FLSA White Collar Exemptions Summary of the Proposed Regulations

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1 Summary of the Proposed Regulations The United States Department of Labor has published its long-awaited proposal on the White Collar Exemptions for executive, administrative, and professional employees under the Fair Labor Standards Act. Below is a quick summary of the proposal, followed by a more detailed explanation. This is an important event for employers that will have a significant impact on the management and regulation of the workplace. We urge careful consideration of the proposed rule, whether and how to respond formally before it becomes final, and how to prepare for operating under the eventual final rule. A. Quick Summary of the Proposal In almost 100 single-spaced pages of the Federal Register, DOL proposes two primary changes, suggests the possibility of three more, and requests public comment on a number of items, including those five proposed and possible changes. Consequently, the actual revisions to the regulatory text are quite limited, but as explained below, their likely impact is not so limited. The two changes actually proposed are: (1) to dramatically increase the salary levels used as thresholds for the standard White Collar Exemptions (from $23,660 to a likely $50,440 per year), the special Highly Compensated Employee Exemption (from $100,000 to $122,148 per year), as well as corresponding adjustments for the special salary thresholds in American Samoa and the motion picture industry; and (2) to fix a process for updating the salary thresholds so they occur automatically and annually according to prescribed formulas or criteria. The three additional changes that have been raised but not yet proposed are: (1) to include non-discretionary bonuses and other incentive pay in the standard salary-level test; (2) to revise the duties test to, among other things, impose a California-type fifty percent rule; and (3) to add specific occupational examples to the regulations to illustrate exempt versus nonexempt positions and duties generally and for computer professionals. The projected impact of the proposed revisions, according to DOL, is that 4.6 million currently exempt employees will automatically and immediately switch to nonexempt status, to the tune of about $1.5 billion in additional overtime compensation in the first year, and an average of about $1.2 billion in new overtime in each of the following nine years. DOL also projects that businesses will incur another $600 million in the first year for direct employer costs and other losses associated with coming into compliance with the new regulations, and roughly $200 million in additional compliance costs in each of the following nine years. The deadline for public comment is September 4, July 2015 ECKERT SEAMANS CHERIN & MELLOTT, LLC Page 1

2 B. Background of the Proposed Regulations President Obama issued a directive to the Secretary of Labor in March 2014 to develop revisions to modernize and streamline the existing overtime regulations, and in doing so, to: consider how the regulations could be revised to update existing protections consistent with the intent of the Act; address the changing nature of the workplace; and simplify the regulations to make them easier for both workers and businesses to understand and apply. The executive, administrative, and professional exemptions have long been known as the White Collar Exemptions, though DOL has taken to abbreviating them as EAP Exemptions in the present proposal. They are based on Section 13(a)(1) of the FLSA, which cryptically defines the exempt employee as any employee employed in a bona fide executive, administrative, or professional capacity, or in the capacity of outside salesman. The details of who falls into these broad categories has always been left to DOL to determine through notice and comment rulemaking. These regulations have been very detailed and have focused for decades on particular duties and levels of managerial or supervisory responsibility within the employer s organization (the so-called duties tests ), and they include any number of complex exceptions and alternatives. The result has been that planning or defending the classification of employees as exempt or nonexempt has been highly particularized. Indeed, cases can go in different directions based on the idiosyncrasies of different individuals employed by the same employer in the same position and location. Employer groups have lobbied for many decades to abandon the duties tests altogether and to institute a salary-only test to eliminate the confusion and uncertainty over misclassification of employees under the EAP Exemptions. However, for just as long, and continuing to the present administration, DOL has maintained that it does not have the authority to do that. However, in the 2015 proposed revisions, DOL has raised the salary thresholds to a level that it hopes will largely outstrip the question of duties, and then has proposed instituting a mechanism for automatic annual adjustments intended to maintain the salary level as the most important factor. Hence, while all the duties tests and their sometimes complex interpretations, exceptions, and alternatives remain exactly what and where they were prior to the proposed regulatory revisions, DOL hopes they will, in effect, become irrelevant, or at least will be greatly overshadowed, in the face of the salary thresholds. The proposed federal revisions have no technical bearing on state and local minimum wage laws, which have taken on much greater significance in recent years. However, the practical effect, if only for the short term, will be to turn attention back to the federal scheme, at least as it relates to the EAP Exemptions. July 2015 ECKERT SEAMANS CHERIN & MELLOTT, LLC Page 2

