United States: Department Of Labor Implements Long-Awaited FLSA Reform

On April 20, 2004, after significant public commentary and debate, the Department of Labor published final regulations changing the standards governing whether employees are exempt from the overtime and minimum wage requirements of the Fair Labor Standards Act ("FLSA"). The changes to the regulations are extensive and are a welcomed effort to update the FLSA to better accommodate the realities of the modern workplace. The new regulations, which can be found at 69 Fed. Reg. 22,122 (April 23, 2004) (to be codified at 29 C.F.R. Part 541) and at http://www.dol.gov/esa/regs/compliance/ whd/fairpay/main.htm, were published in the Federal Register on April 23, 2004, and will go into effect August 23, 2004. The following summary provides an overview of the new final regulations and their impact on employers.

In order to restore the overtime protections intended by the FLSA, but weakened by the dramatic changes in the workplace environment since the regulations were last updated, the DOL’s new regulations reflect multiple changes from the prior regulations, which include:

• Increasing the minimum salary level required for the executive, administrative, and professional exemptions, and establishing the salary level required for an employee to be considered "highly compensated";

• Adopting a single standard duties test for each exemption category, and discarding the "long" and "short" tests structure utilized in the prior regulations;

• Revising and clarifying the elements — while generally retaining key concepts in the basic requirements — to be considered when determining whether an employee’s primary job duties fall within any of the five identified exemptions;

• Including a section explicitly stating that police officers, fire- fighters, paramedics, emergency medical technicians, and similar public safety employees, as well as manual laborers or other blue-collar workers, are entitled to overtime pay; and

• Reorganizing and streamlining the regulations to make them easier to understand, eliminating the distinction between "regulations" and "interpretations" found in the prior regulations, organizing the subparts according to each category of exemption, updating the de. nitions of key terms and phrases, and eliminating outdated examples.

To be considered exempt, an employee must be paid on a salary basis at not less than certain minimum amounts and must meet certain minimum duties tests related to the employee’s primary job duties. The new regulations, like the prior regulations, make it clear that job titles are insufficient to establish the exempt status of an employee. Rather, the critical analysis is whether an employee’s salary and duties meet the requirements of the exemption tests.

Salary Level and Basis Analysis. Executive, administrative, and professional employees will be exempt from the FLSA’s overtime regulations only if they meet certain salary requirements. The previous regulations set the minimum salary level at $155 per week or $8,060 annually. To be exempt under the new regulations, an employee must be compensated at a salary level of at least $455 per week, which is equivalent to $23,660 annually. Thus, workers earning less than $455 per week are guaranteed overtime compensation. In addition, the minimum salary level must be paid on a salary basis.

Generally speaking, employees are paid on a salary basis if they regularly receive, each pay period, a predetermined amount constituting all or part of their compensation, and if that predetermined amount is not subject to reduction due to variations in the quality or quantity of the work performed. Although exempt employees need not be paid for a workweek in which they perform no services, they must receive their full salary for any week in which they perform any work.

Employers should be aware, however, that certain types of exempt employees are subject to unique salary basis rules. For example, the compensation requirement for academic administrative employees — such as department heads, counselors, or principals — may be satisfied at a rate equal to the entrance salary for teachers in the school where the employee works. The salary for exempt computer employees can be based on an hourly formula if the wage rate is no less than $27.63 per hour. Further, under the professional employees exemption, the minimum salary requirements do not apply to teachers, practicing lawyers or doctors, or outside sales employees. In addition, administrative and professional workers may be paid on a fee basis, rather than a salary basis, if the employee receives an agreed sum for a particular job regardless of the time required for performance.

