Labor Department finalizes salary threshold rules under the Fair Labor Standards Act

from People and Organization Labor Department finalizes salary threshold rules under the Fair Labor Standards Act May 26, 2016 In brief The Department of Labor (DOL) has issued final regulations under the Fair Labor Standards Act (FLSA), significantly increasing the salary threshold for exempt employees from $23,660 per year ($455 per week) to $47,476 per year ($913 per week). This standard salary level will be automatically adjusted every three years. The DOL estimates that this increase will cause millions of employees who are currently classified as exempt to become non-exempt. If an employee is classified as non-exempt, the employer must pay overtime at the rate of 1.5 times the employee s regular wage for all time worked over 40 hours per week. The final regulations provide that up to 10 percent of the salary threshold can be met by non-discretionary bonuses, incentive payments and commissions, provided that these payments are paid at least quarterly. The final regulations also raise the salary threshold for the highly compensated employee exemption from $100,000 to $134,004 annually, also to be adjusted every three years. While the DOL had requested comments on the current duties test for exemption, no change was made to the duties test as set forth in the 2004 regulations. The employer is responsible for determining an employee s exemption status, and misclassification can result in liability to the employer in the form of back wages and other damages for violations of the FLSA. In recent years, the DOL has intensified its enforcement of the FLSA, and wage and hour lawsuits have increased significantly. Employer diligence is essential to assessing and maintaining compliance with respect to these complex regulations. In detail Background First enacted in 1938, the FLSA establishes a 40 hour work week for employees. For most employees, hours worked over 40 hours a week are paid at a rate of 1.5 times the employee s regular wage. However, the FLSA provides exemptions from the overtime requirements for salaried employees who meet two criteria: 1. The employee s job duties primarily involve executive, administrative, or professional duties as defined by the regulations (duties test); and 2. The employee s wages are at or above the standard salary level (salary level test). Since 2004, the standard salary level remained constant at $23,660 per year ($455 per week). In July of 2015, the DOL issued proposed regulations to increase this threshold to the 40th percentile of weekly earnings for full-time salaried workers, calculated on a national basis ($50,440 annually in 2016 or $970 per week). This standard salary level was to be www.pwc.com

updated annually. In addition, the DOL requested comment on whether non-discretionary bonuses, incentive pay and commissions should be included in an employee s wages for purposes of the standard salary level and requested comments on changes to be made to the duties test. The FLSA also provides for an exemption from the overtime requirements for highly compensated employees. Under the current 2004 regulations, salaried employees are eligible for this exemption if they earn at least $100,000 annually and regularly perform at least one of the duties of an exempt executive, administrative or professional employee, as defined in the duties test. This is a more relaxed standard than the duties test for the standard exemption, which requires the exempt duties performed to be the employee s primary job duties. The DOL proposed raising highly compensated salary threshold to $122,148, or the 90th percentile of weekly earnings for fulltime salaried workers, calculated on a national basis. Notably, in the proposed regulations, the DOL did not make specific proposals to alter the duties test, but instead solicited comments on whether it should be changed. In response to its proposed regulations, the DOL received over 270,000 comments from the public during the notice and comment stage of rulemaking. On May 18, 2016, the DOL released its final regulations, effective December 1, 2016. Final regulations Increase in the standard salary level Under the final regulations, the DOL has increased the standard salary level to $47,476 per year ($913 per week). Unlike the proposed regulations that corresponded to a national percentile of weekly earnings for full-time, salaried workers, the final regulations instead look to the 40th percentile of weekly earnings in the lowest wage Census Region, currently the South. This standard salary level will be automatically indexed every three years (rather than annually, as proposed), with the first update on January 1, 2020. Each update will raise the standard threshold to the 40th percentile of full-time salaried workers in the lowest-wage Census region, estimated by the DOL to be $51,168 in 2020. The DOL will publish new salary levels 150 days in advance of their effective date, beginning August 1, 2019. In updating the salary basis test, the DOL did not change the duties test analysis for exempt employees. The DOL has stated that it believes that the increase to the standard salary level, coupled with automatic updating every three years, will work effectively with the current duties test to distinguish between overtime-eligible employees and those who may be classified as exempt. In response to comments from employers, who noted that the threshold was too high in areas with a lower cost of living, the DOL indexed the standard salary level to the lowest wage census region. This region is currently the South, but can change upon future updates. Commenters also pushed back on the proposal to update the standard salary level every year, citing administrative burdens to examine classification status on an annual basis. Although the standard salary level in the final rules is slightly lower than was proposed, the DOL estimates that the increase from the current threshold of $23,660 will directly affect approximately 4.2 million employees. These employees are currently classified as exempt but earn less the standard salary level. Accordingly, these employees will no longer be exempt from the overtime rules under the new regulations. Employers must reclassify these employees as non-exempt and pay overtime for any hours worked over 40 per week. In the case of employees near the new salary threshold, employers may choose to increase their base wages to the standard salary level to maintain their exempt status. The employer is not required to change the pay status from salaried to hourly for reclassified employees whose salary is under the new threshold; the exemption does not depend on the designation as salaried or hourly, but on the amount of salary or wages. Salaried employees whose salaries are below the salary threshold are non-exempt, and are entitled to overtime for hours worked over 40. Employers must develop a manner of tracking hours for these salaried employees. This does not have to be a formal punchclock method, as long as the employer maintains adequate records of hours worked. See DOL Fact Sheet 21 for more information on overtime record keeping. The DOL also estimates that another 8.9 million salaried employees will be indirectly affected by the increase in the standard salary basis. These are employees who currently make over the $23,660 per year threshold but are classified as non-exempt because their job duties do not satisfy the duties test for the administrative, professional or executive exemption. Under the final regulations, overtime eligibility will be easier to determine for those employees with salaries below the new standard salary level; the employer will no longer need to make a legal determination on the duties test for these employees. 2 pwc

