New Overtime and 'Exempt' Rules Apply December 1, 2016
Article by Jack Clary
The US Department of Labor recently set December 1, 2016 as the deadline to comply with the new standards governing exemption from overtime as a salaried executive, administrative or professional employee (EAP), or as a highly compensated employee (HCE). Under the new standards, the Obama Administration estimates 4.2 million workers now treated as exempt will become entitled to overtime pay when working over 40 hours in a workweek. This article first highlights the new mandates, then explains why “built-in” overtime, that employers may consider to be a quick fix, almost always does not pass muster. Various compliance considerations were outlined in our December 3, 2015 article “New Year’s Regulation: Misclassifying Employees As Exempt” (see Cures - Planning Ahead Sooner Than Later).
The New Standards
The DOL’s Final Rule primarily hikes the salary and compensation levels required for EAP’s and HCE’s to be exempt. It did not change the additional “white-collar” duties tests for exemption from the 2004 regulations. The new standards include the following:
For an EAP, the standard salary level is $913 per week or $47,476 annually for a full-time worker, and subject also to the respective EAP duties tests;
For an HCE, the total annual compensation requirement, subject to a minimal duties test, is $134,004;
Automatic updating of the salary and compensation levels will occur every three years effective January 1 (starting January 1, 2020) to maintain the levels at the 40th percentile earnings of full-time salaried workers for EAP’s, and 90th percentile for HCE’s, and to ensure the threshold levels continue to provide, as the DOL says, useful and effective tests for exemption; the future updated levels will be published in the Federal Register and DOL Wage and Hour Division’s website 150 days before they are effective; and
The salary basis test is changed to permit using nondiscretionary bonuses and incentive payments, including commissions, to satisfy up to 10 percent of the new standard salary level ($913/$47,476) for EAP’s and, for HCE’s, to make up the difference between that standard salary level ($913/$47,476), which must be paid, and the new HCE threshold of $134,004 annually.
Regarding #4 for EAP’s, to credit nondiscretionary bonuses and incentive payments (including commissions) up to the maximum 10 percent portion of the standard salary level ($913/$47,476), those payments must be paid quarterly or more frequently. If an employer sets a salary below the new threshold and relies on such bonuses/incentives/commissions to make up the difference, but not enough are earned in a quarter, a "catch-up” payment at the end of the quarter is allowed. In that case an employer has one pay period to make up the shortfall (up to 10 percent of the standard salary level for the preceding 13 week period). Any such catch-up payment counts only toward the prior quarter's salary amount and not toward the salary amount in the quarter in which it was paid. If there is no catch-up payment, the employee is entitled to overtime pay for any overtime hours worked during the quarter.
HCE’s must be paid at least the standard salary level of $913 per week/$47,476 per year on a salary or fee basis, while the remainder of the total annual compensation required may include commissions, nondiscretionary bonuses, and other nondiscretionary compensation. In the DOL’s view, because employers may fulfill almost two-thirds of the HCE total annual compensation requirement of $134,004 with commissions, nondiscretionary bonuses, and other forms of nondiscretionary deferred compensation, the DOL decided not to allow employers to also use these to satisfy the standard salary level as is allowed for EAP’s.
Although it may seem as if the DOL tossed a bone to employers in allowing the use of nondiscretionary bonuses and incentive pay (including commissions), the changes can present a catch-22. The catch is that, as has always been the case, nondiscretionary/incentive payments must be included in calculating the regular straight-time hourly rate of pay for non-exempt workers, which is used to calculate the 1.5x overtime pay rate. Many employers use nondiscretionary bonuses to retain personnel or induce them, for example, to work more efficiently, such as bonuses for meeting production quantity or quality goals or for good attendance. Discretionary bonuses, in contrast, are those for which the decision as to both awarding of the bonus and its amount is at the employer's sole discretion and not pursuant to any preannouncement, such as an unannounced bonus which is not often recurring, or a spontaneous reward for a specific act or result.
Some employers may find that the cost and administrative burden of inclusion of nondiscretionary/incentive payments in the regular hourly rate of pay for most of the workforce may outweigh the potential benefit now permitted to reach the standard salary and annual compensation levels for some of the workforce intended to be exempt. More likely is that employers providing such bonuses/incentives have found them to be beneficial and worth their cost, including their direct impact upon overtime costs. In any event, if using the up to 10 percent quarterly or more frequent nondiscretionary/incentive payments to get to the new threshold salary level, those payment “numbers” should be well planned out and therefore fairly predictable.
Can You “Build In” Overtime Pay?
Based upon inquiries over the years including since these regulations were proposed last year, more than a few employers may believe it is acceptable to pay weekly salaries where overtime pay is built in for a certain number of overtime hours worked. For example, take Jane, who will no longer be treated as exempt December 1, 2016 because she will not earn enough, yet her employer still wants to keep her on a weekly salary (in and of itself perfectly okay). Jane consistently works over 40- up to 45-hour weeks unless out ill or on vacation or holiday. The hourly equivalent for her salary is $15.50 per hour, so by December 1, 2016 her new salary is pegged to a 45-hour workweek and is therefore $736 [rounded ($15.50 x 40 ST hours = $620) + ($15.50 x 1.5 x 5 OT hours = $116.25) = $736.25]. Where Jane works up to 45 hours in a workweek she will get the $736; where she works over 45 she will get the $736 plus added pay at the rate of $15.50 x 1.5 = $23.25 per hour for the extra overtime worked over 45. This may seem sensible or logical, but it’s unlawful.
The reason this “built in” pay runs afoul is that overtime pay must be calculated using the regular straight-time hourly rate of pay. This regular rate is almost always calculated by dividing the total workweek compensation for the hours worked by the total hours worked in that workweek. Therefore, in virtually all circumstances, overtime pay must vary as the number of overtime hours worked varies.
In Jane’s example, she is paid the same, $736, whether she works 41, 42, up to 45 hours, that is, 1, 2, up to 5 hours of overtime. Consequently, most likely none of the $736 salary would be considered as any overtime premium under the federal Fair Labor Standards Act (for example, see the regulations under that FLSA, 29 CFR 778.109).
On the other hand, a “Belo” contract under the FLSA is the only way to pay a fixed or constant amount that includes overtime premium for varying amounts of overtime worked. However, it rarely can be used. Among a number of other requirements, a Belo contract requires that the employee’s job duties themselves (not due to scheduled time off like vacation, holidays, personal reasons, or illness) “necessitate irregular hours of work.” That means that even if the fluctuations in hours worked are more than “occasional, minor or insignificant,” if the fluctuations occur “exclusively or nearly so” in the hours worked over 40 in the workweek (in the overtime hours), then this extremely limited exception won’t fly. In the scenario above, then, Jane’s regular over 40 to 45 hours worked each workweek won’t fly for a Belo contract because she consistently has overtime hours and the fluctuations in her schedule occur within those overtime hours.
The coming changes counsel that employers get their ducks in a row on salaried exempt personnel and overtime well before December 1 this year. Please let us know if we may help steer you through these potentially significant changes in the way you do business.