United States: Recent FLSA Changes: Pay Now Or Pay More Later – What You Can Do To Minimize Your Risk

Last Updated: October 14 2016
Article by Adam Brown and Lawrence L. Lee

The U.S Labor Department (USDOL) has finally released the anxiously awaited revised regulations affecting certain kinds of employees who may be treated as exempt from the federal Fair Labor Standards Act's (FLSA) overtime and minimum-wage requirements. After nearly a year of uncertainty, the final rules were published on May 23, 2016. These rules apply to government employers, and they have an effective date of December 1, 2016.

Public employers who currently consider any employees to be exempt "white collar" employees might have to make some sweeping changes.

Exemption Overview

To understand why the new regulations will have such a large effect, it is worthwhile to engage in a quick refresher of the exemptions that will be affected by the new regulations.

The FLSA is the federal statute that mandates that all employees receive at least minimum wage for all hours worked, and they are to receive overtime payments at a rate of time and a half of their regular rate for all hours worked in excess of 40 in any workweek. The FLSA starts from a presumption that every employee is entitled to overtime for all hours worked in excess of 40 in a given week. However, there are exemp­tions or exceptions to this requirement. As relevant here, employees are exempt from overtime if they meet two tests: The duties test and the salary test.

Duties test: Many employers errone­ously believe that any employee that is paid on a salary basis instead of an hourly basis is exempt from overtime. However, in order to be properly exempt from overtime under the FLSA under one of the "white collar" exemptions, the employee must work in an executive, administrative, professional, outside sales, or certain types of computer posi­tions. Each of these duties categories has specific and lengthy definitions and regulations that explain how a particular employee qualifies for the exemption.

Salary test: In addition to the du­ties test, exempt employees must also meet a salary test. Under the old FLSA regulations, which remain in effect until December 1, 2016, the employee must be paid at least $455 per week, which annualizes to a yearly salary of $23,660. If an employee meets one of the duties tests and is paid at least $455 per week, the employee can be properly exempted from the overtime requirements of the FLSA.

Specific and Wide-Ranging Changes For This Year and Beyond

Under the new final rule published on May 23, 2016, the following changes have been made in the USDOL's definitions of executive, administrative, professional, computer-employee, and highly com­pensated exemptions under the FLSA's Section 13(a)(1):

The minimum salary threshold is increasing to $913 per week, which an­nualizes to $47,476 (up from $455 per week, or $23,660 per year). USDOL says that this figure is set at the 40th percentile of data representing what it calls "earn­ings of full-time salaried workers" in the lowest-wage Census region (currently the South). This more than doubling of the minimum salary threshold is sure to affect large numbers of exempt public sector employees, who currently earn more than $23,660, but less than $47,476 per year.

This minimum salary amount will now be "updated" every three years (mean­ing that it will likely increase with each "update"), beginning on January 1, 2020. USDOL will announce these changes 150 days in advance. The practical impact of this change is that public sector employ­ers will now be forced to increase the compensation of exempt employees whose salaries are at the minimum level or below the new "updated" level every three years, regardless of employee performance, budgetary concerns, or other factors that affect the amount of money available for salary increases. The 150 day announce­ment period also presents issues for public sector employers, who often operate based on yearly budgets. These employers will need to be aware of any impending increases when new budgets are in the process of being drafted and approved. Unfortunately, employers may be forced to estimate the updated amount, if it is not released in detail before the new budget is finalized.

Employers will be able to satisfy up to 10% of this new salary threshold through nondiscretionary bonuses and other incentive payments, includ­ing commissions, provided that the payments are made at least quarterly. This crediting will not be permitted as to the salaries paid to employees treated as exempt "highly compensated" ones. This change is less likely to impact pub­lic sector employers, but it is important to keep in mind in the event that it can be utilized to offset some of the burden associated with the mandated salary increases.

The total-annual-compensation threshold for the "highly compensated employee" exemption will increase from $100,000 to $134,004 (which will also be "updated" every three years). USDOL says that this figure is set at the 90th percentile of data represent­ing what it calls "earnings of full-time salaried workers" nationally.

These rules will become effec­tive on December 1, 2016, which is considerably later than had been proposed. Unless this is effective date is somehow postponed, by December 1 employers must have done what is necessary to continue to rely upon one or more of these exemptions (or another exemption) as to each affected employee, or they must forgo exempt status and begin paying over­time to any employee who no longer satisfies all of the requirements.

Considerations for the Public Employer

Essentially, USDOL is doubling the current salary threshold. This is likely intended to both reduce the proportion of exempt workers sharply and increase the compensation of many who will remain exempt, rather than engag­ing in the fundamentally definitional process called for under the FLSA. This represents a stark departure from past USDOL interpretations of the agency's power, when even the agency itself said that manipulating exemption requirements to "give employees a raise" or to establish a minimum wage for exempt employees was not, and never has been, an authorized or legitimate pursuit for USDOL to under­take.

