United States: The U.S. Department Of Labor Overhauls the "White-Collar" Exemptions to the Fair Labor Standards Act

Last Updated: May 18 2004
Article by Holly E. Dolbey

On April 20, the United States Department of Labor ("DOL") announced its final revised regulations governing the so-called "white-collar" exemptions from the overtime requirements of the Fair Labor Standards Act ("FLSA").1 When the DOL proposed overhauling these rules over a year ago, a firestorm of criticism cascaded from Democrats and workers’ advocacy groups who claimed that the revisions would substantially broaden the exemptions, depriving millions of employees from earning overtime pay. The final rules — which will become effective on August 23 — retreat from many of the DOL’s most controversial proposals. Nevertheless, the new rules do include some substantial changes to the executive exemption and to the salary level test, and introduce a new exemption for "highly compensated employees." The rules as a whole also are better organized and contain more specific guidance and examples to help employers in the modern workplace navigate these rules.

Background

Employers covered by the FLSA must provide overtime pay to their nonexempt employees who work in excess of 40 hours in a workweek. The FLSA exempts from its minimum wage and overtime requirements the following categories of employees: (1) bona fide executive, administrative, or professional employees; (2) highly skilled computer-related employees; and (3) employees working in outside sales. 29 U.S.C. §§ 213(a)(1) & 213(a)(17). Extensive regulations issued by the DOL govern the scope of these so-called "white-collar" exemptions.

Under the existing rules, the exemptions generally follow the same framework. Employees must satisfy three elements: (1) the "duties" test, which evaluates the duties performed by the employee; (2) the salary level test, which mandates that employees make a minimum level of salary; and (3) the "salary basis" test, which evaluates whether the employee actually is compensated on a salary basis (or, in some cases, a fee basis) as required by the FLSA. The existing rules guarantee overtime pay to almost all employees earning below $8,060 per year regardless of their duties; employees earning a salary between $8,060 and $13,000 per year generally are exempt if they satisfy a detailed "duties test" (long test) for any one of the exemptions; and employees earning a higher salary are exempt if they satisfy a streamlined version of the "duties tests" (short test). These minimum salary levels, which have not changed in almost 30 years, are so outdated that the "long test" has become virtually meaningless.

The new rules reorganize and consolidate the existing rules and make some modifications to the duties tests, the salary level test, and the salary basis test. The rules bring the minimum salary levels into the 21st century: almost all employees earning less than $23,660 per year will now be nonexempt, entitling them to overtime pay. For employees earning a salary of at least $23,660, the new rules replace the "long" and "short" duties tests with one duties test for each of the exemptions that focuses on the employee’s "primary duty." 2 Although the new "duties tests" have been modified to some extent, they largely mirror the existing "short tests," with the notable exceptions of one new requirement for the executive exemption and a simpler test for outside sales employees. The new regulations include a new "highly compensated employee" exemption for employees earning at least $100,000 per year; such employees are now exempt if they satisfy a relaxed duties test. Finally, with respect to the salary basis test, the new rules provide employers with more flexibility to discipline exempt employees, and establish a "safe harbor" to help insulate employers from the potentially harsh effects of improper deductions from the pay of otherwise exempt employees.

The Duties Tests: The New Rules Largely Adhere to the Existing Short Duties Test, and Introduce A New "Highly Compensated Employee" Exemption

Executive Employees. To qualify for the new executive exemption, an employee must satisfy the new salary level and salary basis tests and must:

  1. Have the primary duty of management of the enterprise or a customarily recognized department or subdivision thereof;
  2. Customarily and regularly direct the work of two or more other employees; and
  3. Either have the authority to hire or fire other employees, or give suggestions and recommendations as to hiring, firing, advancement, promotion, or other changes of status if such suggestions are given particular weight by the employer.

