On December 1, the cost of labor for your business is likely to increase dramatically if you don’t take any action — because that’s the day new federal overtime rules promulgated by the U.S. Department of Labor (DOL) go into effect. These rules change the salary threshold for workers who are listed as exempt from the wage and hour laws, also known as the Fair Labor Standards Act or FLSA. Employers who fail to comply with the new rules will potentially face penalties.
These new rules will have a widespread impact. Any employer or employee engaged in commerce, and all employers grossing over $500, 000 per year are covered by the FLSA. As a matter of fact, the DOL estimates that 22.5 million workers are likely to be affected and possibly receive pay raises. Lawsuits have been filed trying to block the rules, but the litigation is unlikely to be resolved before the December 1 effective date (which, incidentally, falls in the middle of a pay period). Like it or not, employers have some work to do to become familiar with the rule changes, and some decisions to make to try and keep costs down before December 1.
Some things the new rules don’t do
1. The federal minimum wage for non-federal contractor employees is not increased. It’s currently set at $7.25 an hour, and that rate remains in effect for Alabama employers.
2. The new rules don’t require an employer to pay overtime unless an employee works over 40 hours a week. (This is the current law, and that aspect of the law remains unchanged.)
3. The new rules don’t change the duties tests for whether an employee is exempt from these rules. But they do change the amount of money you have to pay employees who you wish to treat as exempt.
So what did change?
Currently, the DOL indicates that approximately only 12 percent of the workforce is eligible for getting paid overtime due to the widespread usage of so called “exemptions” from the wage and hour laws. By contrast, in 2012, that overtime-eligible number was 18 percent. In 1975, a whopping 65 percent of employers were overtime-eligible. In part, the overtime-eligibility of workers depends on how the employer chooses to pay them. If an employee is salaried and otherwise meets the requirements for an exemption, an employer can choose to pay a lump sum amount for all work performed and avoid tracking hours and paying time-and-one-half for all hours over 40 within a given workweek. The new rules change that threshold amount — from its current $455 a week (around $22, 000 per year) to $913 a week (around $47, 000 a year). So to understand how the new rules affect the cost of labor, employers need to understand exemptions and the threshold amount.
Without going into all the complex details of how these two things work for the many different classes of employees, I want to focus on some strategic methods for coping with the new rules. But let’s quickly review some basic concepts about the FLSA and exemptions for one class of employees, called executive employees.
Some basics about the FLSA
The FLSA establishes the federal minimum wage and the 40-hour work week. It also provides that anyone paid on an hourly basis for labor must be paid overtime (time and a half) for any hours over 40 that are worked — unless they are exempt from that provision. The DOL establishes these exemptions by rules. Under these rules, there are three broad classes of exempt employees: executives, administrative personnel and professionals. (These are frequently referred to as EAP exemptions.)
So to be exempt, an employee has to meet three conditions:
1. Be paid on a salary basis, not an hourly basis.
2. Do certain things (the so-called duties tests), not including manual labor.
3. Be paid at least a certain amount in salary (the threshold amount, currently $455 a week).
To be exempt, all three conditions must be met. So that means that merely paying a person a salary (instead of calculating his pay on an hourly basis) does not make him exempt. The employee also has to have certain duties, as defined by the DOL rules, and must be paid a certain minimum amount (the threshold amount).
To demonstrate the coping strategies with an employee who meets the duties test of an executive, I’ll just note the duties tests for executives to give you a taste of how all three conditions interact. For an employee to be exempt from overtime because she is an executive, she must do both of the following:
1. Direct the work of at least two employees.
2. Have the authority to hire or fire those employees or have significant influence over whether those employees are hired or fired.
As you can see, there are plenty of “executive” employees who aren’t CEO-level employees. In fact, let’s assume for our example that our particular executive employee is currently paid just $455 a week. So this means, under the current rules, if she works 60 hours in a week, she will not be paid any more than if she works 40 hours in a week. Under the current rule, her hourly rate is $11.38 ($455 ÷ 40 hours).
But under the new rules, the threshold amount will be $913 a week. So that same executive (still paid a salary and still having supervisory responsibility, ) will have to be paid $796.40 a week ($455 for 40 hours + $17.07 × 20 hours). The new rules require the executive to be paid the overtime rate for the 20 overtime hours and thereby receive a raise. The new rules don’t require the employer to pay this executive $913 a week unless the employer wants this executive to remain exempt from overtime.
This means coping with the new overtime rules is a really big numbers game. After you run the numbers, you can consider one of the following coping strategies.