Additionally, as discussed above, for the first time in the more-than-75-year history of the white collar exemption regulations, USDOL will publish what amounts to an automatic "update" to the minimum salary threshold. This departs from the prior US­DOL practice of engaging in what should instead ultimately be a qualitative evalua­tion that also takes into account a variety of non-numerical considerations. This new imposition also creates a real hardship for public sector employers, which are often constrained by budgetary concerns.

Thankfully, USDOL did not change any of the exemptions' requirements as they relate to the kinds or amounts of work neces­sary to sustain exempt status. The USDOL had previously asked for comments directed to whether there should be a strict more-than-50% requirement for exempt work. The agency, however, apparently decided that this was not necessary in light of the fact that the number of workers for whom em­ployers must apply the duties test is reduced by virtue of the salary increase alone.

What These Changes Mean for Public Employers

Many public sector employers do not close­ly track the hours worked by their exempt employees. Under these new regulations, tracking hours has become even more important than it ever has been. First, there is a good probability that some employees who were formerly classified as exempt and who received a salary will be reclassi­fied as nonexempt because there simply is not money in the budget to increase their salaries to meet the new salary test.

Many public sector employees are not used to working strict 40 hour workweeks, and many of them in fact routinely work more than 40 hours per week. Public sector employers will need to begin closely tracking employees' work hours, to ensure employees are properly compensated for any hours worked in excess of 40 in a work­week, or employers risk increased liability in future lawsuits brought by nonexempt employees alleging unpaid or improperly paid overtime. Another reason to closely monitor hours worked is to avoid future risk from a disgruntled exempt employee who argues that he or she was improperly classified as exempt, and who claims to have worked a large amount of overtime hours. In the absence of a proper timekeeping system that generates contemporaneous records of hours worked, courts have held that an employee's recollection alone is sufficient to prove the amount of overtime hours worked. Proof of hours worked is the foundation for damages in FLSA cases. Thus, it is extremely impor­tant for employers to require all employees to record and track their time every week.

Unfortunately, there is likely no way to avoid feeling the impact of these changes in some fashion. Municipal employer fund­ing is usually defined by taxes, federal or state contributions, and creative budgeting. Public entities are unlikely to see a suffi­cient funding increase to help place all sala­ries at the necessary new levels, because tax increases are unpopular, and even if they are passed, they likely will not make up the gap between the old salary basis amount and the newly doubled amount. This very real possibility has the potential to harm both the local government themselves and the public in general. If public entities are forced to raise some salaries large amounts to meet the new minimum requirements in the regulations, they will be forced to cut other services or programs. The extent of these cuts depend on how many employees are affected in each entity.

By that same token, if public sector em­ployers choose not to raise salaries and to begin classifying affected formerly exempt employees as non-exempt employees, they will still have difficulty making up the necessary funds, because they will likely be paying overtime premiums to employ­ees whose job duties and work habits have evolved to necessitate more than 40 hours per week under the old regulations. Employers who elect to prohibit employees from working overtime will find it difficult to adjust to the decline in productivity as­sociated with key employees reducing their work hours each week.

While granting comp time in lieu of overtime is permissible under the FLSA for public sector employers, the budgetary and decreased productivity issues discussed above will not be improved if employers elect to give comp time in lieu of overtime. This practice usually results in municipal employers paying affected employees to not work, which could further exacerbate the existing issues. Under any scenario, government employers may likely see less work being done and/or more money being paid out. This conclusion is particularly difficult for public sector employers with limited funding, many of whom will be unable to hire ad­ditional employees to make up for any productivity gaps that arise. To make up for the monetary gap necessary to maintain exemptions, more funds will be shifted from programs and services that benefit the public over to increased employee salaries. The extent of these issues is unknown at this time, and will vary between different public employ­ers, but what is clear is that these new regulations will have a profound impact on public sector payroll practices, as well as programs and services offered to the communities as a whole.

These changes also carry the signifi­cant administrative burden of figuring out how to implement them, and decid­ing which of the multiple unpleasant options is the least unpleasant for each affected employee within a particular municipal employer. These tasks will likely include a full compensation review for any exempt employees, as well as an analysis of any needed changes for each employee. For any employee whose sala­ry is not increased to the new minimum $47,500, there will be significant work to decide whether to convert them to hourly or to pay overtime with a salary. The latter could be a problem if such employees are regularly working over­time, but might work well if employees generally work 40 hours or less and only occasionally have overtime spikes.