29 C.F.R. § 541.100.

An employee who owns at least a bona fide 20% equity interest in his employer, and who is "actively engaged in its management," also qualifies for the executive exemption regardless of the employee’s compensation. Id. § 541.101.3

The first two elements of the new standard test are essentially the same as the current "short" test. The "hire or fire" element, on the other hand, is borrowed from the old "long" test; as such, this represents a new requirement for virtually all employees who currently qualify as exempt executives. This means that employers will need to take a close look at their currently exempt executive employees to determine whether these employees can meet the "hire or fire" requirement; if they cannot, these employees will be nonexempt and will be entitled to overtime. The new rule also contains detailed definitions of the terms "management," "customarily recognized department or subdivision," "two or more other employees," and "particular weight." Id. §§ 541.102 – 541.105. Finally, the new rule addresses the application of the executive exemption to employees who perform both exempt and nonexempt work, and provides specific examples to illustrate the principle. Id. § 541.106.

Administrative Employees. To qualify for the administrative exemption under the new rules, an employee must meet the salary level and salary (or fee) basis tests, and:

  1. Have the primary duty of performing office or non-manual work directly related to the management or general business operations of the employer or the employer’s customers; and
  2. The primary duty must include the exercise of discretion and independent judgment with respect to matters of significance.

29 C.F.R. § 541.200. 4

This new test is virtually identical to the existing short test. The new regulations define the term "directly related to management or general business operations," reinforcing the well-established principle that the administrative exemption applies only to employees whose work relates to assisting "with the running or servicing of the business," as opposed to producing or selling the business’s products or services. Id. § 541.201(a). The new rules include an expanded list of business areas in which administrative employees are likely to work, such as tax; accounting; quality control; advertising; safety and health; personnel; legal and regulatory compliance; and computer network, Internet and database administration. Id. § 541.201(b). Despite these examples, the so-called "production versus staff" dichotomy has proven difficult to apply in some circumstances, and the new rules do not offer much of an improvement on this front. Also included in the final rules is a detailed definition of "discretion and independent judgment," which the DOL crafted from existing regulations and case law applying this standard. Id. § 541.202. The DOL nevertheless acknowledges that the "discretion and independent judgment" test has generated significant confusion and litigation, and this will no doubt continue to be one of the more difficult standards to apply in practice.5

Perhaps in recognition of the fact that the administrative exemption has been — and will remain — the most amorphous of the white-collar exemptions, the new regulations include detailed descriptions of a number of jobs that generally qualify for this exemption. These include insurance claims adjusters; certain employees in the financial services industry; employees who lead a team assigned to complete major projects for the employer; executive and administrative assistants; human resources managers; and purchasing agents. Id. § 541.203. Even for these categories of employees, however, the job title does not control, and employers will need to evaluate the actual duties performed by the employees to determine if they qualify for the exemption. The new rules also identify some jobs that normally do not qualify for the exemption, including inspection work; examiners and graders; comparison shoppers; and public sector inspectors or investigators. Id.

Professional Employees. The professional exemption encompasses two types of professionals: the learned professional and the creative professional. To qualify for the new learned professional exemption, an employee must meet the salary level and salary (or fee) basis tests and:

  1. Have the primary duty of work requiring advanced knowledge, which is predominantly intellectual in character and includes work requiring the consistent exercise of discretion and judgment;
  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.

29 C.F.R. § 541.301.

This parallels the current exemption.6 The new rules do clarify the application of this exemption to a small subset of employees. Specifically, the exemption applies to employees working in professions where "specialized academic training is a standard prerequisite for entrance into the profession," as well as to employees who choose a non-traditional path into such professions through a combination of work experience and intellectual instruction. This small subset of professionals includes, for example, the "occasional lawyer who has not gone to law school, or the occasional chemist who is not the possessor of a degree in chemistry." Id. § 541.301(d).

The new rules specifically address the status of certain professionals; some of these examples are borrowed from existing regulations and others are new. The following professionals generally will be exempt provided they meet customary educational and/or certification requirements: registered or certified medical technologists; registered nurses (but not licensed practical nurses or other nurses); dental hygienists; physician assistants; accountants; chefs (as distinguished from cooks); athletic trainers; and licensed funeral directors. Paralegals generally are nonexempt. Id. § 541.301(e).

