The Department of Labor Significantly Increases Salary Thresholds for Overtime Exemptions

Background
The Fair Labor Standards Act requires covered employers to pay overtime premium pay of at least 1.5 times the employee’s regular rate of pay for work in excess of 40 hours per week. The Act contains several exemptions from this requirement, including the EAP or “white-collar” exemptions. To establish an EAP exemption, an employer must show that (1) the employee is paid a salary that is predetermined and not subject to variation based on the quality or quantity of work performed (the salary basis test); (2) the salary paid meets the minimum specific amount (the salary level test); and (3) the employee’s job duties primarily involve executive, administrative, or professional duties as defined by the Department’s regulations (the duties test). An employee who customarily and regularly performs at least one of the exempt duties or responsibilities of an exempt EAP employee may also qualify as exempt under the “highly compensated employee” exemption. The highly compensated employee test pairs a higher salary threshold for the salary level test with a less rigorous duties test.

The salary threshold for the standard white-collar test is currently $684 per week, which annualizes to $35,568 per year. The salary threshold for highly compensated employees is $107,432 per year. Effective July 1, 2024, these thresholds will increase to $844 per week, which annualizes to $43,888 per year, while the new minimum salary to qualify for the highly compensated employee exemption will rise to $132,964 per year.

The minimum salary level for EAP employees was last increased in September 2019, under the Trump Administration, when it was set at the 20th percentile of weekly earnings of full-time salaried workers in the lowest-wage Census region; the July 1, 2024, increase will use the same standard but will simply recalculate the minimum based on current salary data. As of January 1, 2025, the Rule will also change the methodology used to calculate the minimum salary levels for exemption to be equal to the 35^th percentile of earnings of full-time salaried workers in the lowest-wage Census region (currently, the South). The salary threshold for highly compensated employees will be set to equal to the 85^th percentile of earnings of full-time salaried workers nationally.

When the new methodology goes into effect on January 1, 2025, the applicable salary thresholds will increase to $1,128 per week for EAP employees, which annualizes to $58,656 per year, and to $151,164 per year for the highly compensated exemption.

Finally, the Rule provides that the Department will update the salary thresholds every three years, starting July 1, 2027.

Legal Challenges Expected
The Obama Administration had previously attempted to raise the minimum salary for EAP employees to the 40^th percentile of wages for full-time salaried employees in the lowest wage Census region, but a federal court issued an injunction blocking that regulation in November 2016, just days before it would have gone into effect. The Trump Administration formally rescinded the Obama-era regulation when it raised the minimum salary to a much lower level, as explained in this October 9, 2019, Pillsbury alert. Because the first phase of the Rule’s increase to the minimum salary retains the methodology of the current regulations and goes into effect so soon, the Biden Administration may be hoping to avoid having its regulation also blocked by an injunction. Whether the second phase of the increase will escape an injunction due to its a salary-level calculation methodology that is still somewhat lower than the Obama-era regulation remains to be seen, but legal challenges are likely.

The Practical Impact: Next Steps for Employers
Even if lawsuits are filed against the Rule, employers cannot assume that the new regulation will be blocked. The DOL estimates that in the first year after implementation of the Rule, there will be 4.3 million affected workers. Commentators have suggested that this number is likely much higher, and therefore the impact on employers much greater. Given these projections, employers should act now to evaluate their current classifications and determine next steps.

Assess Your Workforce
Employers should take immediate action to assess their employee classifications to ensure that employees are properly classified, both in terms of salary threshold and job duties. Identify now those exempt employees who will be converted to overtime-eligible under both stages of the Rule and start tracking their hours. For each such employee, identify the number and frequency of overtime hours worked, and the reasons for that overtime. Obtaining this information will enable employers to make informed decisions about whether and how to absorb the new overtime costs. Employers should also review any existing benefit plans that offer different benefits to exempt and nonexempt employees and consider whether it is necessary or desirable to make any changes to those plans’ eligibility rules or benefit levels. Given the potential liability for misclassification—which includes payment of back wages as far back as three years, as well as liquidated damages and attorneys’ fees—employers should seek advice of counsel when undertaking such analyses.

What to Do If a Currently Exempt Employee Earns Below the New Minimum Salary Level
Employers with employees who are currently classified as white-collar exempt employees, but who earn less than $43,888, have two options to ensure compliance by the July 1, 2024, effective date: reclassify the employee to non-exempt or increase the employees’ salary. For employees whose salaries are close to the new July 1 increased minimum threshold and who meet the duties test, employers may choose to raise their salaries to meet the new applicable threshold and maintain their exempt status. The second stage of the increase, however, would result in a much more significant compensation bump for affected employees.

Employers may also choose to adjust the amount of an employee’s earnings to reallocate the compensation between the regular rate of pay and overtime compensation. The revised pay may be on a salaried or hourly basis (there is no requirement to convert employees to hourly pay status), but it must include payment of overtime when the employee works more than 40 hours in a week. Consideration should also be given to any administrative complications, particularly under any applicable state laws such as California’s, associated with creating a class of salaried, non-exempt employees.

Some employers may also decide to identify delegable work tasks and offload the burden to a supplemental workforce of part-time employees or, if legally feasible, contractors. Although there will be added costs in bringing on additional workers to take on tasks that a single hard-working employee now handles, it costs less to pay for those additional hours at a straight-time rate than at an overtime rate.

Employers facing personnel cost constraints may look to trim activities from their newly non-exempt employees if those activities count as working hours but don’t add sufficient value. Employers may wish to reconsider frequent staff meetings that consume work time. Similarly, employers may reevaluate whether travel to an in-person meeting is necessary, or whether a video conference call or shared screen technology would be sufficient. Other steps to rein in potential overtime by employees who used to work longer hours as exempt employees may entail limiting how many non-exempt employees need to participate in calls or meetings, or whether subsequent debriefings would free them up to perform work that might otherwise require overtime.

Employers may also find it necessary either to rely upon or seek to amend customer contracts by adding provisions that tie the cost of the contract to changing labor costs. Particularly for government contractors and other employers with contracts in which labor costs are an identified element of the payment price, the increased personnel costs from the overtime rule may be passed on to customers (e.g., federal and state agencies). Because the Rule calls for increases every three years, such employers should consider including provisions in new contracts, and seeking amendments to existing contracts, that adjust the total payment to account for the personnel budget increases the employer will incur.

Whatever strategy an employer pursues to comply with the Rule, educating affected employees about the reason for the change is an important step. Even if becoming overtime eligible may result in larger paychecks, many exempt employees view conversion to non-exempt status negatively, regarding it as a demotion or a sign that their employer does not regard them as holding an important position. Employers should explain to affected employees that the change results from new regulations, that it is based only on their compensation level, and that it affects all similarly compensated employees nationwide in the same manner.

Other Considerations
Beyond the financial and practical effects of reclassification, employers should also be mindful of the impact that reclassifying an employee as non-exempt may have on employee morale. Non-exempt employees generally have less flexibility (e.g., with respect to tracking time). Additionally, in some instances, being classified as non-exempt may mean losing certain benefits, such as paid vacation time and health insurance, depending on the employer’s policies.

In light of such concerns, employers who are forced to reclassify employees should be sure to have a plan in place for rolling out these changes. Additionally, prior to doing so, employers should evaluate current employment practices that relate to treatment of non-exempt employees and make changes to such practices as necessary. Employers with questions about how the new regulations apply to their workforce or about how to implement these changes should consult with legal counsel. Employers should also keep in mind that these regulations only implement the federal FLSA and that state and local laws may have more stringent requirements.