3 C. Updated Salary-Level Tests DOL has proposed doubling (and then some) the salary thresholds for the EAP Exemptions. This is the heart of the 2015 proposal, and it represents a significant conceptual shift in the approach to EAP Exemptions, away from the detailed and often particularized analysis of job duties of individual employees, to a much simpler numerical threshold. As discussed more fully later on, the duties tests have not gone away or even been altered in the proposal, but the salary-level tests have been brought to the fore, intentionally overshadowing the duties tests. The proposal details seven alternative methodologies for determining the numerical rates for the new standard salary-level test. DOL used a combination of those methods and data sources to arrive at the 40th percentile of weekly earnings of full-time salaried workers. That yields $921 per week, or $47,892 per year, using 2013 data. However, as if to forecast the impact of the automatic updating feature discussed below, DOL also estimates that if the proposed regulations become final in 2016, the standard salary rate, based on projected 2016 data, will already have risen to $970 per week, or $50,440 annually, even before the regulations become final. The special Highly Compensated Employee (HCE) Exemption is not often used, but as its name suggests, it is driven by compensation, so it has been included in DOL s proposed revisions. The proposal would increase the salary threshold for this exemption from $100,000 per year to $122,718 per year. As with the standard salary threshold, this is based on 2013 data, so it also will likely be higher in the final regulations. Also as with the standard salary-level changes, DOL has proposed a mechanism for automatic annual updates to this salary threshold. Consistent with its proposal on the standard salary thresholds, DOL has set the HCE Exemption salary threshold using a fixed percentile of wages earned analysis, picking the 90th percentile as the appropriate level for this threshold. DOL has proposed continuing to use the same fixed percentile for succeeding years with the automatic update mechanism discussed below. DOL also has proposed corresponding increases (and annual updates) for the special salary-level tests that already exist for American Samoa and for the motion picture industry. D. Automatic Updates to the Salary-Level Tests If the salary-level increases are the heart of DOL s proposed revisions, the mechanism for automatic updates represents the soul. It is what will keep the initial changes alive and carry them into perpetuity or at least that is the intention. The automatic update is a dramatic proposal whose significance may not be immediately obvious to employers who get caught up in the dramatic initial increases in the salary thresholds. The entire point of this mechanism is, first, to perpetuate the efficacy of the conceptual shift toward a salary-only (or salary-focused) criteria. DOL posits that this is the only way, as a practical matter, to maintain the salary thresholds at the equivalent level in future years. Otherwise, DOL says, it must engage in nearly continuous rulemaking from year to year in order to keep July 2015 ECKERT SEAMANS CHERIN & MELLOTT, LLC Page 3

4 the salary levels up to date. Second, the point of this mechanism is to justify, in perpetuity, DOL s apparent decision not to press for changes to the duties tests. The salary levels have been updated just seven times since 1938, when the FLSA was enacted: 1940, 1949, 1958, 1963, 1970, 1975, and The gaps of thirty-three years and eleven years before the last two changes serve as a significant impetus for automating and annualizing the update process. It is a dramatic change indeed, and its only redeeming benefit for employers will be to perpetuate the relative clarity or certainty offered by the salary-focused test. To borrow DOL s phrase, the result for employers will be nearly-continuous review of their employee classifications to be sure they don t fall below the ever-rising minimum thresholds of the EAP Exemptions. The alternative is to cope with the managerial (and legal) consequences of allowing an ever-widening plume of nonexempt status to overtake whole groups of employees who, for decades, have been accustomed to the greater flexibility and prestige of exempt status, and have been imbued with its work until it s done mindset and habits. DOL discussed alternative methodologies and schedules for updating the salary levels, and invited public comment on which it should choose. Although it did not propose specific changes to the regulatory text, pending its choice of a methodology, it appears clear from the discussion that DOL favors the same fixed percentile method used to arrive at the initial salary thresholds in the present proposal. The primary alternative discussed in the proposal is to tie the increases to the Consumer Price Index for all urban consumers (CPI-U), and DOL has solicited public comments on whether this would be better suited to the objectives of the proposal. DOL also has offered detailed data and analysis of the costs and other impact of the fixed-percentile method as compared to the CPI-U method. DOL also invites comments on whether to update the salary thresholds based on the effective date of the new regulations, January 1 of each year, or some other specified date. E. Changes Discussed But Not (Yet) Proposed Amidst DOL s proposals for changing the salary thresholds and instituting automatic annual updates of those thresholds, DOL also raised several ideas for additional revisions to the EAP Exemption regulations. Though it did not propose to include them in the 2015 revisions, it has solicited input from the public on them nonetheless. It remains to be seen whether or to what extent DOL really wants to tackle these matters in the present rulemaking. 1. Incentive Pay As Part of the Salary-Level Test DOL raised the idea of including nondiscretionary bonuses and perhaps other incentive pay for purposes of determining if an employee meets the new salary-level tests for the EAP Exemptions. Presently, such additional compensation may not be used to meet the salary-level tests, and DOL does not propose to change that. It has, however, raised the question and asked for public comment on whether it should be changed. July 2015 ECKERT SEAMANS CHERIN & MELLOTT, LLC Page 4

