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June 1, 2016

How Recent Changes to the Fair Labor Standards Act’s “White Collar” Exemptions May Affect Your Small Business

On May 18, 2016, the Department of Labor published a Final Rule updating the regulations that set forth the exemption from the minimum wage and overtime pay protections of the Fair Labor Standards Act (“FLSA”) for executive, administrative, and professional employees. This Final Rule will go into effect on December 1, 2016, and while it does not change the basic structure of the EAP exemption, it does make several changes that will affect employers of all sizes.

What the Final Rule Does Not Change: A Primer on the FLSA “White Collar” Exemptions

Generally speaking, the FLSA ensures minimum wage and overtime pay protections for most employees. Certain classes of employees, however, are exempt from some of the FLSA’s protections. These classes of “exempt” employees include bona fide executive, administrative, and professional (“EAP”) employees and highly compensated employees (“HCE”), and are sometimes collectively referred to the “white collar exemptions.”

With respect to the EAP exemption, under the Department of Labor regulations in place since 1940, employers may only properly characterize employees as EAP employees if they satisfy each of three separate tests:

  • Salary Basis Test: The EAP employee must be paid a predetermined or fixed salary that is not subject to reduction based on variations in the quality or quantity of work performed.

  • Salary Level Test: The amount of salary paid to an EAP employee must meet a minimum specified amount.

  • Duties Test: The EAP employee’s job duties must primarily involve executive, administrative, or professional functions as those terms are defined by Department of Labor regulations.

With respect to the HCE exemption, an employer may properly characterize employees as HCE employees if they meet three requirements: (1) their duties must comprise office or non-manual work; (2) they must satisfy HCE compensation requirements; and, (3) they must regularly perform at least one of the duties of a bona fide EAP employee.

The Final Rule leaves the general structure of both of these “white collar exemptions” unchanged.

What the Final Rule Does Change: Salary Thresholds and Calculations

Although the Final Rule does not change the structure of the “white collar exemptions,” it does update some of the thresholds and salary calculation methods.

The Final Rule primarily focuses on updating the “white collar exemptions” by making four changes (this is not an exhaustive list of changes made by the Final Rule):

  • Updating the Compensation Requirements for EAP Employees: The Final Rule increases the minimum salary that must be paid to bona fide EAP employees to qualify for the exemption to $47,476 annually/$913 per week (up from approximately $23,660 annually/$455 per week). This new salary threshold represents the 40th percentile of earnings of full-time salaried workers in the lowest-wage Census region (currently the South).

  • Permitting the Inclusion of Nondiscretionary Bonuses in Salary Level Test Calculation for EAP Employees: The Final Rule amends the Salary Basis Test for EAP employees to permit employers to count nondiscretionary bonuses and incentive payments (including, most notably, commission payments) to satisfy up to 10% of the new standard salary level.

  • Updating the Compensation Requirement for HCEs: The Final Rule also increases the minimum salary that must be paid to employees for them to qualify for the HCE exemption to $134,004 annually (up from approximately $100,000). This new salary threshold represents the 90th percentile of full-time salaried workers nationally.

  • Establishing Automatic Updates to These Salary Levels: The Final Rule establishes a mechanism by which the salary and compensation levels for EAP employees and HCEs shall be automatically updated every three years so as to maintain the salary levels at the percentiles set forth in the Final Rule (i.e., 40th percentile of the lowest Census region for EAP employees, and 90th percentile nationally for HCEs).

So what does the Final Rule mean to employers?

Although the Final Rule leaves the general structure of the EAP and HCE exemptions intact, the changes to the salary thresholds and the manner by which employers may calculate those salaries means the Final Rule will still have a significant impact on employers. At a minimum, employers should consider the following in light of the Final Rule:

  • Compliance with the Final Rule: First and foremost, employers are strongly encouraged to analyze their payroll documentation well in advance of December 1, 2016 (the effective date of the Final Rule), to ensure that all employees who are entitled to FLSA protection under the Final Rule (i.e., those that do not qualify as EAP employees or HCEs) are receiving those protections. The Department of Labor has provided six months of lead time for employers to bring themselves into compliance, so violations could lead to significant penalties.

  • Employee Adjustments: In light of the Final Rule’s significant increases to the compensation requirements for EAP employees and HCEs, it is likely that employers will have some employees who previously qualified for a “white collar” exemption but who no longer do because their salaries fall below the updated thresholds. Absent adjustments on the part of the employer, such employees stand to lose their “exempt” status and, therefore, must begin receiving FLSA protections again, including overtime pay. Employers may want to consider making certain adjustments to mitigate the financial impact of these changes. For example, if a previously exempt salaried EAP employee earns too low of a salary to qualify for the exemption under the updated thresholds, the employer may want to consider either adjusting the employee’s salary up to satisfy the threshold (e.g., if his/her salary is very close to the new threshold such that the raise is a smaller amount than he/she would earn in overtime) or, alternatively, reclassifying the employee as a non-salaried employee with a limit or cap on allowable overtime.

  • Applying Bonuses When Calculating EAP Employee Salaries: This is one area where employers may stand to actually benefit from the Final Rule. To the extent an employer pays any of its EAP employees nondiscretionary bonuses or incentive payments—for example, sales commissions—it should consider recalculating those employees’ salaries taking into account the Final Rule’s authorization that such bonuses/incentive payments may now be used to satisfy up to 10% of the salary threshold. Depending on the amounts of such payments, it is conceivable that employees who otherwise would not reach the required threshold for the EAP exemption will qualify when that 10% is taken into account.

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