On Monday, July 6, 2015, in response to a March 2014 executive order signed by President Obama, the Department of Labor (“Department”) published a Notice of Proposed Rulemaking (“NPRM”) that will more than double the minimum salary necessary for a worker to be classified as “exempt” from the Fair Labor Standards Act (“FLSA”) overtime regulations.  It is estimated that over 5 million, currently exempt, salaried employees will be affected by the increased salary threshold. 

Under the current overtime rules – last updated in 2004 – employers are required to pay all employees covered by the FLSA time-and-a-half for any hours they work in excess of 40 hours in a single workweek.  Certain executive, administrative, and professional workers (“white-collar workers” or “EAP workers”) are “exempt” from overtime if their job responsibilities satisfy the “duties test” and they earn more than $23,660 per year or $455 per week.  The proposed changes would more than double the minimum salary threshold for EAP exempt workers, requiring compensation of $50,440 per year or $970 per week.  The proposed changes would also increase the annual salary threshold from $100,000 to $122,148 for exemption as a highly compensated employee (“HCE”), as well as increase the motion picture producing industry exemption base rate from $695 to $1,404 per week.[1]

An increase to the standard salary threshold is not the only change being considered by the Department.  In the NPRM, the Department also requests public comment on (1) a potential mechanism for automatically adjusting the EAP and HCE standard salary levels, (2) whether nondiscretionary bonuses should be included in calculating the standard salary threshold, and (3) whether the EAP duties tests should be modified.

Automatic updating of the standard salary levels.  The Department seeks comments on whether the Consumer Price Index (“CPI-U” – a commonly used economic indicator for measuring inflation) or a fixed percentile of wage earnings for full-time salaried workers should be applied to automatically update the standard salary thresholds.  In relation to the fixed percentile method, the standard salary level would be adjusted annually to the 40th percentile of weekly earnings for all full-time salaried workers based on information published by the Bureau of Labor Statistics.  By contrast, under the CPI-U method, the standard salary amounts would be adjusted based on changes in inflation.  According to the Department, “past evidence suggests that updating the salary level using the CPI–U would result in a comparable salary level to updating using the fixed percentile approach” with the practical benefit being that “updating the salary level test using the CPI–U would provide a familiar and well understood method for updating the salary level and ensure that the real value of the salary level does not degrade over time.”

Inclusion of nondiscretionary bonuses in calculating EAP salary threshold.  Currently, bonus payments (of any kind) are not considered in determining compliance with the standard salary threshold for the EAP workers.  On the other hand, while HCE’s must be paid the standard salary of at least $455 per week, the remainder of their total annual compensation (i.e., the remainder of the $100,000 salary threshold) may be made up of commissions, nondiscretionary bonuses, and other nondiscretionary compensation.  The Department is considering whether nondiscretionary compensation should count towards partial satisfaction of the standard salary threshold for the EAP exemptions.[2]  One proposal discussed would require the payment of bonuses on a monthly (or more frequent) basis.  Another proposal would limit the amount of nondiscretionary compensation counted toward the salary threshold to 10% of the employee’s annual salary.  The Department seeks comments on what types of employees typically earn nondiscretionary bonuses and incentive payments, the types of nondiscretionary compensation employees receive, and to what extent including nondiscretionary bonuses and incentive payments as part of the salary level would advance or hinder the test’s ability to serve as a dividing line between exempt and nonexempt employees.

Modifications to duties requirements for EAP exemptions.  Given the proposed changes to the salary thresholds, the Department requested comments on whether changes to the EAP duties tests are also warranted.  Specifically, the Department seeks public comment on: (1) what, if any, changes should be made to the duties tests; (2) whether employees be required to spend a minimum amount of time performing work that is their primary duty in order to qualify for exemption – whether the Department should adopt California’s law (requiring that 50 percent of an employee’s time be spent exclusively on work that is the employee’s primary duty) as a model; and, (3) whether the concurrent duties regulation for executive employees (allowing the performance of both exempt and nonexempt duties concurrently) is working appropriately.

The Department’s request for comments on these issues (and in particular with regard to modifications to the duties test) is significant.  Under what is known as the “logical outgrowth” doctrine, the Department is permitted to add regulatory language not initially proposed into the final rule if the community has been put on notice that the topic is being considered.  Notably, the NPRM expressly requests “additional information on the duties tests for consideration in the final rule.”  Accordingly, the reach of the proposed rule changes will not be known for certain until the final rule is issued.

The proposed rules are subject to a 60-day comment period, and any comments must be considered before the final rule is announced. The Department will then draft final regulations which take into account public comments.  From start to finish this process can take upwards of several years, but sometimes as little as a few months.  The last time the Department proposed changes to the overtime rules in 2003, it took nearly 13 months to issue final rules in 2004.

Given what is at stake, employers should consider the consequences of the proposed changes, potential responses based on business needs, and effects the proposed changes may have on related federal, state, and local laws.  Should the proposed rules become final, the choice for many employers will be to meet the new thresholds by increasing the salaries of currently-exempt employees or converting currently-exempt employees to a “non-exempt status” and paying overtime.  A recent study commissioned by the National Retail Federation (“NRF”) estimated that converting salaried employees to hourly could cost employers over $800 million.[3]  The NRF study also concluded that while the proposed changes could cost businesses $9.5 billion in overtime costs, it is unlikely that employers will simply increase salaries or pay additional overtime without making significant adjustments.  Rather, it is more likely that employers will offset projected costs by reducing the wages, discretionary compensation, and hours of full-time workers.  However, shifting employees from salary to hourly or from overtime-exempt to overtime-eligible will have a wide range of operational and legal implications for employers and what employers save in direct labor costs could be lost in decreased morale and production.  Accordingly, having a plan to manage employees through these regulatory changes is key.

We will continue to update you on further developments as the proposed rules are finalized.  In the meantime, employers are encouraged to submit written comments here before September 4, 2015 for consideration in the drafting of the final rule.  Additional information may also be found at http://www.dol.gov/whd/overtime/nprm2015.

* Danielle Thompson is a summer Law Clerk in Sheppard Mullin’s New York Office.

[1]  Currently, employees who satisfy a “minimal duties test” and earn a total annual compensation of $100,000 or more, are exempt from overtime under the highly compensated employee exemption.  Additionally, certain employees in the motion picture producing industry who meet the duties test and are paid a base rate of at least $695 per week, are also exempt from overtime.

[2]  Significantly, the Department made clear that should a final rule permit the inclusion of nondiscretionary bonuses for the standard salary requirement for EAP exemptions, such credits will not be applicable in determining compliance with the standard salary requirement for HCE workers.

[3]  In states like California, converting employees from exempt to non-exempt raises additional concerns with regard to daily overtime and meal and rest break regulations.