The U.S. Department of Labor (DOL) recently issued a new rule that’s expected to make 4 million additional U.S. workers eligible for overtime pay under the Fair Labor Standards Act (FLSA). Employers understandably have a lot of questions about this change that comes with significant budgetary and payroll tax implications. Here are some answers.
When are employers required to pay overtime?
The FLSA generally requires that most employees in the United States be paid overtime pay at 1.5 times their regular pay rate for all hours worked over 40 hours in a workweek. The requirement applies to employees of businesses with an annual gross volume of sales made or business done of $500,000 or more.
Which employees are exempt from the overtime pay requirement?
The FLSA provides exemptions for certain professional, administrative, executive, computer, and outside sales employees—what are also known as “white-collar” exemptions. The exemptions aren’t based on an employee’s job title or status as a salaried worker rather than hourly.
The DOL has established a three-part general test for exempt workers, all three of which must be satisfied:
- Salary basis: The employee regularly receives a predetermined amount of compensation each pay period on a weekly, or less frequent, basis that can’t be reduced because of the quality or quantity of the employee’s work. Professional, administrative, and computer employees can be paid on a “fee basis” rather than a salary basis. If the employee is paid an agreed sum for a single job, regardless of the time required, the employee is paid on a “fee basis.” Fee payments are generally paid for a unique job rather than for a series of jobs repeated a number of times for which identical payments are repeatedly made.
- Salary level: The salary or fee isn’t below the standard salary level or threshold (currently, $684 per week or $35,568 per year). Exempt computer employees may be paid a salary of at least the standard salary level per week, or on an hourly basis of at least $27.63 an hour. Special salary levels apply to U.S. territories and the motion picture industry.
- Duties test: The employee’s primary duty relates to the specific claimed exemption. Separate duties requirements apply for executive, administrative, professional, computer, and outside sales employees. “Primary duty” means the principal, main, major, or most important duty that the employee performs.
Note: Neither the salary basis test nor the salary level test applies to outside sales employees, teachers, and employees practicing law or medicine. The salary level test also doesn’t apply to business owners who have at least a 20 percent equity interest in their business and are actively engaged in its management.
What are the required job duties for the professional exemption to apply?
The DOL regulations recognize two types of professionals.
For learned professionals, their primary duty must be performing work that requires advanced knowledge—meaning it’s predominantly intellectual and requires the consistent exercise of discretion and judgment. The advanced knowledge must be in a field of science or learning, including:
- Law,
- Medicine,
- Theology,
- Accounting,
- Actuarial computation,
- Engineering,
- Architecture,
- Teaching,
- Various types of physical, chemical, and biological sciences,
- Pharmacy, and
- Other occupations that have a recognized professional status.
Also, the profession must require specialized academic training.
A creative professional’s primary duty must be performing work that requires invention, imagination, originality, or talent in a recognized field of artistic or creative endeavor. This includes fields such as music, writing, acting, and the graphic arts.
What are the required job duties for the administrative exemption to apply?
The primary duty of an exempt administrative employee is office or non-manual work that’s directly related to the management or general business operations of the business or its customers. That includes functional areas such as:
- Tax,
- Finance,
- Accounting,
- Budgeting,
- Auditing,
- Insurance,
- Quality control,
- Purchasing,
- Procurement,
- Advertising,
- Marketing,
- Research,
- Safety and health,
- Personnel management,
- Human resources,
- Employee benefits,
- Labor relations,
- Public relations,
- Government relations,
- Computer network, internet, and database administration,
- Legal and regulatory compliance, and
- Similar activities.
An exempt administrative employee’s primary duty must also include “the exercise of discretion and independent judgment on matters of significance.”
What are the required job duties for the executive exemption to apply?
The primary duty must be managing the business or a commonly recognized department or subdivision of the business. The employee must also regularly direct the work of at least two full-time or full-time-equivalent employees (for example, one full-time and two half-time employees are equivalent to two full-time employees). An exempt executive must also have the authority to hire or fire other employees, or provide input that’s given particular weight on the hiring, firing, advancement, promotion or any other change of status of other employees.
What are the required job duties for a computer employee to be exempt?
A computer systems analyst, computer programmer, software engineer, or other similarly skilled worker in the computer field is exempt if their primary duty consists of:
- The application of systems analysis techniques and procedures (including consulting with users) to determine hardware, software, or system functional specifications,
- The design, development, documentation, analysis, creation, testing, or modification of computer systems or programs (including prototypes) based on and related to user or system design specifications,
- The design, documentation, testing, creation, or modification of computer programs related to machine operating systems, or
- A combination of the above.
What are the required job duties for an outside sales employee to be exempt?
