Last month, the United States Department of Labor’s (DOL) Wage and Hour Division issued a proposed rule which would make substantial changes to existing exemptions to overtime and minimum wage requirements under the Fair Labor Standards Act (FLSA). Taken together, the proposed changes would impact millions of employees who are currently considered exempt from overtime pay requirements, potentially giving them access to overtime protections.

Among other things, the proposed rule would greatly increase the minimum salary levels for overtime-exempt employees under a common exemption, often referred to as the “white-collar” or executive, administrative, or professional (“EAP”) exemption. The proposed rule would also update earnings thresholds for another exemption, the highly compensated employee (“HCE”) exemption, and would institute an automatic updating mechanism that would result in changes to each earnings threshold on a regular basis. As detailed below, the changes are significant, and employers should be prepared to take action to ensure they remain in compliance with the law.

Background

The FLSA sets standards for employers regarding the payment of wages and overtime pay. Relevant here, it includes a requirement that covered employers must pay employees overtime premium pay when they work more than 40 hours in a work week. The FLSA provides that certain employees who fall into the white-collar or EAP category are exempt from overtime pay requirements, meaning employers do not need to pay these employees overtime. See 29 U.S.C. 213(a)(1). Generally, eligibility for the exemption is based on three criteria:

1. The “salary basis test”: The employee is paid a fixed salary that is not subject to reduction due to quality or quantity of work performed;
2. The “salary level test”: The salary paid must meet a minimum specified amount (currently $684 per week, or $35,568 per year); and
3. The “duties test”: The employee must perform job duties that are primarily executive, administrative, or professional in nature, as detailed in administrative regulations.

All three of these criteria or tests must be met for the EAP exemption to apply. The FLSA grants the Secretary of Labor the authority to define overtime exemptions. Notably, other exemptions also exist beyond the EAP and HCE. These include the academic administrative personnel and computer employees exemptions, which are subject to their own special earnings thresholds, as well as exemptions for industry-specific work applicable to doctors, lawyers, outside sales employees, and teachers, who are not subject to salary tests. Though worthy of discussion in their own right, for the most part, these other exemptions are not impacted by the proposed rule.

Under the HCE exemption, employees who receive at least $107,432 in total annual compensation (as defined in the relevant regulations) may be exempt from the FLSA’s overtime requirements if they customarily perform one of the exempt duties or responsibilities of an executive, administrative, or professional employee. The HCE test only applies to employees whose primary duties include office or non-manual work, and employees qualifying for exemption under the HCE test, as it currently stands, must also receive a portion of their compensation on a salary or fee basis that meets or exceeds the $684 per week threshold detailed above.

In recent years, the Department of Labor (DOL) has made adjustments to the exemption criteria. The most recent Rulemaking, which was released in 2019 and went into effect in 2020, raised a prior salary level, increased the HCE annual compensation threshold, and made a number of other changes to the ways that bonuses, commissions, and other incentive payments may be used to satisfy salary levels.

The Proposed Rule

The new proposal by the DOL, issued on September 8, aims to update the salary level criteria used in the applicable tests to better reflect changes in earnings over time. Specifically, the DOL proposes to set the standard salary level at the 35th percentile of weekly earnings of full-time salaried workers in the lowest-wage Census Region, which equates to $1,059 per week or $55,068 annually – an increase of nearly $20,000 from the current threshold. Additionally, the HCE exemption threshold would also be raised by more than $35,000 from its current level, to $143,988 annually, representing the 85th percentile of full-time salaried workers nationally. The HCE exemption was introduced in 2004 and, as the name suggests, targets “highly compensated” employees. By using the newer threshold, the DOL aims to set HCE total annual compensation at a level that is “high enough to exclude all but those employees at the very top of the economic ladder.” When adjusted for inflation, however, the proposed threshold is actually lower than the one initially established upon the introduction of this exemption.

The proposal further addresses the need to update salary levels in U.S. territories, which have not seen any changes in nearly two decades, and makes other changes to salary levels for individuals employed in the motion picture industry.

Finally, the proposed rule recognizes the need to regularly update these earnings thresholds to keep them effective in distinguishing between exempt and nonexempt employees. To address this need, the DOL has proposed the addition of a new regulatory provision which would automatically update the salary levels for these tests every three years. The provision would result in automatic adjustments to the salary thresholds above, using the same basic methodology. This mechanism aims to ensure that the earnings thresholds stay relevant and permits employers to plan accordingly.

The Department is not proposing any changes to the duties test.

The proposed rule would have a major impact on employee classification. The DOL estimates that the new standards would entitle approximately 3.4 million additional employees to overtime protection, if implemented. With respect to the HCE test, the proposed changes could affect over a quarter-million employees who are currently exempt, but would become non-exempt, and therefore entitled to receive overtime pay.

Steps to Prepare for the New Rule’s Implementation

The Department of Labor is currently accepting comments on the proposed rule through November 7, 2023. If implemented, the rule may be subject to legal challenges. Employers should nonetheless take steps to prepare for its implementation as changes to these salary thresholds are likely.

1:  Employers should review their employees’ classifications and compensation. At a minimum, employers should review the existing salary thresholds to ensure compliance with the salary test as it stands and gain an understanding of the impact that the proposed rule could have upon their operations.

2:  Employers should review their existing policies regarding working hours, and prepare for the changes that may be needed if they are forced to re-classify employees as non-exempt.

3:  Employers should be prepared to inform employees of the changes, if and when they are enacted. Some states require employers to provide written notice to employees prior to making any changes to their compensation, or the methods used to determine wages due, and reclassifying an employee may require the issuance of written notice to those affected.

Finally, employers should ask for assistance. Classification of employees under the FLSA and related state law can be complicated, and misclassification may carry serious legal ramifications regardless of an employer’s intent. Employers who misclassify employees as exempt may be liable for years of unpaid overtime, liquidated damages, fines, civil penalties, and attorney’s fees, and risk reputational harm.

If you have questions regarding proper classification of an employee under any of these tests, or the DOL’s proposed rule and its impact on your company’s operations, reach out to counsel. Hinckley Allen’s skilled Labor and Employment attorneys are well-versed in these issues and can help you navigate them while remaining in compliance with the law.