New Year's Regulation: Misclassifying Employees as Exempt

New Year’s Regulation: Misclassifying Employees as Exempt

Article by Jack Clary

The holidays are upon us, which means 2015 is quickly coming to a close. Amid all the festivities, don’t leave your business out in the cold. Specifically, there are new laws taking effect in the new year that could have a major impact on you and your enterprise.

Pending overtime regulations which will shrink coverage under the salaried “white-collar” exemptions are coming in early to mid-2016.  Now is the time to assess how they will impact your business.

New proposed regulations will nullify salaried exempt status for many because the salary threshold for exemption will at least double—to about $50,440+/year ($970+/week) from the current $23,660 ($455/week).  The exemptions at issue are Executive, Administrative, Professional and Highly Compensated.  In addition, government enforcement targeting employees misclassified as independent contractors has become more vigorous. 

Misclassifying salaried employees as exempt from overtime is one of the more common and costly problems in employment law compliance.  Federal wage-and-hour lawsuits, including government enforcement, have climbed more than 400 percent since 2000 to over 8,000 lawsuits annually.  To date, the sectors hardest hit have been financial services, IT and sales forces, clerical and administrative staff, retail, and small contractors, among others. 

On June 30, 2015, the US Department of Labor (DOL) announced its proposed rule to reduce the number of salaried exempt workers next year by an estimated 4.6 million-plus and at least tens to hundreds of thousands more every year thereafter.  Every year the salary level for exemption will change as a percentile of the workforce nationwide, and you will have about only 60 days to be in compliance.  Heralded by the Obama Administration as middle class progress, unfortunately the impact may backfire and depress worker income among other negative impacts.  The public comment period expired this past September, and the DOL is now finalizing the new rules.

The Main Proposed Changes and Unknowns

Salary Level More Than Doubles.

  • The regulations are expected to require a salary at or above the 40th percentile of full-time salaried workers (currently $921 per week/$47,892 annually) which is estimated to be $50,440 ($970 per week) in the first quarter of 2016.  This is the salary below which employees automatically are nonexempt and eligible for overtime.  This minimum salary level is to be indexed upward annually for inflation (there was no discussion about downward adjustment), either usng the 40th percentile or CPI-U.  This salary is a nationwide “one-size-fits-all” floor, with no accounting for variations in the cost of living and compensation rates and structures.  The Midwest and South typically have lower cost of living and compensation rates.

Highly Compensated Employees Level Increases. 

  • Proposed is an increase in the HCE salary threshold from $100,000 currently to about $122,148, a final amount to be set nearer the effective date. This number is at the 90th percentile of full-time salaried workers and will change annually based on the percentile or the CPI-U.  Again, 60 days to be in annual compliance is proposed.

Employers Left Guessing on “Duties” Tests. 

  • The DOL did not propose changes to the "primary duty" legal tests for the various exemptions, but is "concerned…the current tests may allow exemption of employees who are performing such a disproportionate amount of nonexempt work that they are not [exempt] employees in any meaningful sense."  That concern prompted inviting public comment on pegging the amount of duties performed to less than 50% nonexempt work (like under California law) or even less. This cap particularly targets the Executive exemption because (most courts have ruled) it currently permits more than 50% nonexempt work so long as the various duties tests are met.  In this regard, think about the difficulty in administering systems to precisely keep tract of the different amount (hours) of duties performed every day for those paid high enough otherwise to be exempt. 

Inclusion of Nondiscretionary Bonuses in the Salary Threshold Not Clear.

  • Nondiscretionary bonuses are those required to be factored into the regular straight-time hourly rate of pay for overtime, and is one of the more frequent areas for wage-and-hour violations.  Nondiscretionary bonuses include those based upon the quantity or quality of work (for example, bonuses for production or performance, profitability, and attendance, etc.).  Will these be permitted to satisfy a portion of the salary thresholds ($50,440+, $122,148+)?  Right now it’s unknown.  The DOL has said it is possible,  citing 10 percent if paid on some regular schedule such as at least monthly or more frequently (not the quarterly or annual norm for bonuses).  Discretionary income, board, lodging or various benefit payments are not to be included in the salary thresholds.

Potential Pain and Cures

Pain Examples

  • Nonexempt often means loss of scheduling flexibility.
  • Nonexempt employees lose opportunities for incentive pay / bonuses, because most need to be rolled into the regular hourly rate of pay in calculating overtime.
  • Reclassified as nonexempt can be perceived as a demotion and can be demoralizing.
  • Publicity and reclassification may cause employees to question whether they are properly classified and owed overtime (for 2 up to 3 years looking back) and seek legal counsel, triggering litigation.
  • Longstanding staffing and compensation structures will be impacted.

Cures - Planning Ahead Sooner Than Later

Operational and financial analysis are needed regarding the following, for example:

  • What staffing is to be, particularly for "close-to-the-line" positions, and for the various functions, lines, deparments, etc. and the job classifications whether managerial, supervisory, production/services, technical, clerical, etc.?
  • What work schedules are to be?
  • What overtime costs will be, including calculating overtime rates (i) if changes are not made to operations, work schedules, job functions, salaries and wages, and (ii) what must they be for your bottom line in the mix of making the various example changes listed here in these bullets and other changes implicated for your enterprise?
  • What salaries need to be raised to meet the new thresholds, or lowered, or converted to hourly, with job functions, increased, bolstered, eliminated, transferred or combined, depending on work schedules, etc.? The correct hourly rate can be computed so that, taking inot account projected overtime at the 1.5 rate, the cost for the employer will be the same (or close to) that of before, if desired
  • What impact do all of these have on fringe benefits and their costs in overall labor costs?
  • Where there will be reclassification to nonexempt, and for all other changes, communications strategies and their timing, timekeeping procedures, training at all levels, monitoring morale, etc. need to be determined.
  • For employers with collective bargaining obligations, there is needed analysis of mandatory bargaining duties and strategies including timing for expected changes to current and possibly new additonal or eliminated bargaining unit positions resulting from legal compliance. 
  • Monitor what is occurring at the DOL about the duties tests—For now, employers must base decisions on the current duties tests, with a view at least towards those who will meet the dramatically increased salary threshold.  But pay close attention to Washington/the DOL over the next several months into 2016 and do some advance predictions and assessments if a 20% to 50% limit on performing nonexempt work can be operationally feasible for those who will meet the salary threshold and, if not, what you will need to do regarding this amount of exempt versus nonexempt work.

Depending on the size of your exempt workforce, operational and financial needs, and culture, the changes required by these new regulations may or may not be significant.  Nevertheless, sorting out their potential impact on you is advisable in the near term. For more information or assistance, please let us know.

Posted on December 03, 2015
Tagged as Labor & Employment Law