5 DOL states that if it were to consider such a change, the includable bonuses or other incentive pay would be limited to ten percent of the salary threshold (using 2013 figures, $92 per week or $399 per month). Moreover, DOL states that in order to be included for meeting the threshold, the bonuses must be payable monthly or more frequently. DOL also has ruled out the use of catch-up payments at the end of the year or quarter to bring employees within the salary thresholds of the exemptions (as is allowed for the HCE Exemption). 2. Revising the Duties Tests As already discussed, the present proposal has moved to a salary-focused model for classifying EAP Exempt employees. This approach leaves the duties tests exactly where they were after the 2004 changes, but overshadows them with the higher salary thresholds. DOL has said in the proposal that this should be sufficient, especially in conjunction with the new automatic annual updating of the salary levels, to do most of the filtering of true exempt personnel. Nonetheless, the proposal includes a significant discussion of the duties tests and expressly solicits public comment on whether changes are needed, laying out five specific queries for commenters to address on this point. DOL s discussion seems to emphasize the idea of adopting a California-style fifty percent minimum duties requirement. This would require that an employee s exempt duties make up at least fifty percent of his overall job activities. This is in contrast to the present federal rule, which is based on the primary duty concept that allows some exempt employees to spend most of their time on nonexempt work. The theory behind the present rule is that the employee s primary duties consist of exempt tasks and responsibilities, and even though most of his actual work time is spent on other (nonexempt) tasks, his primary duties are of sufficient importance to the employer and the overall business operation that they overshadow the nonexempt work in overall significance. Hence, his true nature as an employee is embodied in the more important exempt work, not in the more voluminous or time-consuming nonexempt tasks. This is not an issue that should be ignored by employers during the comment period for the proposed revisions. Shifting to a fifty percent duties test could add an unnecessary wrinkle or trap for employers, most especially in restaurant and other retail businesses where this has been a safe haven for employers and a bone of contention for employee groups. 3. Adding Specific Occupational Examples DOL has invited suggestions for specific occupational examples of exempt versus nonexempt work to supplement examples already provided in the existing regulations. DOL also has requested the same suggestions to supplement the regulations on the statutory computer professional exemption. This is to further or more clearly illustrate exempt versus nonexempt work, but it is also, frankly, a less dramatic way to effect change in the existing duties test, short of making the explicit changes such as the fifty percent rule discussed above. July 2015 ECKERT SEAMANS CHERIN & MELLOTT, LLC Page 5

