Wednesday, the Department of Labor (DOL) issued its highly anticipated final rule modifying the exemptions to the Fair Labor Standards Act (FLSA) overtime rules for white collar employees (executive, administrative, professional, computing and outside sales positions) and highly compensated employees.

The final rule, which goes into effect on December 1, 2016, significantly increases the minimum salary that employees must be paid to qualify for the white collar or highly compensated exemptions.  However, as described further below, while it will still have a big impact, the final rule will not be as disruptive for businesses as it could have been because it does not make changes to the duties tests associated with the exemptions.

In September of last year, the SBLC submitted comments on the DOL’s proposed version of the rule. The DOL, in fact, made multiple references to SBLC’s comments when describing the feedback it received and the modifications it made to the proposed rule in light of these comments. While the DOL did not heed all of the SBLC’s comment it did address some. The end result is that the final rule is, in a number of respects, better for small businesses than the proposed rule.

The key regulatory changes embodied in the final rules are as follows:

On December 1, 2016, the salary threshold for the white collar exemption will increase 100.7 percent from the current $455 per week (or $23,660 annually) to $913 per week (or $47,476 annually).

This increase is actually less than that which was originally proposed by the DOL. The DOL’s proposed rule would have calculated the new salary threshold based on the 40th percentile of weekly earnings nationally for full-time salaried workers as calculated by the Bureau of Labor Statistics (BLS) at the time the rule was finalized. The DOL estimated that this would be $970 per week or $50,440 per year. A number of groups, including the SBLC, raised concerns about setting the threshold based on national data when pay for employees in select large cities significantly outpaces pay in many other parts of the country. Recognizing the validity of these comments, in its final rule, the DOL instead calculated the new salary threshold based on the 40th percentile of weekly earnings for full-time salaried workers in the lowest paid Census Region (currently the South) as calculated by BLS. Thus, although the $913 per week or $47,476 figures were calculated based on the average salaries in the South, the thresholds will apply to the whole country.

The SBLC advocated that any increase to the white collar threshold should have been significantly less than more than 100 percent increase that was proposed. The SBLC specifically recommended an increase more along the lines of the approximately 22 percent increase that the DOL had proposed for the highly compensated salary threshold. Moreover, the SBLC urged the DOL to phase any increase in over a number of years to allow businesses time to adjust. Unfortunately, the DOL did not make these requested changes to the final rule.

On December 1, 2016, the salary threshold for the highly-compensated will increase from $100,000 annually to $134,004 annually.

This increase is consistent with the DOL’s original proposal. The $134,004 figure represents the 90th percentile of weekly earnings nationally for full-time salaried workers as calculated by the BLS. In the final rule, the DOL decided not to make the same regional adjustment to the highly-compensated calculation method as it did for the white collar exemptions. Thus, while the new white collar salary threshold was calculated based on the data from the Southern Census Region, the new highly-compensated salary threshold was calculated based on national data. This distinction between how the two thresholds are calculated will also apply to future updates (discussed further below).

Again, the SBLC recommended that this increase be phased in over time, but the DOL did not agree.

The salary thresholds for the white collar and highly compensated exemptions will be adjusted every three years, with the first change to occur on January 1, 2020.

The new rule marks the first time that the regulations will have a system for automatically increasing the salary thresholds.

Originally, the DOL proposed to increase the thresholds annually. The SBLC pushed back on this part of the proposal asserting that annual increases would create perpetual uncertainty for businesses and recommending that, if the DOL did implement a system of automatic increases, such increase should occur no more frequently than every five years. Specifically referencing the concerns raised by the SBLC, the DOL’s final rule provides for increases every three years rather than annually. The first increase will be on January 1, 2020 and tri-annually thereafter.

The increases will be made based on the BLS data. The DOL asked for comments on whether the adjustments should be made based on the BLS data or the Consumer Price Index (CPI). Despite comments from the SBLC and many other groups that the CPI would be a more accurate measure because the BLS data could be impacted by the changes employers will make in response to the new rules, the DOL settled on using the BLS data. Thus, starting on January 1, 2020, and occurring every three years thereafter, the salary thresholds for the white collar exemption will reset at the 40th percentile of weekly earnings for full-time salaried workers in the lowest paid Census Region and the salary for the white collar exemption will be set at the 90th percentile of weekly earnings for full time salaried workers nationally.