The new rule for creative professionals is essentially the same as the existing rule, although the new regulations clarify the status of journalists.7

Outside Sales Employees. To qualify for the new outside sales employee exemption, an employee must:

  1. Have the primary duty of making sales, or obtaining orders or contracts for services or for use of facilities for which a consideration will be paid by a client or customer; and
  2. Be customarily and regularly engaged away from the employer’s place of business. 29 C.F.R. § 541.500.

This definition is consistent with the existing test for outside sales employees, with one exception: it removes the 20% restriction on nonexempt work. The "primary duty" test replaces this percentage restriction. This should relieve the burden on some employers who now must closely monitor and measure the percentage of time these employees devote to certain tasks. In defining the term "primary duty," the regulation clarifies that work incidental to sales work, such as making deliveries, writing sales reports, updating sales catalogues, or attending sales conferences, is regarded as exempt work. The regulation further defines "making sales or obtaining orders, "away from employer’s place of business," the status of promotion work, and the status of drivers who sell. Id. §§ 541.501-504.

Computer Employees. Due to the unique legislative history of the computer professional/employee exemption, the existing rules address computer employees in several places. The new rules remedy this confusing framework by consolidating the rules governing computer employees. To qualify for the computer employee exemption, an employee must be compensated on a salary basis of at least $455/week (like a salaried professional employee), or at least $27.63/hour if paid by the hour (like the current computer professional exemption). A combined primary duty test, which remains virtually unchanged from the current computer professional rules, requires the employee’s primary duty for both salaried and hourly computer employees to consist of:

The application of systems analysis techniques and procedures, including consulting with users, to determine hardware, software or system functional specifications;

  1. 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;
  2. The design documentation, testing, creation, or modification of computer programs related to machine operating systems; or
  3. A combination of the above, the performance of which requires the same level of skills.

The new rules do expand the exemption somewhat by deleting the requirement that the employee "consistently exercise discretion and judgment," and by broadening the application of the exemption to include additional non-software functions. 29 C.F.R. § 541.400. The new rules also explain that employees engaged in computer manufacture and repair are not exempt, and that computer employees — even if they do not fit the computer exemption — may qualify as exempt executive or administrative employees. Id. §§ 541.401 & 541.402.

Highly Compensated Employees. The new "highly compensated employee" rule marks one of the most dramatic departures from the existing rules. Under this new exemption, an employee who performs office or non-manual work and who makes at least $100,000 per year 8 is exempt if the employee "customarily and regularly performs any one or more of the exempt duties or responsibilities of an executive, administrative or professional employee …" 29 C.F.R. § 541.601(a). In effect, this establishes a looser exemption standard for a highly-paid employee because the employee’s "primary duty" need not fit within the defined exemptions as long as the employee "customarily and regularly" performs exempt duties. The existing regulations contain no comparable test.

Blue-Collar Employees and First Responders. In addition to clarifying and, in a few ways, redefining the white-collar exemptions, the final rules clarify the nonexempt status of two categories of employees, regardless of their compensation: blue-collar employees and so-called "first responders." Manual laborers and other blue-collar employees who perform work involving repetitive operations with their hands, physical skill and energy are nonexempt and thus entitled to minimum wage and overtime pay. 29 C.F.R. § 541.3(a). Likewise, most "first responders" such as police officers, detectives, investigators, correctional officers, parole and probation officers, fire fighters, paramedics, EMTs, and rescue workers who perform specified tasks do not qualify for the white-collar exemptions. Id. § 541.3(b).

