Why the final changes to wage and hour law may have you crying 'uncle'

After much anticipation and speculation, the final regulations changing the salary basis test for determining exemption status have arrived. Among other changes, the final regulations have more than doubled the amount that employees must minimally be paid in order to be considered exempt.

This is no small matter, as it is anticipated that millions of currently exempt employees will be affected.

What does it mean to be exempt?

The Fair Labor Standards Act (FLSA) requires that all nonexempt employees be paid overtime, receive at least minimum wage, and have their work hours accurately tracked. However, the Department of Labor (DOL) created some categories of “exempt” employees for whom those obligations do not apply.

Many employers are surprised to learn that it’s not easy to be exempt. In order to be properly classified as exempt, employees must pass both of the following tests:

  1. The salary basis test
  2. The primary duties test (there are also some limited industry-specific exemptions)

The primary duties test requires that the job’s essential functions fall within one of the recognized white collar exemptions: executive, administrative, professional, computer professionals, or outside sales. Although the DOL has decided not to make any changes to the primary duties test at this time, it has indicated its desire to revisit this test in the future with an eye toward making it more difficult to pass.

The salary basis test currently requires that exempt employees be paid a regular salary of at least $455 per week, which is the equivalent of $23,660 per year. Failing either test means the position isn’t exempt.

The final regulations

Despite the significant impact the final regulations are likely to have on most employers, the actual changes themselves are quite simple:

  1. The salary threshold moves from $455 per week ($23,660 per year) up to $913 per week ($47,476 per year). The new salary threshold applies to any exempt employee, even if he/she is a “part-time exempt” employee.
  2. Up to 10% of the salary can be paid via nondiscretionary bonuses, commissions, or incentive pay (more on this below).
  3. An inflationary adjustment will be applied to the new salary threshold every three years.
  4. The annual salary requirement for the “highly compensated” employee exemption (which applies to certain positions that don’t fall into one of the white collar exemptions) moves from $100,000 per year to $134,004 per year.

Regarding the inclusion of bonuses, commissions, or incentive pay in the salary basis calculation, this option may not be of much practical use to employers since it is subject to a number of limiting conditions. First, it is confined to only 10% of the salary basis calculation, which means that, on average, a maximum of $91.30 per week can be paid via this method.

Second, the bonuses must be paid out at least once every quarter, and the amount of the bonus must bring the average wages in every week within the period the bonus is intended to cover (e.g., quarter, month, etc.) up to at least $913/week.

Third, the bonuses have to be non-discretionary, which means that they should be part of a formal bonus, commission, or incentive pay plan that is designed to accomplish some sort of business-related goal (e.g., a safety/attendance bonus, hitting a sales target, etc.). In other words, you can’t choose to pay employees a straight salary that is below the minimum threshold, and then wait until the end of the quarter to see if you have funds available to pay a “bonus” and retroactively increase their pay to bring it above the $913/week threshold.

Although the regulations are final now, employers have a little bit of breathing room, as the regulations will not go into effect until Dec. 1, 2016. However, that’s not much time and you must start planning now.

Start with an audit

Before implementing a solution, you need to understand the scope of your potential problem, which should start with conducting a thorough audit of all of the positions you currently have classified as exempt. Don’t ignore this step, since even if the regulations hadn’t changed at all many employers have at least one position that they currently misclassify as exempt that really should be nonexempt.

In conducting an audit the first question should not be whether you are paying enough salary, but whether the position can actually pass one of the primary duties tests. For the most part the primary duties tests were not meant to be easy to achieve, and it is this step of the two-part test that people most commonly get wrong.

For those positions that pass the primary duties test, you should next look at how much each is being paid. If they’re already being paid at a rate that exceeds the new threshold, then you have nothing to worry about (although you should revisit your compensation at least every three years in light of the new inflationary adjustor).

For those positions that are currently being paid beneath the threshold, you have several compliance options.

(Continued)

 

What compliance options are available?

Increase salaries

This is the most obvious solution, but it may also not be feasible for employers with many employees well beneath the threshold (nonprofits, for whom spare dollars may be scarcer, may have problems with even two or three employees in this situation).

If raising salaries puts those positions at or above the maximum amount you feel you can pay for them, you will also need to be mindful of the triannual inflationary adjustor, as well as the potential impact on long-term employee engagement and goodwill, since you may have future budget constraints related to current wage increases that make it more difficult to award merit-based raises to recognize strong performance.