6 4. New Nonexempts and Remote Electronic Devices A growing issue for employers has been regulating employees work time in the evenings and on weekends when they use electronic devices to communicate about work matters. DOL s proposal acknowledges the prevalence and difficulty of this issue, and the fact that it will become even more so with the anticipated shift of so many employees from exempt to nonexempt status as a result of the proposed revisions. DOL stated it is beyond the scope of the present proposal, but promised to publish a Request for Information in the near future to address the problem. In the meantime, employers need to be aware that the vast majority of the 4.6 million newly-nonexempt employees most likely have enjoyed the flexibility of such remote electronic communications. With their sudden reclassification, employers must promptly and actively address the situation to avoid potential liability, and to work out operational problems stemming from discontinuance or reduction in after-hours and weekend communications by such employees. F. Projected Effect of the Changes The entire proposal is filled with explanation and illustration, including forty-one tables and figures, geared toward showing the impact of the proposed changes. This is expressed in terms of the number of affected employees (most notably the increased number who will be eligible for overtime compensation), as well as the cost to employers of complying with the proposed regulations (most notably the projected increase in overtime premium compensation, referred to by DOL as transfer of income ). If nothing else, these data and their multi-faceted presentation by DOL illustrate what a few textual changes can accomplish, and point up the significance of DOL s conceptual shift toward a salary-only (or salary-focused) test for the EAP Exemptions. In assessing these impact data, employers should bear in mind DOL has not, at least at this time, proposed changes to the duties tests, so these projections do not take into account the impact of changing the duties tests. Presumably these numbers would increase significantly if, for instance, DOL adopted the California-style fifty-percent rule for the duties test in addition to increasing the salary thresholds and imposing the annual automatic updates. 1. Affected Employees, Industries, and Occupations DOL used 2013 data throughout its proposal and supporting materials. However, because of the automatic updating feature of the proposed regulations, that data almost certainly will change as will the resulting salary thresholds and number of affected employees even before the proposed regulations become final. As already mentioned, DOL expressly acknowledged this in the anticipated increase of the standard salary threshold from $921 per week using 2013 data to $970 per week by the time the proposal becomes final in DOL estimates there are 43.0 million white collar salaried employees out of a total of million employees who are covered by the FLSA. Of those 43.0 million employees, DOL estimates that 28.5 million are exempt ( overtime ineligible ) and 14.4 million are nonexempt ( overtime eligible ). DOL further estimates that 7.1 million of the 28.5 million EAP Exempt July 2015 ECKERT SEAMANS CHERIN & MELLOTT, LLC Page 6

7 employees are in named occupations, meaning jobs that don t have to meet the salary-level test (such as teachers, academic administrators, physicians, lawyers, and outside sales employees). Consequently, DOL estimates that 21.4 million exempt workers (28.8 minus 7.1) are potentially affected by this proposed rule. These numbers are illustrated by industry, occupation, and Metro Statistical Area (MSA) in DOL s Table 11, which is replicated below from DOL s proposal. July 2015 ECKERT SEAMANS CHERIN & MELLOTT, LLC Page 7

8 DOL estimates that 4.6 million of the above 21.4 million currently exempt employees will be switched to nonexempt status by the proposed regulations. That is, there are 4.6 million current EAP employees who earn (as of 2013) between $455 and $921 per week. Moroever, DOL estimates there are 36,000 current HCE employees who will drop to nonexempt under the proposed regulations, meaning there are 36,000 employees who meet the HCE duties test and who (as of 2013) earned between $100,000 and $122,000 per year. These numbers are illustrated in the flow chart in Figure 2 from DOL s proposal, which is replicated below. Finally, DOL estimates there are 10 million nonexempt salaried workers (6.3 million white collar, 3.7 million blue collar) who do not presently meet the duties tests for the EAP Exemption, but whose salaries fall between the current and proposed salary thresholds. DOL posits that this large population also will benefit directly by the proposed regulations even though they will not suddenly shift from exempt to nonexempt status (because they already are, or should be, classified as nonexempt by virtue of the duties tests). They will benefit, DOL says, because their right to overtime compensation will be clear rather than depend upon an analysis of their duties. 2. Projected Cost to Employers DOL articulates three types of costs that will be imposed on employers by the proposed regulations: direct employer costs, transfer costs, and deadweight loss. For the first year after the proposed regulations become final, DOL projects the direct employer costs will be $592 million. Direct employer costs are comprised of the internal expenditures required for regulatory familiarization (cost of having employees learn the new regulations), adjustment (costs July 2015 ECKERT SEAMANS CHERIN & MELLOTT, LLC Page 8