Inclusion of nondiscretionary bonuses, incentive pay and commissions in the salary threshold determination In the final rules, the DOL has allowed employers to apply nondiscretionary bonuses, incentive payments and commissions toward the standard salary threshold, in an amount of up to 10% of the indexed threshold ($4,747.60 for 2016). However, these payments must be distributed on a quarterly basis or more frequently. Accordingly, an employee making $43,000 in salaried wages can still satisfy the standard salary test if the employees receives quarterly nondiscretionary incentive bonuses that make up the difference. If an employee does not earn enough incentive pay in a given quarter, the employee can lose exempt status for the quarter. However, the employer can make a catch-up payment (up to 10% of the standard salary level for the preceding 13 week period) within one pay period after the quarter. This catch up payment will count toward the prior quarter s salary amount and not toward the salary amount in the current quarter in which it was paid. If the employer chooses not to make the catch-up payment, then the employee would be entitled to overtime pay for any hours worked over 40 in a given week during the quarter in which salary plus bonus fell below the threshold. The final rules mark a significant change to the DOL s position in the proposed regulations, where the agency stated that an employee s salary was the best and most easily measured factor in determining whether an employee is important enough to a company to be classified as exempt. The DOL had recommended that only incentive payments made at least monthly should be applied to an employee s salary level. In contrast, the final regulations are reflective of many commentators, who asserted that incentive pay is a vital portion of exempt employees compensation in many industries. While the final rules are more flexible than the proposed regulations in terms of including incentive payments in the salary threshold calculation, the payments must still be made at least quarterly and may only be used to satisfy up to 10% of the standard salary level. This means that annual incentive bonuses that many employers provide to employees will not be factored into employees salary levels. Additionally, employers who choose not to make catch-up payments at the end of each quarter for those employees that do not earn enough incentive pay to remain exempt must accurately track overtime hours throughout each quarter in case overtime wages must be remitted to the employee. Potential reclassification of employees on a quarterly basis can create an administrative burden for HR and payroll departments. Increase in threshold for highly compensated employees In addition to raising the standard salary level, the final regulations also raised the threshold for the highly compensated employee exemption, to a total annual compensation level equal to the 90th percentile of earnings of full-time salaried workers nationally. This is not a departure from the 2015 proposed regulations, but the DOL did quantify this amount as $134,004 annually in 2016. As with the standard salary level, the highly compensated employee level will be automatically updated every three years, beginning January 1, 2020. For an employee to be exempt as a highly compensated employee, the employee must also receive at least the new standard salary amount of $913 per week ($47,476 per year) on a salary or fee basis and pass a minimal duties test. The rest of the compensation can be made up of nondiscretionary bonuses, incentive pay and commissions. Unlike incentive payments under the standard salary level, which must be paid at least quarterly, additional incentive payments for highly compensated employees can be made on an annual, catch-up basis. The DOL has stated that the increase in the highly compensated employee salary threshold will avoid the unintended exemption of a significant number of employees in highwage/cost of living areas, such as San Francisco and New York, who clearly are not performing exempt job duties. The final regulations do not allow an employer to use incentive pay to satisfy a portion of the minimum standard salary amount per $913 per week ($47,476 per year). The DOL s rationale is that employers may satisfy the remaining amount of the highly compensated employee total annual compensation threshold of $134,004 with nondiscretionary bonuses, incentive pay and commissions. The DOL determined that it would not be appropriate to permit employers to also use nondiscretionary bonuses and incentive payments to satisfy this minimum standard salary level requirement. Effect on benefit plans and programs As a result of the final regulations, potential increases in both base salary and overtime wages for employees will likely have an effect on employee benefit plans. Employee benefit plans may have several definitions of compensation, which could include or exclude overtime wages and incentive 3 pwc