Impact of Deductions. The new regulations, like the prior regulations, provide that regardless of the payment arrangement, an employee will not be considered to be paid on a "salary basis" if deductions are made from the predetermined amount of compensation for any absences arranged by the employer or due to the operational needs of the business. The new regulations did not modify the specific circumstances in which an employer may make deductions from pay on a salary basis without sacrificing the overtime exemption, such as deductions for personal absences of more than one full day, for absences due to sickness and disability if made pursuant to a bona fide plan or policy of providing compensation for loss of salary, and for penalties imposed for infractions of major safety rules. However, the revised regulations add a new permissible deduction: An employer now may deduct an exempt employee’s pay for unpaid disciplinary suspensions of one or more full days for infractions of workplace conduct rules applicable to all employees. As under the prior regulations, all other types of deductions may expose employers to the risk that their classification of certain employees as exempt will be challenged.

An employer who makes improper deductions will lose the exemption applicable to particular employees for the affected time period if the facts demonstrate that the employer did not intend to pay the employees on a salary basis. Thus, if the employer has an actual practice of making improper deductions, the overtime exemption will be lost during the time period in which the deductions were made, for all employees in the same job classification who work for the same manager responsible for the deductions.

On the other hand, in a new safe harbor provision, the revised regulations provide that isolated or inadvertent improper deductions may not always jeopardize exemption status. To avoid losing exempt status based on an inadvertent improper deduction, an employer should have a clearly communicated policy prohibiting improper deductions, include a complaint mechanism in that policy, reimburse employees for any improper deductions, and, if an inadvertent improper deduction is made and discovered, take corrective steps to ensure compliance with the regulations in the future.

Special Rule for Highly Compensated Employees. Recognizing that a high level of compensation is a strong indicator of exempt status, the regulations offer a special exemption for highly paid employees without engaging in a detailed analysis of their job duties. Under the new regulations, employees earning a total annual compensation of at least $100,000 are exempt from the FLSA overtime requirements, if they customarily and regularly perform any one or more of the exempt duties of an executive, administrative, or professional employee. The total annual compensation figure must include at least $455 per week paid on a salary or fee basis and may include commissions, nondiscretionary bonuses, and other nondiscretionary compensation earned during a 52-week period.

It is important to remember that this overtime exemption applies only to highly compensated individuals who perform primarily office or non-manual work. Thus, for example, nonmanagement production line, maintenance, and construction workers — including carpenters, mechanics, iron workers, longshoremen, and other laborers — are not exempt, no matter how highly paid.

Job Duties Analysis. As a preliminary matter, recurring through the duties tests are three significant concepts generally applicable to all the exemptions under both the prior regulations and the new regulations: (1) an employee’s "primary duty"; (2) work "directly and closely related" to exempt work; and (3) combination exemptions.

Under the new regulations, an employee’s "primary duty" is the principal or most important duty of the employee. The test to determine the primary duty remains substantially unchanged: The employee’s job must be considered as a whole, looking at factors such as the relative importance of the exempt duties as compared to any nonexempt duties, the amount of time spent performing exempt work, freedom from direct supervision, and the relationship between the employee’s salary and the wages paid to other employees for the kind of nonexempt work performed by the employee. The regulations further specify that the amount of time spent performing exempt work provides guidance, but is not determinative. Thus, although an employee who spends more than 50 percent of his time performing exempt work likely will meet the primary duty requirement, an employee who spends less than 50 percent of his time performing exempt duties may meet the requirement so long as other factors support the conclusion that the performance of exempt work is the employee’s primary duty. Notably, the new regulations eliminate the 20 percent limitation (or 40 percent limitation for retail or service establishments) on the amount of time devoted to nonexempt tasks.

In this same vein, work that is "directly and closely related" to the performance of exempt work remains exempt work under the new regulations. This includes tasks that are related to exempt duties and contribute to or facilitate the accomplishment of exempt tasks — e.g., physical, menial, or routine tasks that are necessary to the proper performance of the exempt work — even if such tasks themselves do not constitute exempt work.

Finally, the new regulations continue to recognize that an employee may perform a combination of exempt duties under multiple exemptions. Further, the combination exemptions provision of the revised regulations eliminates the prior requirement that the employee meet the "stricter" of the requirements on salary and nonexempt work.

