Coping With the New Definition of Exempt Employees: The Proposed New Salary Test May Not Benefit Currently Salaried Employees

Under the Federal Fair Labor Standards Act (and state wage hour laws) certain hourly paid employees must be paid time and one-half their regular rate of pay for all hours worked over 40 in a regular work week.

But certain employees (for example many general managers and lead managers) are exempt from this requirement if they satisfy three qualifications imposed by federal regulations:

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;
2. the amount of salary paid must be at least $455 per week; and
3. the employee's job duties must primarily involve executive, administrative, or professional duties as defined by the regulations (the “duties test”).

On July 6, 2015, the U.S. Department of Labor proposed a major change in the salary level test from $455 per week to $970 per week which if implemented would invalidate the exemption of any  currently exempt employee earning less than $970 per week ($50,440 annually) and reclassify those employees as non-exempt employees (pdf).

Such a reclassification could adversely impact the self-respect of many employees who believe that their salary is a mark of status superior to hourly paid rank and file employees and assures them of a regular paycheck in a regular amount each week.

In addition there is the specter of an employer having to pay hefty amounts for employees working many overtime hours or increasing head count to avoid overtime.

But there may be a silver lining for employers.  If the employer sets the regular rate for an employee reclassified from exempt to non-exempt at a rate which would yield an amount similar to the former salary when regular overtime is factored in, the employer may not be economically impacted and the employee will not get a government imposed raise for doing the same work s/he had always done.

Alternatively, under certain circumstances, the employer is permitted to pay a salary to non-exempt employees, which would help avoid the potential stigma of losing a salary and instead being paid an hourly wage, as discussed above.  This is known as the fluctuating work week method of paying overtime.

Here is how it works:

A non-exempt employee whose hours typically vary from week to week is paid a salary which is agreed to cover all hours worked in each regular workweek.  Thus, salary status is preserved.

To determine the amount of overtime owed, the regular rate is calculated by dividing the employee’s weekly salary by the number of hours worked each week. Since the salary covers all hours worked each workweek, the employer is only required to pay an additional half time amount for each hour worked over 40 in a workweek.

Here is an example:

Under the hourly rate of pay method of compensation, a non-exempt employee paid $20 per hour earns $800 for a forty hour week and must be paid $30 per hour for each hour worked over 40 in a workweek

If s/he works an additional 10 hours the employer must pay an additional $300 for that workweek for a total of $1,100 per week.

Under the fluctuating workweek calculation, the employee would be paid a salary.  Assuming the employee’s weekly salary is $800, if the employee works 50 hours in one workweek, the employer would calculate overtime by dividing $800 by 50 hours yielding a regular rate of $16 per hour.  Because the $800 salary is paid for all hours worked, the employer is only required to pay an additional half-time, which in this case is $8.00, for each of the ten hours worked in excess of 40.  Thus, the employer’s overtime exposure for this workweek is only $80 for a total of $880 per week, as opposed to $1,100 under the hourly rate of pay method.

Assuming the DOL’s proposed new regulations to increase the salary basis are implemented, employers can take measures to avoid the significant increase in their operating costs and help sustain profitability.

CAVEAT:  Check your state laws to see if the fluctuating work week method is allowed.  The New York State Hospitality Regulations (pdf) do not permit the fluctuating work week method for restaurant operations.  Thus, New York restaurant operations employers should set an hourly rate so as to minimize the cost of regular overtime.