Convert to nonexempt status

Converting exempt employees to nonexempt starts with figuring out what their hourly wage rate should be. The easiest way is to take their current salaries and divide them by 2080, which is the number of hours worked in a year averaging 40 hours per week. However, that may not be entirely accurate to an employee’s individual circumstances, as he or she may actually average 45, 50, or even more hours per week for the salary they’re paid, and as such, technically earn a lower hourly wage equivalent.

In converting to nonexempt status, you have three implementation options:

  1. Convert and pay. This is the easiest conversion option, which, of course, is why it’s the most expensive. Not only will you be paying for each hour worked in excess of 40 hours per week, you’ll be doing so at time-and-a-half of the hourly equivalent rate. So, for instance, for an employee earning $40,000 per year, the hourly wage equivalent (using 2080 annual hours) is $19.23 per hour, for which the overtime rate is $28.85 per hour. As you can imagine, that kind of pay rate can add up quickly.

    And matters can be made worse if the employee is eligible for some sort of bonus plan, such as a production, safety, or attendance bonus, since those dollars will have to be included in the hourly wage rate (overtime pay is based on the “regular rate,” which includes almost all income received by the employee, not just the base hourly wage rate).
     

  2. Convert and pay, but try to adjust responsibilities to keep weekly hours close to 40. Overtime isn’t a problem for employees who work 40 or fewer hours in the week. If it’s possible to adjust your staffing levels and workloads so that converted employees don’t actually end up working more than 40 hours, then you won’t really take a financial hit in connection with the conversion.

    However, while that may be easy for me to type, it is probably quite difficult for you to do in the real world, as there usually are sound reasons that some employees work a lot of hours. This option also requires that you prohibit unauthorized work hours, closely monitor timecards, and make sure that employees don’t secretly or inadvertently work off the clock (such as by logging in from home at night or using a smartphone over the weekend to clear out a few e-mails).
     

  3. Convert and keep the hours the same, but lower the hourly wage you pay to accommodate expected overtime. If you can figure out how many hours of overtime an employee is expected to average over the course of the year, you can set an artificially low hourly wage rate so that, when overtime is factored in on the anticipated work hours, the employee’s annual amount of pay closely approximates his/her current salary.

    As an example, let’s use the $40,000 per year employee I mentioned above. If I expect that she will average five hours of overtime per week, she will have 260 hours of overtime for the year. If I pay her at her normal hourly equivalency, I will wind up paying her $7,501 of overtime, for a total of $47,501 on the year.

    If I want to keep her at about $40,000 per year, I have to use the following formula (where “W” equals the necessary wage rate): W x ((2080) + (260 x 1.5)) = 40,000. In turn this sums up to W x 2470 = 40,000, which means W = $16.19 per hour.

    There are two potential problems with this approach. First, the employee’s actual hours for the year may not align with what you’d anticipated, which means she’ll arguably be either under or overpaid. Second, an employee who believes she should be paid her 2080 hourly equivalency of $19.23 per hour might very well feel insulted by an artificially low wage rate. If you’re going to do this, the way in which you communicate it to the employee is critical so as to properly manage expectations and understandings.

Deciding which approach to take

How close an employee’s current salary is to the new threshold, along with how close his/her current weekly hours are to 40, will determine which outcome is best for you.

If you convert to nonexempt status, there are a couple of additional things to take into consideration.

First, since the final regulations won’t go into effect until Dec. 1, it may be worthwhile to conduct a time study for the employees you intend to convert, during which you carefully track their hours over a set period of time in order to get some sort of gauge on how many hours they’re actually working per week.

In doing so, you may be surprised by the results, as in many cases, an employee’s belief as to the excessive number of hours that he/she works per week can be belied by the facts, and you might find that he/she actually hovers around 40 (or below). You should also be mindful of seasonal fluctuations of hours that may or may not be captured during the period of your time study.

Second, employees who have never had to record their hours before can sometimes be bad about doing so, especially for off-hours work such as logging in from home. You’ll want to be sure to get them in the habit of recording all time actually worked, as you’re legally required to do so for all nonexempt employees.

Conclusion

You shouldn’t put off making a decision until the last minute, since the change is coming soon. By taking a close look at the variety of options available, you can ensure that your company makes an informed decision that’s fair to both employer and employees.

James Olney is vice president and senior HR consultant at Associated Financial Group.

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