Executive Employees Exemption. Under the prior regulations, an employee quali. ed for the executive exemption if his primary duty consisted of management of the enterprise (or a customarily recognized department or subdivision) and if he customarily and regularly directed the work of two or more employees. Under the new regulations, an employee qualifies for the executive exemption if: (1) he earns a salary of not less that $455 per week; (2) his primary duty is management of the business or management of a customarily recognized department or subdivision of the business; (3) he customarily and regularly directs the work of at least two or more other full-time employees or their equivalent; and (4) he has the authority to hire or fire other employees, or his suggestions or recommendations as to the employment actions concerning other employees are given particular weight (even if a suggestion or recommendation is subject to review by a higher-level manager and the employee does not have the authority to make the ultimate decision on an employment action).

Moreover, the regulations recognize that concurrent performance of exempt and nonexempt duties does not automatically preclude an employee from the executive exemption if the remaining requirements are met. The key distinction here is that an exempt employee makes the decision for himself whether to perform nonexempt work and always remains responsible for the business operations under his management while performing nonexempt work. In contrast, a nonexempt employee performs work — exempt or nonexempt tasks — at the direction of a supervisor for particular time periods.

Finally, the new regulations retain a safe harbor for business owners. An employee who owns at least a bona fide 20 percent equity interest in the business and is actively engaged in management of the organization qualifies for the executive employees exemption. Moreover, the salary requirements of the executive employees exemption do not apply to employees who qualify under the business owners rule.

Administrative Employees Exemption. Under the new regulations, an employee qualifies for the administrative exemption if: (1) he earns a salary of not less than $455 per week; (2) his primary duty is the performance of office or non-manual work directly related to the management or general business operations of the employer or the employer’s customers; and (3) his primary duty includes the exercise of discretion and independent judgment with respect to matters of significance. This test has been streamlined substantially, but remains similar to the prior regulations, except for the updated salary level, the deletion of the required categories of job duties, and the addition of the clarifying phrase "with respect to matters of significance" to the existing requirement that the employee exercise discretion and independent judgment. In addition, the list of illustrative examples has been updated to discuss the classification of specific types of white-collar employees such as claims adjusters, financial services industry employees, purchasing agents, human resource employees, inspectors, and examiners/graders.

As under the prior regulations, for an employee’s primary duty to be "directly related to the management or general business operations," the employee must perform work directly related to assisting with the running or servicing of the business. For example, this includes work in functional areas such as tax, finance and accounting, budgeting, purchasing and procurement, personnel management, etc. Similarly, the discretion and independent judgment element requires that the employee be empowered to evaluate possible courses of conduct and to make independent decisions, free from immediate supervision (even if the decision is subject to higher review). Specifically excluded from the administrative exemption are employees who apply well-established techniques, procedures, or specific standards described in manuals or other sources within closely prescribed limits, including performing clerical or secretarial work, recording or tabulating data, or performing other mechanical, repetitive, recurrent, or routine work.

Professional Employees Exemption. This exemption remains substantially similar to the prior regulations, although the new regulations provide additional and updated guidance on the specific requirements. Under the new regulations, an employee qualifies for the professional employees exemption if he earns a salary of not less than $455 per week and his primary duty is the performance of work (1) requiring knowledge of an advanced type in a field of science or learning customarily acquired by a prolonged course of specialized intellectual instruction; or (2) requiring invention, imagination, originality, or talent in a recognized field of artistic or creative endeavor. The regulations refer to these kinds of employees as "learned professionals" and "creative professionals," respectively.

Learned Professionals. To qualify under the "learned professionals" exemption, an employee must meet a three-part primary duty test: (1) the employee must perform work requiring advanced knowledge; (2) the advanced knowledge must be in a field of science or learning; and (3) the advanced knowledge must be customarily acquired by a prolonged course of specialized intellectual instruction.

