The Law @ Work

DOL Overtime Rule: Compensation Options to Consider

by John S. Gannon

As followers of The Law @ Work are surely aware, last month the U.S. Department of Labor (DOL) released its final overtime rule for “white collar” workers.  DOL estimates the final rule will result in an additional 4.2 million workers becoming overtime eligible under the Fair Labor Standards Act (FLSA).  The new rule kicks in on December 1, 2016.  As employers prepare for this implementation date, they need to consider which compensation options make the most sense for employees near or below the new annual minimum salary threshold of $47,476 per year.

Option 1:  Give Raises to $47,476/year ($913/week) to Preserve Exempt Status

This is the simplest option from an administrative standpoint.  Preserving exempt status avoids the hassle of paying overtime and keeping strict records on nonexempt hours worked.  Of course, this option might not be in the cards for employees making well below $47,476 a year, but if employees are near the new threshold, you should analyze whether a raise makes fiscal sense.   For example, consider a currently exempt employee making $45,000/year.  Without a raise, this employee would need to be reclassified as nonexempt under the new rule, meaning s/he would be eligible for an overtime premium when working more than 40 hours in a workweek.  If you estimate that this person works an average of 50 hours per week, giving a $2,500 raise to preserve exempt status would make more economic sense than paying 10 hours of overtime each week.

If raises are given to preserve exempt status—by way of a weekly base salary increase or new/modified nondiscretionary bonus and incentive payments plans —employers will need to consider whether other employees near this pay grade will get a similar increase.  You can be sure that employees making slightly above the new threshold might expect similar salary raises.

Option 2:  Reclassify as Nonexempt and Convert to Hourly Rate

If you are not going to give raises to employees making less than the required $913/week, you will need to reclassify those employees as nonexempt as of December 1, 2016.  This means two things:

  1. You will need to compensate these employees at an overtime rate when they work more than 40 hours a week; and
  2. You will need to keep more detailed records, including the hours worked each day and the total hours worked by nonexempt employees in a workweek.

Once the decision  not to raise the salary to the new minimum threshold is made, employers need to determine whether reclassified employees will be paid on an hourly or salary basis (yes, nonexempt employees can be paid a salary—more on this below in Option 3).  If you choose to reclassify and convert salaried employees to an hourly wage, you next need to figure out what the new hourly rate will be.  Employees who are reclassified will likely expect that their new hourly rate will be linked to a 52 week/40 hour workweek (i.e., their current salary divided by 2080 hours), but this formula does not account for new overtime costs.  To account for new overtime costs, you will need to calculate an hourly rate that factors in expected overtime.  This can done by dividing the annual salary by 40 plus the estimated number of overtime hours worked in a workweek.  The following formula gets you the proper hourly rate calculation:  Weekly salary / (40 + (OT Hours x 1.5)).  Here’s an example:  Consider the employee in Option 1, making $45,000/year, and working 10 hours of overtime per week.  The weekly salary is $865.38.  Divide this weekly salary by 55 (40 + (10 x 1.5)), and you get an hourly rate of $15.73.

This is a good option for businesses operating on thin margins and/or without the ways and means to increase labor costs.  However, this is the least attractive option for reclassified employees, so employers will need to consider whether this option will lead to higher attrition rates and difficulty recruiting.  Also, keep in mind that in order to make this option work, you will need to have a good sense of how much overtime your soon-to-be reclassified employees will be working.  If you don’t know how much overtime these folks are putting in, now is the time to audit your compensation practices so you can make an informed decision by December 1.  Now is also the time to consider implementing policies aimed at limiting the amount of overtime employees are authorized to work.

Option 3:  Reclassify as Salaried Nonexempt

Some employers may be surprised to learn that employees can be classified as nonexempt and still be paid on a salary basis.  Nothing in the FLSA requires that nonexempt workers be paid on an hourly basis.  In fact, nonexempt employees can be paid in a variety of ways, including a salary basis, fee basis, per visit basis, straight commissions, and piece rates.  The trick is making sure the weekly compensation meets the applicable minimum wage and that overtime is paid at time-and-a-half the regular rate when a nonexempt employee works more than 40 hours in a workweek.

The nice part about reclassifying currently exempt staff to a salaried, nonexempt status is that those employees may not feel as much of a sting when they are reclassified.  Employees typically view salary-structured compensation as a status symbol, and taking this away is likely to have a negative hit on employee morale.  If you choose to reclassify employees as on a salaried, nonexempt basis, you will still need to pay overtime and track their hours worked, but payment on the salary basis is perfectly lawful.  In fact, employers may be able to significantly reduce overtime liability by paying salaried, nonexempt workers pursuant to the fluctuating workweek method, which permits an employer to pay a half-time rate (rather than a time-and-a-half rate) for any hours worked in excess of 40 hours in a workweek.  The fluctuating workweek method has a few caveats that are a bit beyond the scope of this post, so contact employment counsel to find out whether this is a good fit for your business model.

Timothy Murphy, Esq., partner with Skoler, Abbott & Presser, P.C ., will explore these options while discussing the impact of the final overtime rule on Tuesday, June 28, 2016, during a lunch event for the Springfield Regional Chamber of Commerce.  Registration is not limited to members, and more information can be found here.

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