Exempt from Overtime? Maybe Not – The Rules Are Changing

By Corbett Gordon and Haley Morrison

On March 13, 2014, President Obama signed a Presidential Memorandum directing the Department of Labor (Department or DOL) to update the regulations for the "white collar exemptions" to overtime. In response, the DOL issued a Notice of Proposed Rulemaking (NPRM) on July 6, 2015, inviting comments to the proposed rule until September 4, 2015. We do not yet know what the final rule will be, but we can anticipate some drastic changes starting in 2016, particularly as it applies to the "salary basis" test. Employers are wise to start considering the ramifications now.  

The white collar exemptions under the Fair Labor Standards Act (FLSA) exclude certain executive, administrative and professional employees from federal minimum wage and overtime requirements. To qualify for an exemption, white collar employees generally must:

  1. Be paid a predetermined and fixed salary above a minimum threshold, which is not subject to reduction because of the quality or quantity of work performed (the "salary basis" test); and
  2. Primarily perform executive, administrative, or professional duties, as set forth in the DOL's regulations (the "duties" test).

Certain white collar exempt employees must satisfy additional tests. For example, "learned professionals" — such as doctors and lawyers — must have advanced knowledge in a field of science or learning as a result of specialized intellectual instruction.

The proposed rule sets the "salary basis" for white collar employees at the 40th percentile of earnings for full-time salaried workers. In 2016, that threshold is anticipated to be about $970 a week ($50,440 a year), which more than doubles the current threshold of $455 a week ($23,660 annually). The DOL believes that this figure "minimizes the risk that employees legally entitled to overtime will be subject to misclassification based solely on the salaries they receive, without excluding from exemption an unacceptably high number of employees who meet the duties test."  

The proposed rule also contemplates an increased salary for "highly compensated employees" (HCE), workers (1) who meet a higher salary requirement, (2) whose primary duty includes office or non-manual work, and (3) who customarily and regularly perform at least one of the white collar exempt duties. The proposed rule suggests increasing the HCE salary threshold from the current rate of $100,000 a year to the 90th percentile of earnings for full-time salaried workers. In 2013, that figure was $122,148 a year.  

This is not a one-time increase. The Department's rule advocates for continuously raising the basis consistent with some outside measure, such as the 40th and 90th percentiles for white collar workers and HCEs, respectively, or based on inflation, as measured by the Consumer Price Index for all Urban Consumers. The DOL believes that this will ensure the salary basis test remains a meaningful measure for distinguishing between bona fide exempt employees and those entitled to overtime, and will "accurately reflect current economic conditions."  

Although the NPRM did not make any adjustments to the "duties" test, the DOL sought comment as to whether those analyses are working as intended. The Department expects that the higher remuneration threshold will lessen the burden of the duties test, however, because many employees will not qualify for exemption based on pay alone. There will thus be fewer workers for whom employers will even need to perform a duties analysis. Moreover, as a practical matter, the duties test may become easier to apply: presumably, employees who meet the increased salary basis test are more likely to be performing higher-level functions for the business.

So what does this mean for employers? The DOL estimates that with the proposed rule, 4.6 million white collar exempt workers and 36,000 HCEs will not satisfy the respective salary basis tests. Without a pay adjustment commensurate with the rule, all of these individuals will be misclassified as exempt.

The potential liability for employee misclassification can quickly become enormous due to the domino effect it causes. In California, for example, misclassification can result in violations related to overtime, regular rate of pay compliance, recordkeeping, meal/rest periods, timing of pay, terminating pay, and inaccurate wage statements, among other things. California employees can also "stack" penalties for every such violation. Not surprisingly, these high-value wage and hour matters are often asserted as class actions. It is very important that companies get it right.  

Therefore, while we wait for the Department to issue the final rule, employers should look at their workforce and analyze the impact on their business. Along with determining which employees would not meet the proposed salary basis test, companies should consider:

  • The overtime exposure for workers in the potentially reclassified positions;
  • The ramifications of non-traditional aspects of pay (e.g., bonuses and/or incentives) that are includable in the regular rate for the purposes of overtime;
  • Whether to hire additional workers to reduce hours versus raising pay to meet the salary basis;
  • The effect on benefits packages, such as PTO accrual and use;
  • Timing of pay issues;
  • Any necessary changes to management structures;
  • The impact of meal and rest period requirements for reclassified workers; and
  • The effect on employee morale

The promulgation of a new rule provides employers with a perfect opportunity to take a close look at their exempt workers and make any necessary adjustments. Employers should also consider issuing talking points, FAQ's, and other employee communications when these changes take place.

Finally, keep in mind that although the FLSA sets the minimum requirements that states must follow, the statutes of some jurisdictions — such as California — are even stricter, and may require additional analysis.

If you have any questions, or would like assistance with analyzing your workforce, please contact:

Corbett Gordon
Tonkon Torp LLP

Phone: 503.802.2150
Licensed in Oregon and Washington
Haley Morrison
Tonkon Torp LLP

Phone: 503.802.2121
Licensed in California and Oregon
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