Finally, although most governmental employers do not have many employees who meet the "highly compensated employee" exemption, the change to that exemption may force some employers to reevaluate whether a few of their people who presently fall under that designation will be raised to meet the new amount or not. This is likely to be minimal for most public sector employers, but some government entities have employees who qualified for this exemption under the old salary test, who would not qualify under the new test.

How Can Public Sector Employers Comply with the New Rules?

The new rules have left many employers puzzled about how to ensure compliance. While the practical impact of the solutions proposed by this article may be somewhat harsh, fortunately the concepts and meth­ods necessary to ensure compliance are not complex.

First, the simplest, yet perhaps least plau­sible, way to ensure compliance is to make sure all employees who are exempt under one of the exemptions discussed in this article are paid a salary of at least $913 per week, and that their job duties qualify them for one of the relevant exemptions. However, this option may not be available to cash strapped municipal employers. Fortunately, there are other solutions available.

Public sector employers can also convert exempt employees who will no longer meet the salary basis test to nonexempt employees. These employees can lawfully receive their wages either as a salary, or as hourly pay, but they must be paid overtime at time and a half of their regular rate of pay for any hours worked in excess of 40 in a week. For this reason, employers should always track the hours worked by these employees, and should consider implementing strict "no overtime" policies that require prior managerial approval for any overtime hours. These policies will not completely protect against liability for future claims of unpaid overtime, but they will likely dissuade employees from working overtime.

If nonexempt employees do work over­time, the FLSA allows public sector employ­ers to grant employees compensatory time off, or comp time, in lieu of cash overtime. This comp time must be granted at a rate not less than one and one half hours of comp time for every overtime hour worked, and employees must be free to use comp time within a reasonable period of time after it is earned. Additionally, employers may not permit employees to accrue more than 240 hours of comp time (except for certain safety-related positions), and employers must compensate employees for all banked comp time hours upon separation from employ­ment for any reason.

Why is this Important?

Compliance with the FLSA is mandatory for all employers, and there are multiple avenues of risk associated with noncompliance. First, the employer may face a lawsuit from one or more employees alleging violations. Its applica­tion is very mechanical, and damages in these cases are ordinarily very easy for employees to prove by using simple math. Employers that violate the statute, even unintentionally, face harsh consequences. FLSA lawsuits are difficult for employers to win, and prevailing plaintiffs under the FLSA are presumptively entitled to their entire amount of unpaid wages, plus an additional equal amount as liquidated damages designed to compensate the employee for the period where they were forced to live without wages they were owed under the FLSA, plus full payment of their at­torneys' fees by the employer. This last point is important, because it is not uncommon for FLSA plaintiffs to have a relatively small amount of damages, and for their attorneys to spend far more litigating the case than the amount to which the plaintiff is entitled, since the attorneys know that the employer will ultimately be on the hook for their fees if they win. Additionally, the FLSA has a sepa­rate statutory provision that allows employees to join together in a "collective action" which is easier to maintain than a traditional class action. Obviously, the larger a collective action against an employer becomes, the more potential exposure there is to increased damages and attorneys' fees.

Employers also face potential risk if FLSA violations are discovered during a USDOL audit. USDOL has the power to audit any business at any time, but audits come about most frequently in response to employee complaints. If violations are found, the USDOL has the power to re­cover back wages and liquidated damages for employees either administratively, or through its own lawsuit. Additionally the USDOL may assess civil money penal­ties of up to $1,100 per violation against noncompliant employers. Finally, USDOL can recommend felony criminal charges under the FLSA against any person if violations are egregious enough.

Put simply, it is critical that all em­ployers ensure full compliance with the FLSA at all times.

What Should You Do Now?

Some members of Congress are still considering action aimed at stopping these changes, and it is possible that lawsuits will be filed with the same goal. The Obama Administration intends to make the new rules a key piece of its legacy, and thus the President is extremely likely to veto any such legislation that makes it to his desk. Additionally, only time will tell whether any lawsuits will be filed, and how successful they may be if ultimately filed. While one or more of these chal­lenges may be successful, municipal em­ployers should assume for the time being that the new requirements will take effect as scheduled. Employers would be wise to immediately begin analyzing and ad­dressing any issues presented by the new rules, in light of the bureaucratic process inherent in making such changes, and the lengthy timeline that often accompanies such changes.

Right now, public sector employers should be:

  • Analyzing whether the requirements for the "white collar" exemptions they have been relying upon will continue to be met under the new rules;
  • Evaluating what might be changed about one or more jobs so that the incumbents may be treated as exempt in the future;
  • Considering the possible application of alternative FLSA exemptions;
  • Developing FLSA-compliant pay plans for employees who have been treated as exempt but who will be reclassified as non-exempt after December 1, 2016; and
  • Contacting your internal personnel attorney or a reputable and knowledge­able private employment attorney that is well-versed in wage and hour law.

Originally published in Municipal Lawyer.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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