Understanding The Changes To Overtime Regulations
President Obama and Secretary Perez announced on May 18, 2016, the Department of Labor’s (DOL) final ruling regarding overtime regulations. These changes are effective Dec. 1, 2016. While the rule changes do not affect how overtime is calculated, it will have a direct impact on “who” is required to receive overtime payment.
Understanding The Difference
Before beginning our discussion on the new overtime regulations we must understand the difference between the exempt and non-exempt classification and the difference between employees paid an hourly rate compared to ones paid salary rates.
The terms “Exempt” and “Non-Exempt” are defined in the Fair Labor Standards Act (FLSA) and also in most states’ labor laws. An “Exempt” employee is an employee who is exempt by the FLSA and states from receiving overtime pay. To become an exempt employee, three tests must be applied and passed. These tests are discussed further in the below section “Exempt Employee Test”.
An hourly employee is paid by the hour at a rate of pay no less than the minimum wage. Cities and states may have a minimum wage rate that is higher than the current federal wage of $7.25 per hour. Hourly employees are required to receive overtime for hours worked in accordance with the city, state, or federal regulations (see “State Regulations” below). A salaried employee is an employee who receives the same wage amount each pay period.
Exempt employees are required to be paid a salary. However, being a salaried employee is not the same as being an exempt employee. A salaried employee who cannot pass the three FLSA testing is a non-exempt employee and must be paid overtime in accordance with their local overtime requirements.
Under the Fair Labor Standards Act (FLSA), “Non-Exempt Employees” receive overtime payment (1.5 times their hourly rate of pay) for all hours worked in excess of 40 hours in the “work week”. It is extremely important that all employers define their “work week” for the purposes of determining the total number of hours worked in that week. The most common practice is to define the “work week” as beginning on Sunday and ending on Saturday. Once you have declared your “work week” it must be consistently applied to the calculation of overtime.
Several states have overtime regulations that are in excess of the FLSA standards, such as:
- California which requires overtime to be paid at 1.5 times the employees hourly rate of pay for all hours worked in excess of eight hours per day, 40 hours in the work week, or for the first eight hours of work on the seventh consecutive day of the work week. Additionally, California provides that two times the employees’ rate of pay for all hours in excess of 12 hours in the day or for work over eight hours on the seventh consecutive day of the work week.
- Colorado requires overtime to be paid at 1.5 times the employee’s hourly rate for all time in excess of 40 hours in the work week and for hours in excess of 12 hours in the day.
- Kentucky requires overtime to be paid at 1.5 times the employee’s hourly rate for all time in excess of 40 hours in the work week and on the seventh day of the work week.
- Nevada provides for 1.5 time the hourly rate for hours worked in excess of eight hours per day if the employee’s hourly rate is less than 1.5 times the minimum wage.
All employers should review their state’s requirements on overtime regulations to ensure compliance.
Exempt Employees Test
For an employee not to be eligible for overtime, the employee must meet the requirements of an “Exempt” employee. The primary classifications for “Exempt” employees are: executive, administrative, and professional (there are additional classifications for computer and outside sales person; these two classifications are not affected by the rule changes), and highly compensated.
Determining the exempt status is not always easy to do. An employee is not an exempt employee simply because they are paid on a salary basis or because of their job title.
The DOL requires that the employee must be reviewed through the process of the following three tests:
- Salary Basis Test – This test requires that the employee be paid on a salary basis.
- Salary Level Test – This is the area where the DOL made major changes to their regulations. The current regulations provided that in order to be an exempt employee, the employee was required to earn $455 per week ($23,660 per year). Effective Dec. 1, 2016, the required earnings will increase to $913 per week ($47,476 per year).Based upon the results of this test, employees earning less than $913 per week will lose their exempt status and be eligible to receive overtime in accordance with the above discussed DOL overtime requirements or state overtime requirements, whichever is more beneficial to the employee. In the “Items to Consider” section below, we will discuss items you should consider when an employee loses their exempt status due to the rate increase.
- Duties Test – Of the three tests, the duties test is the most difficult test to complete. The “Primary Duties” for the executive, administrative, and professional exemptions are listed in the chart below. It should be noted that, in addition to this basic test, the DOL requires additional duties as provided in their regulations 29 CFR 541 Subpart B, C, and D. If the employee does not meet the “Primary Duties” requirements there is no need to look at Subpart B, C, or D.
|Duties Test||The employee’s “primary duty” must be managing the enterprise, or managing a customarily recognized department or subdivision of the enterprise (and managing two full-time employees).||The employee’s “primary duty” must include the exercise of discretion and independent judgment with respect to matters of significance.||The employee’s “primary duty” must be to primarily perform work that either requires advanced knowledge in a field of science or learning or that requires invention, imagination, originality, or talent in a recognized field of artistic or creative endeavor.|
All three tests must be satisfied to provide for an “Exempt Status”. It must be pointed out that the Duties Test in California is much more stringent, in that the Primary Duties make up at least 51% of their worktime.