9 associated with determining the eligibility of affected employees for the EAP exemptions), and managerial (increased managerial costs due to need for greater supervision of newly-nonexempt employees, primarily to minimize overtime). This is shown in DOL Table ES1, replicated below. DOL estimates the first-year direct employer costs for regulatory familiarization will be a one-time cost of $254.5 million. The other direct employer costs will be recurring costs, and have been estimated by DOL over a ten-year period using a 7% discount rate. In the first year, these are projected to be $160.1 million for adjustment costs and $178.1 million in managerial costs. In the following nine years, average annualized direct employer costs are estimated to be between $239.6 million and $255.3 million (depending on the update method ultimately used). DOL projects the transfer cost to employers in the first year will be $1.483 billion. This is mostly increased overtime pay to employees who are currently exempt, but who become nonexempt by operation of the new regulations. The proposal also projects the average annualized increase in transfer costs over the succeeding nine years, and estimates it will be between $1.178 billion and $1.271 billion, again depending on which update method DOL implements. Deadweight loss is not a direct expenditure by employers, but represents the difference between the wage employers are willing to pay for the hours lost, and the wage workers are willing to take for those hours. This is projected by DOL to be between $9.5 million and $10.5 million, depending on the updating methodology DOL ends up selecting in the final rule. July 2015 ECKERT SEAMANS CHERIN & MELLOTT, LLC Page 9

10 DOL also projected the impact of the proposed automatic annual updating mechanism, by projecting the cost of implementing the new regulations as proposed (that is, including the automatic updates) as compared to implementing just the initial increases in the salary thresholds. That comparison is shown in DOL s Table 31, which is replicated below from the proposal. This table also shows a comparison, for both scenarios, between the alternative methods for updating the salary thresholds. G. Employer Compliance if Proposed Regulations Become Final Employers need to start considering how to comply with the proposed regulations once they are finalized. In particular, how will employers deal with the estimated 4.6 million employees who are currently classified as exempt (overtime ineligible) but who will immediately be reclassified as nonexempt (overtime eligible) by virtue of the new regulations? Also, how will employers deal with the still uncounted number of employees who will automatically switch to nonexempt status each year thereafter by virtue of the automatic updates to the salary thresholds? To begin with, for affected employees who do not work overtime, DOL notes that employers can continue to pay the same salary as before, without running afoul of the FLSA under the new regulations, although they will need to monitor work schedules carefully to be sure employees continue to avoid overtime. However, for the remainder of affected employees who do work overtime, DOL notes, there are five basic approaches to compliance with the new regulations: July 2015 ECKERT SEAMANS CHERIN & MELLOTT, LLC Page 10

11 (1) pay the required overtime premium for the current number of overtime hours based upon the current implicit regular rate of pay; (2) reduce the regular rate of pay so total weekly earnings and hours do not change after overtime is paid; (3) eliminate overtime hours; (4) increase employees salaries to the proposed salary level; or (5) use some combination of these responses. In any event, even if the affected employees end up not working any overtime, employers still must comply with the recordkeeping requirements for these newly nonexempt employees, which in itself will require a significant administrative and managerial change for employers. H. Impact on Small Entities In accordance with its duty to conduct a regulatory flexibility analysis of proposed regulations and their potential impact on small entities, DOL offers detailed analysis and associated data for small businesses and governmental entities. Small entity is defined as a (1) small not-for-profit organization, (2) small governmental jurisdiction, or (3) small business. Manufacturing businesses are considered small entities if they have fewer than 500 employees, and nonmanufacturing businesses are considered so if they have less than $7 million in revenues. Depository institutions are classified based on total assets (credit unions, commercial banks, and non-commercial banks). Small governmental entities are those with a population of less than 50,000 people. DOL estimates there are 1.8 million affected workers in small entities, working at 211,000 establishments across America. DOL further projects that small entities will incur $134.4 million to $186.6 million in direct employer costs (regulatory familiarization, adjustment, and managerial costs) in the first year after the rule is finalized. For the same year, DOL projects additional overtime compensation for small entities ( transfer costs ) to be $561.5 million. I. Public Comment on the Proposed Regulations The deadline for submitting public comments on the proposed regulations is September 4, The comments may be submitted electronically at We would be happy to assist clients with a more detailed analysis of the proposal and in drafting comments for submission to DOL. July 2015 ECKERT SEAMANS CHERIN & MELLOTT, LLC Page 11