Tax Alert: DOL’s final overtime rule brings sweeping changes

By Mark R. Baran  |  June 14, 2016  |  Download PDF

The U.S. Department of Labor (DOL) has released a final rule that makes dramatic changes to the rules for determining overtime for certain executive, administrative and professional employees — otherwise known as “white-collar workers” — under the Fair Labor Standards Act (FLSA). The final rule will make it more difficult for employers to classify employees as exempt from overtime requirements. In fact, the DOL estimates that 4.1 million salaried workers will become eligible for overtime when they work more than 40 hours in a week.

The changes will also have a negative tax impact on employers especially with respect to payroll tax liability. Employers’ payroll tax liability may increase due to increased overtime payments to previously exempt employees who work in excess of 40 hours a week or as a result of higher salaries paid in order to maintain overtime exemptions.

Current requirements for white-collar exemptions

Until the new final rules takes effect on December 1, 2016, the current overtime rules will continue to apply. To qualify for a white-collar exemption from the overtime requirements under current federal law, an employee generally must satisfy three tests:

1. Salary basis test. The employee is salaried. This means that the employee is paid a predetermined and fixed salary that is not subject to reduction because of variations in the quality or quantity of work performed.
2. Salary level test. The employee is paid at least $455 per week or $23,660 annually.
3. Duties test. The employee primarily performs executive, administrative or professional duties.

Neither job title nor salary alone is determinative of whether an overtime exemption exists. The employee’s specific job duties and earnings must meet applicable requirements. However, there are a few exceptions. For example, certain employees (generally doctors, teachers and lawyers) are not subject to either the salary basis or salary level tests. The current regulations also provide a relaxed duties test for certain highly compensated employees (HCEs) who are paid total annual compensation of at least $100,000 and at least $455 per week.

Significant changes under the final rule

 The final rule issued by the DOL takes effect on December 1, 2016.

The revisions in the final rule mainly relate to the salary level test - increasing the salary threshold for exempt employees to the 40th percentile of weekly earnings for full-time salaried workers in the lowest-wage Census region (currently the South). This new salary threshold amounts to $913 per week or $47,476 per year.

In response to what the DOL described as “robust comments” from the business community, the final rule allows up to 10% of the salary threshold for non-HCE employees to be met by nondiscretionary bonuses, incentive pay and commissions, as long as these payments are made on at least a quarterly basis. Thus, an employee’s production or performance bonuses could push the employee over the threshold and into exempt status (assuming the other tests are satisfied).

The rule also updates the HCE threshold above in situations where the relaxed duties test applies. It raises the level to the 90th percentile of full-time salaried workers nationally, or $134,004 per year.

The final rule continues the requirement that HCEs receive at least the full standard salary amount — or $913 — per week on a salary or fee basis without regard to the payment of nondiscretionary bonuses and incentive payments. Such payments will, however, count toward the total annual compensation requirement.

The standard salary and HCE annual compensation levels will automatically update every three years to maintain the levels at the prescribed percentiles, beginning on January 1, 2020. The DOL will post new salary levels 150 days before their effective date.

The duties test

The final rule makes no changes to the duties test. The DOL had sought comments regarding the effectiveness of the test aimed at screening out workers who are not bona fide white-collar workers. The final rule did not claify how the new standard salary level and automatic updating will work with the duties test to distinguish between overtime-eligible workers and those who may be exempt. However, because of the new revised salary level, the duties test may not be as relevant.

Compliance options

According to the DOL, employers have a range of options when it comes to complying with the changes to the salary level (although it doesn’t require nor recommend any method). Options include the following:

Do nothing. An employer may choose to do nothing if their white-collar workers fall short of the new salary level but never work more than 40 hours per workweek.

Raise salaries. Employers may consider raising the salaries of employees who meet the duties test, have salary near the new salary level and regularly work overtime. Paying a salary at or above the salary threshold will maintain their exempt status.

Pay overtime above a salary. Employers may choose to pay their employees a salary covering a fixed number of hours that may include hours above 40 hours per week. Options include the following:

• Pay employees a salary for the first 40 hours of work per week and overtime for any hours exceeding those initial 40 hours.
• Pay a straight-time salary representing more than 40 hours in a week for employees who regularly work more than 40 hours, and pay overtime in addition to the salary. You will only be required to pay an additional half-time overtime premium for overtime hours already included within the salary, plus time and a half for hours beyond those included.
• Agree with the employee on a predetermined fixed salary for any workweek of more than 40 hours including overtime compensation under certain conditions. Since employees must always be paid based on the hours actually worked during the workweek, salary adjustments may be required. This will likely work best for employees who consistently work the same amount of overtime every week.
• For employees with fluctuating hours, consider paying a fixed salary covering a fluctuating number of hours at straight time if certain conditions are met.

It is important to note that employers often reorganize workload distributions or adjust employee schedules to redistribute work hours in excess of 40 across current staff. Many choose to hire additional employees to reduce or eliminate overtime hours worked by current staff.

The big picture

In addition to increased compensation, the new overtime rules create additional payroll tax liability and administrative costs. At Marks Paneth, we can help you assess the financial impact of the new overtime rules on your organization, evaluate additional compliance requirements and provide valuable options that may reduce or eliminate potential exposures. 

For more information  

If you have questions about this alert, please contact Mark Baran, Principal in the Tax Practice, by phone at (212) 503-8991 or by email at mbaran@markspaneth.com or any of our Marks Paneth professionals.

About Mark R. Baran