Salary Level Test: The New Rules Almost Quadruple The Minimum Salary Level

As discussed above, the new rules modernize the regulatory framework by increasing the minimum annual salary to $455/week ($23,600/year). 29 C.F.R. § 541.600. Almost all employees who earn less than this now will automatically qualify for overtime, regardless of whether they are paid on an hourly or salary basis and regardless of their duties.9 The DOL estimates that the new minimum salary requirement alone will give overtime protection to 1.3 million workers who are currently exempt, and guarantee overtime to another 5.4 million employees whose status is "ambiguous" under the existing rules. Workers earning a salary between $23,600 per year and $100,000 per year are exempt if they satisfy the "primary duties" tests discussed above.10

The Salary Basis Test: The New Rules Permit One-Day Disciplinary Suspensions and Create a New "Safe Harbor" For Employers Who Make Improper Pay Deductions

As discussed above, to qualify for most of the exemptions, employees generally must be paid at least a minimum amount on a salary basis (or, in some cases, a fee basis). Like the existing regulations, the new regulations define the "salary basis" test, explaining that an exempt employee must receive a "predetermined amount" on a weekly or less frequent basis, and the salary cannot be subject to reduction due to "variations in the quality or quantity of the work performed."11 29 C.F.R. § 541.602. The new regulations also maintain the "no-docking" rule providing that exempt employee "must receive the full salary for any week in which the employee performs any work without regard to the number of days or hours worked"; in other words, partial-pay deductions based on the number of hours worked generally are not allowed. There are a few exceptions to the "no-docking" rule under both the old and new rules, including deductions in pay for circumstances like personal absences, sickness or disability; hours taken as unpaid FMLA leave; offsets for jury fees, witness fees and military pay; and deductions for penalties imposed for violations of significant safety rules. Id. § 541.602.

The new rules add one new exception to the "no-docking" rule. An employer will now be able to place an exempt employee on an unpaid disciplinary suspension of one or more full days, provided such suspension is imposed in good faith for an infraction of "workplace conduct" rules pursuant to a written policy applicable to all employees. Id. § 541.602(5). In contrast, the existing rules permit an employer to impose an unpaid disciplinary suspension on an exempt employee only if the suspension lasts for at least one full workweek. The new rule allowing unpaid suspensions of a shorter duration is designed to permit employers to impose the same sort of discipline on exempt employees that they do on their nonexempt workforce. In issuing this new rule, the DOL explained that its application is limited to "serious workplace misconduct" like sexual harassment, violence, drug violations, or violations of state or federal laws, although the text of the rule contains no such limitation. It is clear, however, that the rule is not intended to apply to suspensions for performance or attendance issues.

Both the existing and new regulations discuss the effect of improper deductions from salary. The new rules are more detailed in this respect, and they provide more protection for employers that make improper deductions in at least two ways. Id. § 541.603. First, where an employer has a practice of making improper deductions, the exemption will be lost for the period during which the improper deductions were made, but only for employees in the same job classification working for the same managers responsible for the improper deductions. Id. § 541.603(b). This logical limit on the impact of improper deductions does not exist in the current rules, and employers have sometimes suffered harsh consequences as a result.

Second, the new rules carve out a new "safe harbor" for employers, providing:

If an employer has a clearly communicated policy that prohibits the improper pay deductions … and includes a complaint mechanism, reimburses employees for any improper deductions and makes a good faith commitment to comply in the future, such employer will not lose the exemption for any employees unless the employer willfully violates the policy by continuing to make improper deductions after receiving employee complaints.

Id. § 541.603(d). The DOL intends to publish a model safe harbor policy that would comply with this provision.

What Should Employers Do Now?

Employers subject to the FLSA need to assess the impact of the updated white-collar exemptions on their workforce before the new rules take effect on August 23. First, employers should keep in mind that the federal regulations set the floor, not the ceiling, on minimum wage and overtime protection. Some states, most notably California, provide more overtime protection for their workers. The effect of the revised federal rules in such states is likely to be minimal.