The regulations provide that this exemption requires that an employee perform work that is predominantly intellectual in character, including work requiring the consistent exercise of discretion and judgment, and in which the employee uses advanced knowledge to analyze, interpret, or make deductions from varying facts or circumstances. The regulations explain that such advanced knowledge does not include work involving routine mental, manual, mechanical, or physical work and cannot be attained at the high school level.

This exemption thus extends to professions such as law, medicine, theology, accounting, actuarial computation, engineering, architecture, teaching, physical, chemical and biological sciences, pharmacy, and other similar occupations that have a recognized professional status. Excluded from this exemption are mechanical arts or skilled trades, even where the knowledge is of a fairly advanced type, that are not in a field of science or learning. Only those professions where specialized academic training is a standard prerequisite for entrance into the profession qualify for the exemption. The exemption is not available for occupations that may be performed with only the general knowledge acquired by an academic degree in any field, with knowledge acquired through apprenticeship, or with training in the performance of routine mental, manual, mechanical, or physical processes. Further, this exemption does not apply to occupations in which most employees have acquired their skill by experience rather than by advanced specialized intellectual instruction.

Creative Professionals. Alternatively, to qualify under the "creative professionals" exemption, an employee’s primary duty must be the performance of work requiring invention, imagination, originality, or talent in a recognized field of artistic or creative endeavor. Excluded from this exemption is work that can be produced by a person with general manual or intellectual ability and training.

This exemption extends to employees in fields such as music, writing, acting, and the graphic arts, and its requirements typically are met by actors, musicians, composers, conductors, soloists, painters, cartoonists, essayists, novelists, writers, and other comparable employees. However, this exemption does not apply to employees whose work is not creative in character, such as copyists or photograph retouchers. Journalists may qualify as exempt creative professionals if their primary duty is performing on air, conducting investigative interviews, analyzing or interpreting public events, writing editorials or commentary, or acting as a narrator or commentator. In contrast, media employees who collect, organize, or record routine or public information, or who do not contribute a unique interpretation or analysis to a news product are not exempt creative professionals.

Teachers. The professional employees exemption also includes any employee with a primary duty of teaching, tutoring, instructing, or lecturing in the activity of imparting knowledge and who is employed and engaged in this activity as a teacher in an educational establishment. Certified teachers qualify for the exemption, but a teacher’s certificate is not required to qualify for the exemption, so long as the individual is employed as a teacher by the employing school.

Practice of Law or Medicine. The professional employees exemption also includes: (1) any employee who is the holder of a valid license or certificate permitting the practice of law or medicine or any of their branches and is actually engaged in the practice thereof; and (2) any employee who is the holder of the requisite academic degree for the general practice of medicine and is engaged in an internship or resident program. The medical practice exemption applies to physicians and other practitioners licensed and practicing in the field of medical science and healing. The regulations further provide that employees engaged in internship or resident programs, whether or not licensed to practice at the time the program begins, qualify as exempt professionals if they enter such programs after earning the appropriate degree required for the general practice of the profession.

Computer Employees Exemption. This exemption remains substantially similar to the prior regulations. An employee qualifies for the computer employee exemption if he earns a salary of not less than $455 per week or is compensated on an hourly basis at a rate not less than $27.63 per hour, and his primary duties consist of: (1) the application of systems analysis techniques and procedures, including consulting with users, to determine hardware, software, or system function specifications; (2) 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; (3) the design, documentation, testing, creation, or modification of computer programs related to machine operating systems; or (4) any combination of the above duties, the performance of which requires the same level of skills.

In line with the above test, the computer employees exemption does not apply to employees engaged in the manufacture or repair of computer hardware and related equipment. The exemption likewise does not apply to employees who are not primarily engaged in computer systems analysis and programming, regardless of whether their work is dependant on or facilitated by the use of computers or computer software programs (including engineers, drafters, and others skilled in computer-aided design software). In addition, a computer employee, whether or not he is covered by this exemption, may also have executive or administrative duties that independently qualify him for one of those two exemptions.