1. Eliminate overtime. Don’t allow your currently exempt employees to work overtime when the new rules go into effect. Require advance approval and limit hours. If you need people to do the extra work the currently exempt employees are performing, hire part-time or full-time employees to do that work at a lower rate. Yes, your cost of labor will be increased, but not by as much as when you have to pay time and a half to your currently exempt employees. Keep in mind that if your idea is to “eliminate overtime, ” you have to enforce that rule by pure discipline. You can terminate an employee for working unapproved overtime, but you can’t deny them the money you owe them.
2. Just pay the overtime. As demonstrated previously, if the currently exempt employee is getting paid $455 a week and typically works 20 hours of overtime, her typical weekly paycheck will be $796.40 under the new rules. That amount is still less than paying $913 a week to keep her exempt. So just pay the overtime.
3. Reduce overtime. With this approach, you take the same approach as strategy 2, but you require the executive to reduce her overtime. For example, you may limit the overtime to 10 hours a week.
4. Reduce the hourly rate. Suppose you are currently paying a store manager $455 a week and he typically works 20 hours a week in overtime. He’s currently getting paid $11.38 an hour for the 40 hours he works ($455 ÷ 40 hours). In essence, he works the additional 20 hours for free. So when the new rules go into effect, start paying the store manager the minimum wage of $7.25 an hour. If he continues to work 60 hours a week, his typical weekly paycheck will be $507.50 ($7.25 × 40 hours + $10.875 × 20 hour). But I’m not sure that this is a very realistic approach because it’s likely to motivate the current store manager to look for another job.
With these first four strategies, there are some dangers and constraints, which I will address later. (See warnings below.)
5. Restructure pay. Although I haven’t discussed the details of this, the new rules allow replacing salary pay with incentive pay. In fact, 10 percent of the threshold amount can be “made up” with incentive pay. This requires careful and complex calculations to properly motivate employees and meet the requirements of the rule. So hold onto your seats as we give you an example.
The new rules allow the employer to base the $913 weekly minimum on nondiscretionary bonuses, incentives or commissions. If the minimum is not met by the bonuses, incentives or commissions, the employer can make up the deficiency to keep the employee exempt, but the makeup must be done on a quarterly basis. That makes the minimum quarterly amount $11, 869 ($913 × 13). The makeup amount must be made by the next payday after the preceding quarter and the makeup amounts are limited to 10 percent of the quarterly minimum ($1, 186 in this example).
So let’s take a look at how the executive might be paid. Suppose the executive is paid a base salary of $500 a week, with the pay period ending on every Friday. Additional amounts are paid if the store sales goals are met:
● $413 if sales exceed $10, 000 a week.
● $1, 000 if sales exceed $15, 000 a week.
● $1, 600 if sales exceed $20, 000 a week.
Suppose sales are between $10, 000 and $15, 000 for 12 of 13 weeks in a quarter, but for one week, sales are only $9, 000. So for one week, the executive is paid only $500, meaning the executive will not get paid the minimum quarterly amount of $11, 869. Because the last payday of the first quarter is April 7, 2017, the employer must pay the executive an additional $413 on or before April 14 to make sure she remains exempt from overtime.
Remember I told you it was a numbers game, right?
6. Change the benefits employees are eligible for. Although this may reduce the cost of labor, take this approach only after careful consultation with your employee benefits attorney. For small businesses especially, the benefits programs may be primarily designed for the owners and their families, but other employees must be included to meet certain qualifying conditions. Cutting those benefits to employees in general without careful planning and implementation may jeopardize the benefits received by the owners and their families.
7. Reorganize your management or staff. Consider reducing levels of management. For example, if there are three levels of managers in your organization (a general manager, several assistant managers, and numerous team leads), reduce the number to two levels (a general manager and team leads). Consider reducing the total number of managers. For example, if a store employs one general manager and three assistant managers, eliminating one assistant manager may offset the increased labor costs for implementing the new rules.
Steps to take before December 1
1. Identify currently exempt employees below the threshold of $913 a week ($47, 476 a year).
2. Determine the patterns of overtime for these employees. Gathering this information may require informal estimates from the employees involved.
3. Make sure that these employees meet the duties tests. Be especially vigilant for borderline cases that may allow you to redraft job descriptions to move them from exempt to non-exempt or vice versa, depending on what the numbers indicate is best to do.