Frequently, I see employees misclassified because the employer believes that the work performed is confidential in nature. It is true that employees in the accounting department such as payroll, accounts payable/receivable staff and the human resources department such as HR generalist, corporate recruiters, or executive assistant, may have access to confidential information such as an employee’s earning, disciplinary actions, budgets, financial statement, bank statements, etc., however, having access to confidential information is not a requirement to being an exempt employee. The key area of being an exempt employee is having and utilizing the authority to make decisions and exercising discretion and independent judgment. Simply “applying well-established techniques, procedures, or specific standards …, clerical or secretarial work, recording or tabulating data, and performing mechanical, repetitive, recurrent, or routine work” is not, according to the DOL, exercising discretion or independent judgment.
Key Elements Of The New DOL Regulations
- The regulations are effective Dec. 1, 2016.
- The salary threshold has been increased to $931 per week or $47,476 per year. To be classified as an exempt employee they must earn at least this amount.
- The threshold may increase every three years to maintain the salary level at the 40th percentile in the lowest-wage census region.
- The minimum salary for a “Highly Compensated Employee” has been increased from $100,000 per year to $134,004 per year.
- Employers will be able to use nondiscretionary bonuses and incentive payments to satisfy up to 10 percent of the standard salary level test.
Items To Consider
There are several items you should consider when moving an employee from an Exempt status to a Non-exempt status:
- Give consideration to the cost of the salary increase compared to the potential cost of paying overtime for the employee to complete his/her job.
- Determine the impact that an increase in salary for one person may have on other employees within the organization.
- Consider the impact of morale. Some employees may consider this a demotion or a move to a less prestigious position.
- Determine the cost of administering non-exempt employee work hours.
Examples Of Potential Penalties
Employees file complaints with the DOL or their state’s labor commission all of the time. When a complaint is filed, the DOL/state will open an investigation and review your payroll for the past three years. They will look at all employees (current and former) to determine if there is a violation of the wage and hours provisions. Awards may be issued to terminated employees regardless of why they were terminated.
Penalties that may be assessed include (but are not limited to):
- Penalties for failure to pay properly as may be required within the labor codes
- Back wages for failure to pay overtime
- Back wages and penalties for failure to provide meal and rest periods
- Payment of employer state and federal employment taxes
- Penalties for failure to pay state and federal employment taxes
Assume that an employee making the minimum amount to be an exempt employee is determined to be improperly classified and that the employee worked just three hours of overtime per week. That employee’s hourly rate of pay is $22.825 per hour. Three hours of overtime per week equals $102.71; 49 weeks equals $5,032.91; and 49 weeks of missed meal periods equals $838.82 (that amount does not include penalties). The total cost for that one employee equals $5,861.73.
With that example in mind, it only makes sense—as well as cents—to take the time to determine each employee’s correct classification. You can never be too diligent when it comes to avoiding the potentially costly penalties that would result from misclassifications or miscalculations.
Get It Straight!
Here are seven steps you should begin immediately:
- Review all employees who are currently considered exempt to determine if they meet the new salary level of $913 per week.
- Take the opportunity to review the duties test for all remaining exempt staff to ensure compliance with DOL.
- For employees who do not meet the new salary level but do meet the duties test, you must determine if you should keep them an exempt employee by raising their salary to a minimum of $913 per week or convert them to a non-exempt employee. This will make the employee eligible to receive overtime in accordance with state or federal requirement (See “Items to Consider” below).
- For employees who do not meet the duties test, you must change those employees to the classification of a non-exempt employee.
- You are required to have accurate and detail records of the worked hours for non-exempt employees. These records should include the start time, meal periods, and the end time for each workday. These recordings may be done through electronic timekeeping programs or on manual timesheets. If you are using timesheets which require employees to manually enter their times, it is critical that the employees acknowledge that the time they are reporting includes all hours worked and is true and accurate.
- If overtime becomes excessive, employers should implement a procedure which requires all employees to obtain approval before working any overtime. Should an employee violate this rule, you are still required to pay them for all hours worked; however, the employee maybe subject to disciplinary action for violating the procedure.
- All employees, and specifically employees moving from exempt to non-exempt, should be provided with a written statement that working “off the clock” is prohibited.
Ted Medeiros is the CEO of TM San Ramon, California-based Consulting Services LLC, a company that specializes in Human Resources, Payroll, Safety, and Finance.