Outside Sales Employees Exemption. As under the prior regulations, an employee qualifies for the outside sales exemption under the new regulations if: (1) his primary duty is either making sales or obtaining orders or contracts for services or for the use of facilities for which a consideration will be paid by the client or customer; and (2) he is customarily and regularly engaged away from the employer’s place or places of business in performing his primary duties.

For purposes of this test, work performed incidental to and in conjunction with the employee’s own outside sales or solicitations, including incidental deliveries and collections, should be regarded as exempt outside sales work. Similarly, other work that furthers the employee’s sales efforts should be regarded as exempt outside sales work, including writing sales reports, updating or revising the employee’s sales or display catalogue, planning itineraries, and attending sales conferences.

The regulations require that the employee make sales at the customer’s place of business or at the customer’s home. Outside sales do not include sales made by mail, telephone, or the Internet, unless such contact is merely in addition to personal calls. Moreover, a driver who delivers and sells products may, depending on the circumstances, qualify as exempt if he has a primary duty of making sales.

It is important to remember that the recent changes to the FLSA regulations do not change the general rule that no provision contained within the FLSA will excuse noncompliance with any state or local law establishing a minimum wage higher than the minimum wage established in the FLSA or a maximum work week lower than the maximum work week established in the FLSA. Therefore, employers always must be familiar with any applicable state or local wage and hour law.

Indeed, although many state wage and hour laws closely track the FLSA, opposition to the revisions to the FLSA regulations may lead to local wage and hour legislative activity. For example, on April 2, 2004, before the DOL passed its final rules, Illinois passed legislation that rejected — prior to publication of the final rules — the proposed changes to the definitions of the three primary job categories exempt from overtime pay. This legislation purports to maintain overtime rights for employees who may have lost those rights under the revised regulations and effectively retains the prior exemption rules in Illinois. Similarly, the Minnesota Senate passed a bill on April 15, 2004 aimed at preserving overtime pay for many hourly workers who would be reclassified as exempt salaried employees under the proposed federal regulations, and it is possible that other states will follow the same course.

The new regulations are expected to go into effect August 23, 2004. During this short interim period, employers should review their policies and practices and identify any necessary changes in preparation for the new standards.

• Evaluate the impact of the new salary levels. Identify those employees who earn less than $455 per week ($23,660 annually) and evaluate whether they meet any of the duties tests. If they otherwise meet the exemption standards, consider whether increasing their compensation to preserve exempt status is a viable option or, if they do not meet any duties test, adjust practices to provide overtime compensation or to strictly adhere to a 40-hour work week.

• Evaluate the job duties of your workforce to determine whether, under the revised duties tests, employees are properly classified. Where necessary, revise or update job descriptions. Pay close attention to the classification of those employees who, under the prior regulations, were difficult to classify; the revised regulations may tip a close analysis the other way. Remember to consult the updated examples provided in the new regulations for guidance.

• If some employees previously classified as nonexempt could now be classified as exempt, consider employee retention and morale issues before changing the status of a large group of employees.

• Evaluate payroll, attendance, timekeeping, compensation, and discipline policies and practices for compliance with the revised salary basis requirements. Both policies and actual practices are important in evaluating whether an employer properly compensates exempt employees on a salary basis and whether the safe harbor for deductions may apply.

• If substantial changes to exempt status and/or company practices are required, develop a comprehensive communication strategy for explaining the changes to the workforce. Remember that the DOL's changes to the regulations have been controversial, and organized labor and other interested groups have stated publicly that the changes will operate to deprive employees of overtime compensation for time worked. Clear communication with employees about any changes, the reasons for the changes, and their practical impact will help counter any misinformation and maintain employee morale.

• Remember that any applicable collective bargaining agreements and local wage and hour laws still apply. Nothing in the revised FLSA regulations relieves an employer from these parallel obligations.