Under the new rule, employers will be permitted to count non-discretionary bonuses and incentive compensation (including commission) towards up to 10 percent of the white collar salary threshold as long as the payments are made at least quarterly.

Prior to the new rules, employers have never been permitted to include any types of bonuses or incentive compensation in calculating whether an employee’s compensation meets the white collar salary threshold. Responding to urging from many groups, including the SBLC to change this, the new rule now permits employers to satisfy up to 10 percent of the new white collar salary threshold through the at least quarterly payment of non-discretionary bonuses or incentive compensation.

To account for the fact that an employer may not be able to calculate in advance what an employee’s non-discretionary bonus or incentive compensation will be, the new rule also allows employers to make catch-up payments to bring employees up to the salary threshold as long as the catch-up payments are made no later than the pay period after the end of the quarter. Thus, when the new rules go into effect an employer can pay an employee a base salary of at least 90 percent of the salary threshold (or $821.70) and then make up the remaining 10 percent with non-discretionary bonuses and incentive compensation. If at the end of the 13-week quarter the employee’s base salary plus his or her non-discretionary bonuses and incentive compensation are not at least $11,869 ($913 x 13 weeks) on the next payday after the end of the quarter, the employer can pay the employee the difference between the employee’s actual earnings and $11,869 without the employee losing his or her exempt status.

Prior to the new rules, employers were permitted to include certain types of bonus and incentive payments for the purposes of the highly compensated salary threshold and the new rules do not make any changes to how bonuses and incentive compensation are treated for the purposes of the highly compensated exemption.

The new rule will make no changes to the duties tests for the white collar or highly compensated exemptions.

In its proposed rules, the DOL did not suggest any specific changes to the duties tests but simply asked for comments on whether any changes should be made to the duties tests. The SBLC advocated strongly against changes to the duties tests which would have changed the entire framework of the exemption and required businesses to expend significant costs and time to learn and comply with the new framework. Thankfully, the DOL listened to the comments it received and made no changes to the duties tests for the white collar or highly compensated exemptions.

Bringing together the preexisting rules with the new rules going forward:

  • To be exempt under a white collar exemption, an employee’s primary duties must be executive, administrative, professional, computing, or outside sales (as defined by regulation) and the employee must be paid a salary of at least $913 a week. Employees in computer-related positions can either be paid a salary of at least $913 a week or on an hourly basis at a rate of no less than $27.63 (unchanged by the final rule).

  • To be exempt as a highly compensated employee, the employee must regularly and customarily perform one or more of the duties of an executive, administrative or professional employee (as defined by regulations) and the employee must earn at least $134,004, which includes at least $913 per week on a salary basis.

While there are bills pending in the House and Senate that would prevent these new rules from taking effect, they do not have sufficient support to override a certain presidential veto.  Accordingly, businesses will need to begin to prepare for the December 1, 2016 effective date of this new rule.

Although it is not as disruptive as it could have been, the new rule will have a significant impact on many businesses. Businesses that have employees who were previously classified as exempt but who do not earn enough to meet the new salary thresholds will have to decide whether to reclassify these employees as non-exempt (in which case they will be eligible for overtime) or to increase their compensation to meet the new thresholds.

From a financial standpoint, this will largely require businesses to make an employee-by-employee assessment of the amount of overtime that a particular employee works versus the amount that the employee’s salary would need to be increased to meet the new threshold. Businesses can, of course, place strict limitations on the amount of overtime it will allow a newly non-exempt employee to work in order to avoid increased payroll costs. However, this will need to be balanced with productivity concerns, particularly where the employee has traditionally worked significantly more than forty hours per week. For employers who do end up reclassifying employees as nonexempt, they will also have to start tracking hours in order to calculate when and how much overtime is due.

Produced by the Small Business Legislative Council (SBLC), of which PPAI is a member and PPAI president and CEO Paul Bellantone, CAE, serves as a board director, the SBLC Report offers a quick and candid review of what’s going on in Washington. The mission of the SBLC is twofold: to make improvements in public policy for small business and to help member associations in their communications with business members. Please note that this weekly is for the sole personal, informational use of PPAI members and should not be posted to any website.