The primary duty of an exempt outside sales employee is making sales or obtaining orders or contracts for services or for the use of facilities for which the client or customer will pay consideration (generally, money). “Sales” includes any sale, exchange, contract to sell, consignment for sale, shipment for sale, or other disposition. It also includes the transfer of title to tangible property and, in some instances, of tangible and valuable evidence of intangible property. In addition, the employee must regularly work away from the employer’s place of business.
When are highly compensated employees exempt from overtime pay requirements?
Under the current rules, highly compensated employees are exempt if they’re paid annual compensation (including incentive payments and nondiscretionary bonuses) of at least $684 per week and $107,432 per year.
If an employee’s total compensation in a given annual period doesn’t meet the HCE total annual compensation threshold, an employer can make a catch-up payment within one month of the end of the annual period. A catch-up payment counts toward only the prior year’s total annual compensation; it doesn’t apply toward the salary amount during the 52-week period it was paid.
Highly compensated employees are subject to a less stringent duties test than is applied for other exemptions. Under the duties test for highly compensated employees, the employee’s primary duty must still consist of office or non-manual work, but the employee need only regularly perform one of the exempt duties of an executive, administrative, or professional employee.
How does the final rule expand overtime eligibility?
The new rule addresses the salary level test. It raises the thresholds by 65 percent in two steps:
- Starting July 1, 2024, the standard level threshold increases to $844 per week or $43,888 per year.
- As of Jan. 1, 2025, the standard threshold will climb to $1,128 per week or $58,656 per week.
The final rule adopts a new methodology, setting the standard salary level at the 35th percentile of weekly earnings of full-time salaried workers in the lowest-wage Census Region (the South). The current methodology pegs the salary level to the 20th percentile in the South region.
For highly compensated employees, the compensation level will be set at the annualized weekly earnings of the 85th percentile of full-time salaried workers nationally (up from the current 80th percentile), resulting in a compensation level of $132,964 on July 1, 2024, and $151,164 on Jan. 1, 2025.
Note: If a highly compensated employee no longer meets the salary threshold for that exemption, their duties may make them eligible for one of the other white-collar exemptions (assuming they satisfy the applicable salary threshold).
How long will those salary levels apply?
The final rule includes a mechanism to update the salary levels every three years, with at least 150 days of notice to employers. The next update is slated for July 1, 2027.
The rule also has an exception for unforeseen economic or other conditions. In such circumstances, the DOL can temporarily delay a scheduled update.
Do bonuses count toward the salary threshold?
Employers can apply nondiscretionary bonuses and incentive payments (including commissions) to satisfy up to 10 percent of the standard salary test requirement as long as they make such payments on an annual or more frequent basis. Eligible bonuses include, for example, nondiscretionary incentive bonuses tied to productivity or profitability—like a bonus based on the specified percentage of the profits generated by a business in the prior year—and bonuses for the quality and accuracy of work.
Employees who are exempt as highly compensated employees must receive at least the full standard salary amount on a salary or fee basis. Their salary threshold test doesn’t allow any portion of this amount to be satisfied by nondiscretionary bonuses or incentive payments.
Can an employer make a catch-up payment toward the standard salary threshold?
Similar to what’s allowed for highly compensated employees, an employer can make a catch-up payment to reach the standard threshold within one pay period of the end of the 52-week period. The catch-up payment counts toward the prior year’s salary only.
Must salaried employees earning below the new salary level be converted to hourly pay?
Employees currently paid a salary may continue to be paid on that basis as long as:
- the salary is equivalent to a base wage at least equal to the federal minimum wage rate for every hour worked, and
- the employee receives a 50 percent premium on their regular pay rate for any overtime hours each week.
Does the rule change the duties test?
The final rule makes no changes to the existing job duties requirements. But it’s worth stressing that salary alone isn’t enough to secure an exemption—the applicable duties test must also be satisfied.
How should employers prepare for the new salary threshold?
Employers have several options for handling currently exempt employees who won’t be exempt under the new salary thresholds. For example, they can:
- Increase the salary of newly nonexempt employees to make them exempt,
- Reduce the amount of pay they allocate to such employees’ base salary to offset new overtime pay,
- Bite the bullet and pay overtime for newly exempt employees when required, or
- Reduce or eliminate overtime hours.
Depending on the approach, it may also be necessary to adjust budgets and payroll procedures. In addition, newly nonexempt employees might require training on time tracking and restrictions on off-hour work.
Bear in mind, though, that the rule is likely to be challenged in court, as was the case for a similar Obama-era final rule from 2016. With that rule, a federal court blocked it just days before it was scheduled to take effect in 2017, and the Trump administration opted not to defend it further so it never took effect.
With all of the uncertainty, employers should consult with an attorney to determine the best approach for their circumstances.
**
Exemption management and time tracking can eat up a lot of small business owners’ time. Gusto’s payroll service can ease some of the burden by making it easier to pay employees and automatically file your payroll taxes.
