How Employers Should Prepare for the New Overtime Threshold

The long-awaited updates to the U.S. Department of Labor Fair Labor Standard Act white-collar exemption will be published in the next few months. We expect the updates to include salary-level increases, which will significantly impact business operations and costs.

Employers should start identifying affected jobs and employees now – compliance will likely take more time than anticipated. Given the Department of Labor’s (DOL) aggressive stance on investigating and handing down penalties, it’s advantageous to start reviewing practices before the rule is finalized. According to data from the DOL, the most commonly noncompliant employers are in the retail, construction and food services industries. The most common mistakes causing noncompliance include not properly determining and paying overtime by incorrectly claiming exemptions or making calculation errors. The increase in the salary threshold will increase the potential for noncompliance.

Primary Implications

Currently, employees with a salary of less than $23,660 per year must be paid overtime if they work more than 40 hours per week. The proposed DOL rule would raise the salary threshold to $35,308 per year.

Companies cannot simply view the DOL changes as one isolated element. Instead, they should adopt, or continue following, a total compensation approach to remain an employer of choice, including designing creative and compliant programs to meet the diverse needs of the entire workforce.

Because this change in minimum threshold could result in higher costs, some employers may need to consider aggressive solutions to offset these cost increases, such as reducing or eliminating ancillary benefits and evaluating 401(k) and pension formulas.

The final rules maintain certain core features:

• The primary duty test remains the same. This helps identify categories of job positions: executive, administrative or professional (and eligible for FLSA’s exemptions.)
• The salary basis test is used to determine whether an employee must receive at least the minimum salary, which cannot be subject to reduction because of variations in the quality or quantity of work performed.

Many employers erroneously believe that if the new exemption rules require reclassifying employees from exempt to nonexempt, they will have to pay those newly reclassified employees on an hourly basis with overtime calculated at a rate of 1.5 times that hourly rate. While an hourly rate is the most common way to pay nonexempt employees, the new FLSA regulations will offer a number of other pay plans, such as a day rate, a piece rate and even a salary.

Employers should be aware of other key parts of the proposed rule:

• Bonuses and incentives: Employers will be permitted to include in threshold calculations certain nondiscretionary bonuses (such as those tied to productivity and profitability) and incentive payments (such as commissions) up to 10 percent of an employee’s salary.
• Catch-up payments: This would permit employers to make a final “catch-up” payment within one pay period after the end of each 52-week period to bring an employee’s compensation up to the required level.

An Action Plan for Employers

Review Employee Exemptions and Compensation – Review employees currently classified as exempt who will fail the new higher-threshold salary test. Determine employees who will be reclassified to nonexempt. Create a list of employees who are currently classified as exempt and earn a base pay slightly above the current threshold of $23,660.

Review Job Descriptions – Review all job descriptions to determine whether they are still accurate, reflecting the jobs being performed and the skills necessary to perform the job. This is vital to ensure that the job functions listed match reality.

Analyze Wage Rates – Conduct a market study of wage rates to determine overall salary and wage competitiveness of pay, as this data will be useful in making an overall assessment of the competitiveness of wages so to support any potential salary changes.

Calculate Overtime Pay – Determine if overtime pay for current nonexempt employees has been properly calculated.

Examine Processes and Operations – Determine how operations would be impacted by reclassification to nonexempt status and/or salary increases to ensure compliance, including how those changes would then impact other employees (in addition to those directly impacted).

Before any changes are implemented, review internal and external pay equity. Estimate lead time required to implement necessary changes to payroll and timekeeping systems. Outline how to train new nonexempt employees on timekeeping matters. Create an overview of how these changes will be communicated to all employees.

Anticipated Impact and Costs

If the proposed rule results in an increase in workers’ earnings, employers will have to manage or offset the anticipated cost of paying overtime or its equivalent. With the tight labor market and customer demands that make price increases or service reductions unlikely, possible solutions include:

Evaluating Health Benefits – Higher overtime costs could make it more likely that ancillary benefits, such as dental, vision and disability insurance, are converted from company-provided to voluntary benefits. Aside from the Affordable Care Act, there are very few federal or state laws that require businesses to offer benefits. The Employee Retirement Income Security Act (ERISA) mandates that certain rules must be followed if a business decides to provide particular benefits. Some exempt employees will be eligible for additional benefits or perks that they will lose when reclassified as nonexempt.

Evaluating the 401(k) or Pension Formula – The overtime rule could have implications for sponsors of 401(k) and similar retirement plans. This will depend on the inclusion or exclusion of overtime pay and/or bonuses in the plan’s formula for employer contributions. If the plan includes overtime pay in the contribution formula, costs could increase. Plans that have definitions of compensation that exclude overtime pay could experience a bias toward highly compensated employees (HCEs), resulting in nondiscrimination testing failures. Qualified retirement plans are subject to annual nondiscrimination testing to make sure they aren’t biased toward HCEs. To offset costs, 401(k) matching formulas may need to be reduced.

Evaluating Life Insurance and Disability Benefits – Similar issues exist under the definition of compensation for benefits such as life insurance and disability. With the potential changes in classifications, benefits like these may need to be available to more employees.