pay. Furthermore, some benefit plans may have eligibility requirements tied to hourly or salaried pay status, which could affect decisions to change the pay status of newly non-exempt employee from salaried to hourly. Employer contributions to qualified retirement plans will increase as more employees receive overtime pay. Contributions will also increase if the employer chooses to raise certain employees salaries to the new standard salary level in order to maintain their exempt status under the FLSA. Affected plans and programs may include 401(k) plans with discretionary contributions, hybrid plans and defined benefit plans and other programs with benefits based on total compensation, such as life insurance. Employers should review the definitions of compensation in their benefit plans to see whether overtime wages are included or excluded. If overtime is excluded in the definition of compensation, plans should be reviewed to determine whether the additional overtime that will be payable might cause the definition of compensation to be discriminatory. Effective Date One of the most significant changes made in the final regulations concerns the effective date. Although the final regulations were released on May 18, 2016, the DOL has set an effective date of December 1, 2016. This gives employers the rest of this year to review current FLSA classifications for both the salary level test and the duties test, make determinations on classification, and address HR change management issues, including technology implications (HRIS, payroll and time-keeping) and employee communications/relations. The takeaway Organizations need to understand how the FLSA changes could affect their current employee classifications. This includes evaluating the potential costs of maintaining compliance with FLSA classification requirements and implementing necessary changes. Employers should assess the impact of the final rules by performing an FLSA risk analysis and developing an appropriate implementation plan. Let s talk For more information, please contact our authors: Bruce Clouser, Philadelphia (267) 330-3194 bruce.e.clouser.@pwc.com Steven Slutsky, Philadelphia (267) 330-1565 steven.slutsky@pwc.com Daniel Trisdorfer, Philadelphia (267) 330-8452 daniel.trisdorfer@pwc.com or your regional People and Organization professional: US Practice Leader Scott Olsen, New York (646) 471-0651 scott.n.olsen@pwc.com Jack Abraham, Chicago (312) 298-2164 jack.abraham@pwc.com Ed Donovan, New York Metro (646) 471-8855 ed.donovan@pwc.com Scott Pollak, San Jose (408) 817-7446 scott.pollack@saratoga.pwc.com Charlie Yovino, Atlanta (678) 419-1330 charles.yovino@pwc.com Todd Hoffman, Houston (713) 356-8440 todd.hoffman@pwc.com Bruce Clouser, Philadelphia (267) 330-3194 bruce.e.clouser@pwc.com Nik Shah, Washington Metro (703) 918-1208 nik.shah@pwc.com Craig O'Donnell, Boston (617) 530-5400 craig.odonnell@pwc.com Carrie Duarte, Los Angeles (213) 356-6396 carrie.duarte@pwc.com Jim Dell, San Francisco (415) 498-6090 jim.dell@pwc.com 4 pwc

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