4. Most important: Run the numbers for each employee or class of employees to see what the best strategy is going to be.
I’ve already demonstrated how an executive currently getting paid $455 a week and typically working 20 hours a week in overtime can be paid less than $913 a week under the new rules. But that example is based on the minimum threshold under the current rule. Let’s take a look at what happens for an executive who is currently paid $800 and works an average of 20 hours a week in overtime. Under the new rules, his typical new weekly paycheck will be $1, 400 ($800 for 40 hours + $30 × 20 hours). So in that case, it makes sense to give that executive a pay raise to $913 a week so that the manager remains exempt.
But what if that same executive works an average of no more than 3.7 hours a week in overtime? Under the new rules, his typical new weekly paycheck will be $911 ($800 for 40 hours + $30 × 3.7 hours). So in this case, it doesn’t make sense to raise his pay to $913 a week.
Of course, the point is that similar calculations have to be made for almost every employee or class of employee in your business to minimize the effect of the new overtime rules on your cost of labor.
If you change currently exempt employees to non-exempt employees, there are some very important things to keep in mind.
1. Formerly exempt employees must keep time. A time clock, a computer-based system (perhaps the same one used by the currently non-exempt employees), or a paper system will suffice. But formerly exempt employees may have difficulty adapting to signing in and out when they go to lunch or when they take some time off to get a haircut, things they didn’t think about when they worked 60 hours a week and got paid a salary. DOL requires that you keep the time records for at least three years. I recommend four years.
2. Overtime must be paid. Even when a boss tells employees not to work overtime, they may work overtime anyway — and they must be paid for the overtime. An employer can’t have a rule that says this: “If you work overtime without approval, you don’t get paid.” An employer can require prior approval for overtime, but unapproved overtime must be addressed by your discipline system, not by refusing to pay the employee for working the overtime.
3. Don’t tell employees to work “off the clock.” This violates the FLSA. If you go down this route to try to cut your cost of labor, you will eventually have a disgruntled employee who complains to the DOL’s Wage and Hour Division. You will wind up paying the overtime plus a fine.
4. Don’t compensate hourly employees with “comp time.” Under current labor laws, comp time doesn’t exist and attempting to pay hourly employees with additional vacation time at a later date is illegal. So you can’t tell an employee that if she works overtime (60 hours) during the first week in January, you’ll pay her regular weekly salary for that January week and you’ll let her have an “extra” 20 hours of paid vacation time in June (at her regular hourly rate).
This is all because the FLSA is based on a seven-day workweek. So if an hourly employee works more than 40 hours during a seven-day workweek, the employee must be paid time and a half for any hours over 40 worked during that workweek. (We won’t go into a great deal of explanation, but the employer gets to set up when the seven-day workweek begins and ends, but must consistently apply that workweek to all work.)
But “flex time” can be used within the seven-day workweek. So that means that if an hourly employee works 13 hours on Monday, she can take off five hours early on Friday so that she doesn’t work any overtime.
5. Using an hourly approach instead of a salary approach can open a Pandora’s box of labor-law issues for employers. Among other things, the following practices may trigger overtime payments:
● Pressuring hourly employees to volunteer for community projects.
● Having hourly employees answer questions by telephone when they are “off duty.”
● Traveling to and from out-of-town work assignments or training events.
● Taking breaks.
● Donning and doffing special clothing.
● The EAP threshold amount for exempting employees will increase from $455 a week to $913 a week (from $23, 600 to $47, 476 annually).
● Up to 10 percent of the EAP threshold amount can be calculated by including nondiscretionary bonuses, incentive payments and commissions.
● The threshold amount for qualifying for the highly compensated employee (HCE) exemption will increase from $100, 000 to $134, 000 annually.
● The EAP threshold amount and the HCE threshold amount will be adjusted every three years. The first adjustment will be on January 1, 2020.
● No changes were made to the duties tests for the EAP exemptions.
● No changes were made to the federal minimum wage law nor the 40-hour threshold for overtime payments.
Be prepared to implement or otherwise cope with the new overtime rules that go into effect on December 1, 2016. There is a small chance the rules may be blocked by a court order before that date, but I don’t consider this very likely.
One final word of caution
The new rules themselves are over 500 pages; this article doesn’t cover everything! What is more, the above scenarios are generalized examples not targeted to any particular employer or situation. And there are some possible solutions that could be implemented that aren’t necessarily discussed in this article. It’s best to make your employment decisions based upon specific advice of legal counsel. All employers should be reaching out to their legal counsel this fall to get ready for the new rules.
David Canupp is a shareholder with Lanier Ford.
Text by David J. Canupp of Lanier Ford