Second, employers will need to audit their workforce to evaluate which employees qualify for the new exemptions. The new minimum salary requirement will be easy to apply and, if the DOL’s predictions are correct, will result in a change of status from exempt to nonexempt for at least 1.3 million employees. At the other end of the spectrum, currently nonexempt employees earning at least $100,000 may meet the new relaxed standard for the highly-compensated employees exemption; however, the number of employees who fall into this category is likely to be small. Given that the new "duties tests" largely mirror the existing tests, it is unlikely that large numbers of currently exempt employees will lose their exemption, with the possible exception of exempt executives who will need to satisfy the new "hire and fire" requirement. As always, an exemption audit cannot rely solely on job titles or even written job descriptions, which often are too general and can become outdated and inaccurate. Rather, the employer must evaluate the actual duties performed by the employees. The importance of a timely and accurate audit cannot be understated — the stakes are high, with the costs of private litigation and DOL wage and hour enforcement steeply rising. 12

Third, employers should take advantage of the new safe harbor by adopting a policy that prohibits improper pay deductions from otherwise exempt employees, including methods for communicating the policy and a complaint mechanism.

Footnotes

1: A copy of the new regulations, along with additional guidance, is located on the DOL’s web site at http://www.dol.gov/esa/regs/compliance/whd/fairpay/main.htm/.

2: The new rules include an extensive definition of "primary duty." 29 C.F.R. § 541.700.

3: This final rule departs in one important way from the DOL’s proposed rule and existing law: it eliminates the existing exemption for employees who are in "sole charge" of an independent establishment or branch of an employer.

4: Both the existing and new regulations include an alternative test for employees whose primary duty is performing administrative functions directly related to academic instruction or training. 29 C.F.R. § 541.204.

5: The proposed regulations sought to replace the "discretion and independent judgment" standard with a requirement that the employee hold a "position of responsibility." Many attacked this controversial proposal as broadening the administrative exemption with an ambiguous standard, leading the DOL to abandon it.

6: The professional exemption marks another area where the DOL abandoned a controversial proposal. The agency initially sought to eliminate the "discretion and judgment" requirement and to allow employees to acquire their knowledge not only through a prolonged course of specialized intellectual instruction, but also "by alternative means such as an equivalent combination of intellectual instruction and work experience." Critics argued that these proposals improperly broadened the professional exemption to include historically nonexempt employees such as medical technicians, licensed practical nurses, and engineering technicians, as well as military veterans.

7: To qualify for the creative professional exemption, the employee must meet the salary level and salary basis tests and have as his or her primary duty the performance of work requiring invention, imagination, originality or talent in a recognized field of artistic or creative endeavor. 29 C.F.R. § 541.302(a).

8: The employee’s total annual compensation must include at least $455 per week on a salary or fee basis, but can also include commissions, nondiscretionary bonuses and other nondiscretionary compensation. 29 C.F.R. § 541.601(b).

9: The salary level tests do not apply to outside sales employees or to professionals who work as teachers, doctors, or lawyers. 29 C.F.R. § 541.600(e). Such employees are exempt regardless of their salary.

10: Under both the existing and new regulations, different compensation tests may apply to academic administrative employees and computer employees. 29 C.F.R. § 541.600(c) & (d).

11: Both the existing and new rules address the status of employees who receive additional compensation beyond the minimum amount that is paid as a guaranteed salary, and address the "fee basis" rules applicable to some administrative and professional employees. 29 C.F.R. §§ 541.604 & 605.

12: The Wage and Hour Division of the Department of Labor collected over $182 million in back wages for violations of the FLSA in fiscal year 2003, a 27% increase over its 2002 collections. These wages were distributed to over 314,000 employees, a 30% increase over the number of employees receiving back wages the previous year. See http://www.dol.gov/esa/regs/compliance/whd/fairpay/statistics_2003.htm/. On April 27, the U.S. Secretary of Labor Elaine Chao announced a new enforcement task force within the Wage and Hour Division and highlighted the fact that the agency "is setting new enforcement records."

Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Morrison & Foerster LLP. All rights reserved

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