DOL Proposes to Increase Salary Threshold for Overtime Exemption: Will It Raise Wages or Cut Hours?

On June 30, 2015, the U.S. Department of Labor announced a notice of proposed rulemaking (NPRM) which proposes to more than double the current salary threshold for the executive, administrative, and professional (EAP) exemptions to overtime.  The proposal aims to plug a gap that some claim has caused many lower-level managers to be unfairly deprived of overtime when they work more than 40 hours.  Skeptics say the new rule likely will decrease the number of hours many employees are allowed to work, replacing full-time workers with part-timers, raise costs, and make it more difficult for hourly workers to climb the ladder to management positions.  The public has 60 days to submit comments on this proposal.  (Read the full text at http://www.dol.gov/whd/overtime/NPRM2015/OT-NPRM.pdf.)

Background.

Since 1940, regulations implementing the white collar exemption to the normal rule that workers are entitled to be paid time-and-a-half overtime when they work more than 40 hours generally have required three tests to be met for the exemption to apply:  (1) the employee must be paid a predetermined and fixed salary that is not subject to reduction because of variations in the quality or quantity of work performed (the "salary basis test"); (2) the amount of salary paid must meet a minimum specified amount (the "salary level test"); and (3) the employee's job duties must primarily involve executive, administrative, or professional (EAP) duties as defined by the regulations (the "duties test"). The proposed new regulations would change the salary requirements.  Salary level requirements have changed seven times since 1938, most recently in 2004 when the Department of Labor’s Wage and Hour Division (WHD) undertook a wholesale revision of Part 541 of the regulations.

Under the current regulations, to qualify for the exemption an executive, administrative, or professional employee must be paid at least $455 per week ($23,660 per year for a full-year worker).  (To qualify for a different exemption for highly compensated employees (HCE), an employee must earn at least $100,000 in total annual compensation.) WHD has long recognized the salary level test as "the best single test" of exempt status. But inflation can erode the level:  if left at the same amount over time, the effectiveness of the salary level test as a means of determining exempt status diminishes as the wages of employees entitled to overtime increase and the real value of the salary threshold falls.

Proposed Changes:  A Big Rise, and Indexing.

In order to maintain the effectiveness of the salary level test, WHD proposes to 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: $921 per week, or $47,892 annually for a full-year worker, in 2013. WHD also is proposing to set the highly compensated  level at the 90th percentile, or $122,148 (up from $100,000 in the 2004 regulations)  Then, in order to prevent the salary levels from becoming outdated, WHD proposes to include in the regulations 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).  The Department is proposing these changes to ensure that the FLSA's intended overtime protections are fully implemented and to simplify the identification of overtime-protected and exempt employees, thus making the exemptions easier for employers and workers (and HR departments) to understand. The current Administration considers that the $455/week salary level set in the 2004 amendments was too low to restrict the exemption to bona fide managerial employees when paired with the standard duties test.

The latest data currently available are for the first quarter of 2015 sets the 40th percentile of weekly earnings at $951, which translates into $49,452 for a full-year worker. Assuming two percent growth between the first quarter of 2015 and the first quarter of 2016, the Department projects that the 40th percentile weekly wage in the final rule would likely be $970, or $50,440 for a full-year worker.

Raising the minimum salary will substantially reduce the number of workers for whom employers must apply the duties test to determine exempt status.  Similarly, setting the HCE total annual compensation level at the annualized value of the 90th percentile of weekly wages of all full-time salaried employees ($122,148 per year, based on 2015 statistics) will ensure that the HCE exemption cover only the top 10% of earners, employees who almost invariably meet all the other requirements for exemption. Finally, automatic annual updates to the standard salary and compensation are designed to ensure that they maintain their effectiveness.

Methodology.

DOL arrived at their estimate for the threshold earnings level by including broad categories of employees, many with high earnings, who are fully exempt from the overtime rules.  The proposed rule uses data including employees previously excluded by the Department in 2004. For example, teachers, physicians, lawyers, outside sales employees, and federal employees were excluded from the 2004 sample because they are not subject to the part 541 salary level test.   The proposed revision included them, and netted many very high earners.  According to BLS, in 2012 physicians and surgeons averaged more than $187,000 in annual earnings; the Office of Personnel Management stated that the average earnings for Federal employees in 2012 was over $78,000.  This makes comparing the 2004 study with the current proposal more difficult.  In a rare fit of transparency, DOL admits that its basis for these calculations is not totally . . . transparent:  "The Department notes that the public will not be able to exactly replicate the weekly earnings and percentiles used in this NPRM from the public-use data files made available by BLS.  As with all BLS data, to ensure the confidentiality of survey respondents, data in the public-use files use adjusted weights and therefore minor discrepancies between internal BLS files and public use files exist. BLS publishes quarterly the earnings deciles of full-time salaried workers on which the Department relies to set the proposed salary level at http://www.bls.gov/cps/research_series _earnings_nonhourly_workers.htm."

Inclusion of Nondiscretionary Bonuses in the Salary Level Requirement.

