number of workers for whom employers must apply the duties test to determine exempt status is reduced, thereby simplifying the exemption, according to the Labor Department. Both the standard duties test and the HCE duties test remain unchanged.

Educational institutions. While some have anticipated that there would be an exemption from overtime for schools and higher educational institutions, the preamble to the final rule states that preschools, elementary and secondary schools, and institutions of higher education are covered by the FLSA, and nothing in the final rule changes that coverage. However, the DOL has provided guidance for employers in higher education. The DOL noted that schools and institutions of higher education are generally covered under the FLSA’s minimum wage and overtime provisions, but several provisions apply to many employees at these institutions that exempt them from the final rule. For example, teachers are exempt when their primary duty is teaching, tutoring, instructing, or lecturing.

Non-enforcement policy. In conjunction with the final rule, the Labor Department also announced a time-limited non-enforcement policy for providers of Medicaid-funded services for individuals with intellectual or developmental disabilities in residential homes and facilities with 15 or fewer beds. Under the policy, from December 1, 2016, to March 17, 2019, the DOL will not enforce the updated salary threshold of $913 per week for the subset of employers covered by this non-enforcement policy. While the non-enforcement policy is in effect, the DOL will engage in outreach and technical assistance efforts, including to providers of services in settings covered by this policy. The policy does not apply to providers of Medicaid-funded services for individuals with intellectual or developmental disabilities in residential care facilities with 16 or more beds.

Additional guidance. The Labor Department has provided extensive guidance on the final rule, including: a final rule webpage; a summary of final rule; a fact sheet: a Q&A document; a comparison between the current, proposed and final rules; guidance for private employers; and guidance for higher education.