United States: Texas Overtime Ruling Directly Affects California Employers

California employers are directly affected by a decision of a federal district court in Texas enjoining the implementation of the Department of Labor (DOL) minimum salary guideline for employees. State of Nevada v. U.S. Dept. of Labor, 4:16-CV00731 (ED. TX, Nov. 22, 2016). This decision applies nationwide and will continue in effect until a final ruling modifying or reversing it on appeal. The appeal process, as well as the continued viability of the proposed regulation, may be impacted by the change in DOL administration in a manner that would invalidate the proposed regulation.

While the State of Nevada decision holds that the federal Fair Labor Standards Act does not authorize the DOL to set a minimum salary, California employers face a different set of issues.

Effective Jan. 1, 2017, the California minimum wage is $10.50. In order to qualify as an exempt employee in California, an employee must:

  1. Be compensated at two times the minimum wage; 
  2. Be paid on a salary basis; and
  3. Under the decision in Ramirez v. Yosemite Water Co., 20 Cal. 4th 785 (1999), perform exempt duties more than 50 percent of the time. 

The California compensation standard equates to an annual salary of $43,680. To avoid paying overtime and the risks of litigation for failing to do so, an employer must pay exempt employees that minimum effective Jan. 1, notwithstanding the ruling of the Texas court.

While it was expected that the California minimum salary for exempt employees would be subsumed by the higher federal standard ($47,476) in the DOL guidelines and that some significant number of exempt employees would be converted to hourly, the Texas decision eliminates that development. Most California employers now are expected to simply absorb the additional salary cost of exempt employees who were paid at exactly the minimum salary level under California law in 2016.

Next steps

In deciding how to proceed, an employer might look at a hypothetical. Assume that an exempt employee now making the minimum salary of $41,600 must be paid $2,080 more in 2017, in order to continue meeting the minimum salary standard. If the employer converts that employee to an hourly employee, the employee would earn $15.75 for every overtime hour worked in a day or for every hour over 40 per week (and double time for working more than 12 hours in a day). Given these factors, the employee, now paid on an hourly basis, would have to work 132.06 hours of overtime in 2017 before the cost of converting the employee to hourly would exceed the increase in annual salary if the exempt status were retained.

Alternatively, assume that an exempt employee is paid a salary halfway between $41,600 and $43,680. The cost of maintaining that employee's exempt status is only half of the $2,080 increase. Converting that employee to hourly might not be cost effective: At the new hourly overtime wage of $15.75, the employee would only need to work 66.03 hours before the cost of converting the employee would exceed the increase in annual salary were the exempt status retained. The closer the salary of an exempt employee gets to $43,680, the fewer overtime hours that individual needs to work in order to make the employer's decision to covert an employee to hourly status counter-productive.

Since most employers in 2016 and before did not require exempt employees to record their actual hours of work, many employers will not be able to determine with precision the cost/benefit of converting a California employee to hourly status. Accordingly, a more senior supervisor or manager should observe each exempt employee's actual hours of work throughout December 2016, focusing on those earning between the 2016 minimum of $41,600 and the 2017 minimum of $43,680. 

The observation and report to human resources may assist the employer in deciding whether to convert or to bear the salary increase as of Jan. 1. If an employer decides to convert an exempt employee to hourly status, it must provide a thorough orientation to the time recordation procedures. Moreover, the employer must ensure that the itemized pay statement requirements of California Labor Code 226(a) are met in order to avoid future litigation and liability.

It is difficult to determine how many employees might be impacted by a mass conversion from exempt to hourly. According to the Social Security Administration, the average net compensation of American workers was $46,119 in 2015. Exempt employees are a small percentage in the average workforce, suggesting that most exempt employees earn well above the minimum salary. If the same small percentage applies to any specific company's California workforce, that employer will have fewer employees to evaluate for possible conversion.

Deciding how to address the impact of compliance with the new minimum exempt salary requires special care. An exempt employee earning $41,600 at the bottom of the narrow range who is converted to hourly could, in theory, earn more in 2017 than an exempt employee earning $43,640 at the top of the range or more, creating morale problems. Moreover, converting employees from exempt to nonexempt status may itself be demoralizing, creating its own tensions. 

Additionally, converting some employees in a job classification and not others potentially presents serious legal issues. And an employee's compliance with the employer's daily time recordation practices often creates issues that result in individual or class action wage litigation, the costs of which far outweigh the benefits of converting exempt employees to hourly status. You should of course consult your labor counsel before embarking on any changes. 

Reprinted with permission from the Los Angeles Daily Journal.

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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