Until now, WHD looked only at actual salary or fee payments made to employees and, with the exception of the highly compensated test, did not include bonus payments of any kind in this calculation. However, several business representatives asked then to include nondiscretionary bonuses and incentive payments as a component of any revised salary level requirement.  Such payments are an important component of employee compensation in many industries, and might be curtailed if the standard salary level was increased and employers had to shift compensation from bonuses to salary to satisfy the new standard salary level.  The proposed rules provide that in order for an employer to be permitted to credit such compensation toward the weekly salary requirement, the employee will have to receive the bonus payments monthly or more frequently.  (WHD was not willing to consider allowing employers to make a yearly catch-up payment as they may under the HCE exemption.)

Annual Adjustments (Indexing).

In a bid to avoid inflation-driven "bracket creep," WHD proposes to establish a mechanism for automatic updates for the standard salary test, as well as the total annual compensation requirement for highly compensated employees.  (This is an idea that has been considered for the minimum wage, although never formally proposed.)  The Department is considering two alternate methodologies for annually updating the salary and compensation thresholds.  One method would be based on a fixed percentile of earnings for full-time salaried workers.  The other would be based on changes in the CPI-U. Both methods are described in detail in the NPRM.  

Duties Test.

WHD's proposal to set the salary threshold at the 40th percentile of weekly earnings of full-time salaried employees is intended to severely limit the need for a duties test by restricting it only to employees who earn more than the increased salary threshold.  They believe that the proposed salary level increase, coupled with automatic updates, will address most of the concerns relating to the application of the EAP exemption.  A regularly updated salary level will screen out employees who spend significant amounts of time on nonexempt duties and for whom exempt work is not their primary duty.  However, WHD invites comment on whether adjustments to the duties tests are necessary or desirable.  Duties remain a critical metric of exempt status, but it will be relevant to a much smaller number of employees.

Impact on Employers and Employees.

In 2013, there were an estimated 144.2 million wage and salary workers in the United States, of whom DOL estimates that 43.0 million were salaried employees who may be affected by a change to the Department’s part 541 regulations.  Of these workers, DOL estimates that 21.4 million are currently exempt EAP workers under existing rules.  DOL projects that their proposed changes, if adopted, would affect an estimated 4.6 million currently exempt workers who earn at least $455/week but less than the 40th earnings percentile ($921).  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.     

In addition to the 21.4 million potentially affected current EAP exempt workers, WHD estimates that an additional 6.3 million salaried white collar workers who do not satisfy the duties test and who currently earn at least $455 per week but less than the proposed salary level will become entitled to overtime because the salary test alone will determine their status, without the need to examine their duties.  At the current standard salary threshold, there are 11.6 million salaried workers who fail the standard duties test and are therefore overtime eligible, but earn at least the $455 threshold, while there are only 845,500 salaried workers who pass the standard duties test but earn less than the $455 level.  The number of workers who pass the current salary threshold test but not the duties test is nearly 14 times the number of workers who pass the duties test but are paid below the salary threshold.  This underscores the large number of overtime-eligible workers for whom employers must perform a duties analysis, and who may be at risk of misclassification as EAP exempt.  If the salary threshold is raised to the 40th percentile, WHD estimates that the number of overtime-eligible salaried workers who would earn at least the threshold but do not pass the duties test would be reduced to 5.6 million.

Alternatives. 

Employers will not be required simply to raise the pay of all formerly EAP workers to the 40th percentile ($921/week) to comply with these rules.  It is likely that many employers will shift salaried workers paid less than the new minimum to hourly status, with hourly rates that approximate their former salaries, and control costs by restricting overtime.   Salaried, nonexempt pay will remain a viable option to employers interested in controlling overtime expense in states where the practice is permitted (not in California).  This allows an employer to pay a nonexempt employee a guaranteed salary for all hours worked, plus an overtime premium of an additional one-half 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.

Unintended Consequences.

Aside from causing many salaried, managerial employees to take perceived "demotions" to hourly status, the proposed changes will move up that first rung on the ladder of success for many workers – a lot.  The old exemption threshold ($455/week) works out to about $9/hour over 50 hours, not an unusual rate for a starting-level assistant manager at a discount retail chain, for example.  It's certainly an improvement over a starting minimum hourly wage of $7.25.   Learning to be a manager can take time, as the employee learns procedures and develops supervisory skills.  If the starting point for a salaried managerial position is moved up to $921/week, an effective rate of $18.42 over 50 hours, the employer is making more than twice the investment in the employee.  Most employers are not going to be willing to give inexperienced first-timers an opportunity to move up from hourly work at annual rates in excess of $50,000. 

The proposed salary level increase will raise 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.  This may create an incentive to work more overtime.   An employee earning $22.50 per hour will earn $33.75 per hour overtime:  a 60-hour week will cost the employer $1575.  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.  Remember, an employer may adopt a rule prohibiting employees from working overtime, but it must pay if they work.  When more high-earning employees are nonexempt, the stakes will rise for back pay awards (and attorneys’ fees).  The change also may affect employee benefits such as health insurance, since many employers provide more or better benefits to salaried, exempt workers than they do to nonexempt, hourly employees.

Conclusion.

            The proposed steep increase in the minimum amount of salary an employee must be paid to qualify for the "white collar" exemption from overtime, is unlikely to substantially raise the income of more first-level managers right away.  It is more likely that this change will reinforce a perceived social chasm between hourly workers and salaried managers, and delay the promotion of hourly workers into managerial positions where they can grow professionally. 

Questions?  Need more information?  Contact Larry Stine or Betsy Dorminey at (404) 365-0900 or jls@wimlaw.com or ekd@wimlaw.com