New Overtime Rules Go Into Effect December 1st; What Tax Practitioners Need to Know

(Parker Tax Publishing October 2016)

On December 1, 2016, final regulations updating overtime rules go into effect. The new rules, estimated to affect over 4.2 million workers, double the salary threshold at which a white collar worker can be classified as an "exempt employee" not entitled to overtime pay. The regulations also increase the salary threshold for highly compensated employees, who are subject to looser exemption criteria. The rules defining the types of employees who can qualify for exemption remain unchanged. RIN 1235-AA11.

Background

Federal overtime rules are contained in the Fair Labor Standards Act (FLSA). The FLSA covers more than 135 million workers at 7.3 million businesses nationwide. Unless exempt, employees covered by the FLSA must receive overtime pay (generally time and one-half) when they work more than 40 hours in a workweek.

Observation: Federal overtime rules exist side by side with state overtime rules, which are often identical. Where federal and state rules diverge, employers must comply with whichever rules are stricter.

Generally, the FLSA applies to employees of enterprises that have an annual gross sales of $500,000 or more, and to employees individually covered by the law because they are engaged in interstate commerce or in the production of goods for commerce. In addition, employees of the following types of entities are covered by the FLSA regardless of gross sales: hospitals; businesses providing medical or nursing care for residents; schools (whether operated for profit or not-for-profit); and public agencies.

While the FLSA overtime rules apply to most hourly and salaried workers, they do not apply to executive, administrative, and professional (EAP) employees meeting certain criteria. The EAP exemption applies to workers who pass three tests:

(1) the employee must be paid a predetermined and fixed salary that is not subject to reduction because of variations in the quality or quantity of work performed ("salary basis test");

(2) the amount of salary paid must meet a minimum specified amount ("salary level test"); and

(3) the employee's job duties must primarily involve executive, administrative, or professional duties as defined by the regulations ("duties test").

Highly compensated employees (HCE) are subject to the same exemption criteria, but with a higher salary threshold and a looser version of the duties test, referred to as the "minimal duties test."

Key Changes in the New Overtime Rules

Salary Threshold for the Standard EAP Exemption Has Doubled. The biggest change in the new rules is the increase in the threshold for passing the salary level test. The regulations increase the minimum specified salary from $23,660 to $47,476 (or $455 a week to $913 a week). Under the new rules, employees with annual salaries of less than $47,476 cannot be considered exempt employees, regardless of their job responsibilities.

Salary Threshold for Highly Compensated Employees Has Increased. The new rules also increase the salary threshold for HCEs (who are subject to a relaxed version of the duties test) from $100,000 to $134,004 a year. Adjusting for wage inflation, this change effectively resets the HCE threshold to where it was in 2004, the last time it was changed.

Compliance Tip: Employers should take care not to round down to the nearest thousand in setting a salary right at the HCE threshold. An employee with an annual salary of $134,000 will fall four dollars short and will not be classified as an HCE under the new rules.

Thresholds will be Updated Automatically Every Three Years. Under the new rules, both of the above salary thresholds will be automatically adjusted for wage inflation every three years, beginning January 1, 2020. The standard and HCE thresholds are projected to increase to $51,168 and $147,524 respectively in 2020. The Department of Labor will post new salary levels 150 days in advance of their effective date, beginning August 1, 2019.

Incentive Payments May Satisfy Part of Standard Salary Level Amount. For the first time, employers can use nondiscretionary bonuses and incentive payments (including commissions) to satisfy up to 10 percent of the salary level amount in order to reach the threshold for the standard EAP exemption (i.e., up to $91 of the $913 per week threshold), provided these payments are made on a quarterly or more frequent basis. Before the new overtime rules, the entire salary level had to be paid in each pay period.

"Salary Basis" and "Duties" Tests Remain Unchanged

Neither the rules for what constitutes a bona fide salary arrangement (salary basis test), nor the rules governing what types of employees fall into the "executive, administrative, or professional" category (duties test) were changed by the new regulations.

Salary Basis Test. To meet the salary basis test, an employee must regularly receive a predetermined amount of money each pay period on a weekly, or less frequent, basis. The predetermined amount cannot be reduced because of variations in the quality or quantity of the employee's work; however, deductions from pay are permissible for certain limited reasons.

Generally, an exempt employee must receive the full salary for any week in which the employee performs any work, regardless of the number of days or hours worked. Exempt employees do not need to be paid for any workweek in which they perform no work.

As noted above, the final rules provide that employers can use nondiscretionary bonuses and incentive payments (including commissions) to satisfy up to 10 percent of the standard salary level amount.

Administrative, professional, and computer employees may be paid on a "fee basis" rather than on a salary basis. If the employee is paid an agreed sum for a single job, regardless of the time required for its completion, the employee will be considered to be paid on a "fee basis." A fee payment is generally paid for a unique job, rather than for a series of jobs repeated a number of times and for which identical payments repeatedly are made. To determine whether the fee payment meets the minimum salary level requirement, the test is to consider the time worked on the job and determine whether the payment is at a rate that would amount to at least $913 per week if the employee worked 40 hours.

Duties Test. To qualify for any of the white collar exemptions (commonly known as "executive, administrative, and professional" or "EAP" exemptions), employees must meet certain tests regarding their job duties. The regulations establish separate duties requirements for executive, administrative, professional, outside sales, and computer employees, respectively. The following link provides a detailed explanation of the duties requirements for various types of employees that may qualify for EAP exemption: Federal Overtime Rules - Duties Tests for Various Professions.

Under the standard duties test, an employee's primary duty must be that of an exempt executive, administrative or professional employee. "Primary duty" means the principal, main, major, or most important duty that the employee performs. The determination of an employee's primary duty must be based on all the facts in a particular case, with the major emphasis on the character of the employee's job as a whole.

Employees can also qualify for exemption under the special rule for HCEs, which pairs a more relaxed duties test with the higher HCE total annual compensation requirement. Under the HCE duties test, the employee's primary duty must still consist of office or non-manual work, but the employee need only "customarily and regularly" perform one of the exempt duties of a bona fide executive, administrative, or professional employee.

Options for Compliance

Employers have several options for responding to the changes in the new overtime rules. Organizations may ensure compliance for those employees affected by the rules by providing pay raises that increase workers' salaries to the new threshold, spreading employment by reducing or eliminating work hours of individual employees working over 40 hours per week for which no overtime is being paid, or paying overtime. The rules does not require employers to convert a salaried worker making less than the new salary threshold to hourly status: employers can pay non-exempt employees on a salary basis and pay overtime for hours worked beyond 40 in a week.

Compliance Tip: The new rules go into effect on a Thursday, creating a situation where an employee may be exempt for half of the week, and non-exempt for the other half. To sidestep the administrative complexity of a midweek switch, employers may want to consider making any changes required to comply with the new rules at the beginning of the workweek that includes December 1 (e.g., Monday, November 28 for employers with Monday-Sunday workweeks).

Employers may use any method they choose for tracking and recording hours, as long as they are complete and accurate. The method for compliance, which is entirely within each employer's discretion, will likely depend on the circumstances of that organization's workforce, including how much employees currently earn and how often employees work overtime, and may include a combination of responses, such as paying overtime and adjusting employees' hours and schedules.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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