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U.S. Department of Labor Issues Final Regulations on Overtime Exemptions

Client Updates

On May 17, 2016, the Department of Labor’s Wage and Hour Division (the “DOL”) published the final rule increasing the salary basis requirement to establish that an executive, administrative, professional, outside sales, or computer employee is exempt from overtime pay (the “Final Rule”). Under the Final Rule, an estimated 4.2 million formerly exempt employees under the white collar exemptions will now be entitled to overtime pay as required by the Fair Labor Standards Act (“FLSA”). This rule is effective as of December 1, 2016.

Highlights of the Final Rule for Employers:

  • Effective date is December 1, 2016 
  • Required salary level is $913/week ($47,476 per year) 
  • Highly compensated employee salary level is $134,004 
  • First automatic increase date is January 1, 2020
  • Bonus, incentive, and commission payments may count up to 10% of the salary level for employees who are not classified as highly compensated

Details of the Final Rule’s Changes to the Overtime Regulations

The DOL contends that an employee’s salary is the most effective test of whether a white collar employee should be exempt from overtime. Even so, the DOL has not updated the overtime regulations’ salary level requirements since 2004. Currently, in order to qualify for one of the white collar exemptions, a full-time employee must be paid at least $455 per week, which equates to $23,660 per year.

After President Obama directed the DOL to revise the regulations that determine how white collar workers are to be treated under the FLSA, the DOL initially proposed changes to the salary level requirement, including a mechanism that would automatically update the salary level annually based on a nationwide salary level, and sought comments on whether bonuses or incentive payments should count toward the salary level.

The Final Rule sets the standard salary level needed to qualify for a white collar exemption at $913 per week, which equals $47,476 annually, for a full-time employee. This salary level is equal to the 40th percentile of earnings of full-time salaried workers in the lowest-earning Census region, currently the southern United States, not nationwide as originally proposed.

The level will be updated automatically every three years in keeping with the fixed percentiles of weekly earnings set in the Final Rule. The first update to the threshold levels will be effective on January 1, 2020. On this date the DOL anticipates that the standard salary level will likely be $984 per week, or $51,168 if annualized, for a full-time employee.

In calculating an employee’s salary level, for the first time, the Final Rule permits employers to count non-discretionary bonuses, incentives, and commissions as up to 10% of the required salary level for the standard exemption, as long as those amounts are paid on a quarterly or more frequent basis.

The Final Rule also sets the total annual compensation level for highly compensated employees (“HCE”) at $134,004 annually for full-time employees. This amount is equal to the 90th percentile of earnings of full-time salaried workers nationwide. In addition, the HCE total annual compensation level is subject to the same automatic updates every three years. As of January 1, 2020, the DOL anticipates that the HCE total annual compensation requirement will be $147,524. However, if an employee falls short of the HCE total annual compensation level threshold required to achieve exempt status, the employer may make one final payment sufficient to achieve the required level if this payment is made during the last pay period or within one month after the end of the 52 week period. In contrast, employers may not count bonus, incentive, or commission amounts toward the HCE total annual compensation level.

Potential Impact of the Final Rule for Employers

The DOL estimates that approximately 4.2 million currently exempt employees will likely become entitled to overtime pay (barring further action by their employers). Furthermore, approximately 65,000 currently exempt high-earning employees who meet certain duties requirements will become eligible for overtime pay (those who earn more than the previous $100,000 threshold but less than the new $134,004 threshold). Over the next ten years—based on the automatic salary level increases every three years—approximately 5 million workers will be affected by the standard salary level change, and 221,000 workers will be affected by the HCE total annual compensation change.

Next Steps for Employers

Anticipating the changes, many employers have been reviewing their employee populations that are projected to lose an exemption due to the increase in salary levels and determining whether the employees are working overtime and how much. Then, employers are considering, among many other factors, whether it is more cost-effective to give employees a pay increase to meet the new salary level requirements or to have the employees track their hours and pay them overtime when required.

With an effective date of December 1, 2016, employers have ample time to analyze how the Final Rule may affect their employees and take action to comply with the updated regulations, consider adjustments to employees’ compensation arrangements, or train employees and managers on the employer’s time tracking system and policies. These issues will require thoughtful consideration and legal analysis from in-house counsel and human resources professionals over the coming months.

If you have any questions about how your organization may be affected by the Final Rule, please contact the Baker Botts L.L.P. Labor & Employment Practice Group.

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