As predicted in our January 2015 article, FLSA 2015: Employee Classification and Revised Exemptions, change in the salary level test has arrived with proposed updates to the FLSA’s minimum wage and overtime protections. The clear intention of the proposed rule, a two hundred ninety-five (295) page report, is to reduce the number of individuals now identified as exempted to a non-exempt status, thus allowing those individuals to be eligible for overtime. The proposed rule has the potential to affect in excess of 21 million people who would now be eligible for overtime. 

Pursuant to the Fair Labor Standards Act (“FLSA” or the “Act”), an employer covered under the Act must pay an overtime rate of at least one and one-half times the employee’s regular rate if the employee works more than forty (40) hours in one (1) work week. However, if the employee falls into one of the several categorized exemptions under the FLSA, no overtime pay is required irrespective of the number of hours an employee works in a work week. Section 13(a)(1) of the FLSA provides an exemption from both minimum wage and overtime pay requirements for employees employed as a bona fide executive, administrative, professional, and outside sales employee. The exemptions identified in Section 13(a)(1) are typically referred to as the “white collar exemptions” and most of the regulations affecting the exemptions have not been revised since 2004. Since 2004, a white collar employee is exempt from receiving overtime pay if he or she is paid on a salary basis that is at least $455 per week or $23,660 annually. This salary amount cannot be adjusted due to variations in quality or quantity of work performed or due to the amount of hours or days worked by the employee. Additionally, to be exempt from overtime pay, the employee’s primary job duties and responsibilities must meet the tests outlined by the Department of Labor. Put simply, an employee must meet each of these three (3) tests to be exempt under the white collar exemption: (1) salary basis test, (2) salary level test and (3) duties test. 

The Proposed Rule 

On March 13, 2014, President Barack Obama signed a Presidential Memorandum charging the Department of Labor with updating and simplifying the overtime exemption standards for executive, administrative, and professional employees. On June 30, 2015, the U.S. Department of Labor (“DOL”) responded to that memorandum with an announcement of a proposed rule that would change the landscape of overtime pay to white collar employees. The proposed rule aims to significantly increase the salary level that is required for the exemption and create a mechanism for additional increases on an annual basis. Specifically, the proposed rule includes three proposed changes: 

1. Set the standard salary level at the fortieth (40th) percentile of weekly earnings for full-time, salaried workers ($921 per week or $47,892 annually); 

2. Increase the annual compensation requirement that is required to exempt highly compensated employees to the ninetieth (90th) percentile of weekly earnings of full-time salaried workers ($122,148 annually); and 

3. Create a mechanism that automatically updates salary levels in the future. 

The Department of Labor believes that the salary level is the “best single test” of exempt status, and the increases outlined in the rule affirm that belief and aim to simplify the white collar exemption. This is a departure from previous DOL positions which focused on the duties an individual performed. Since the 2004 amendment that created the $455 per week salary amount, there have been three (3) increases in the federal minimum wage for employees in the private sector from $5.15 to $6.55 to thecurrent $7.25 per hour. Additionally, the DOL reports that the annualized $23,660 salary level required for exemption falls short of the 2014 poverty threshold of $24,008 per year for a family of four. Because of those factors, the Department of Labor seeks to increase the salary level annually to ensure the salary level accurately reflects an effective dividing line between exempt and nonexempt workers. The proposed salary level changes will largely affect the previously exempted employees whose duties meet the exemption requirements, but the employee’s salary fails to meet the new minimum. 

Using the past salary level increases as an example, the Department of Labor compiled and analyzed salary data from all full-time salaried employees across the nation. Unlike past computations, there were no exclusions based on the type of job. In 2004, the salaries of teachers, physicians, lawyers and others were excluded from the data because they were not subject to the salary level test. In direct contrast to the methods of analysis in 2004, in this proposed rule, the Department of Labor wanted a complete sample of all salaries in the workforce, regardless of whether or not the employees are subject to the salary level test. Obviously an attempt to artificially increase the proposed salary level. In the proposed rule, the salary level is set as a percentile as opposed to a precise dollar amount, which purportedly attempts to serve as a more accurate proxy across a relative distribution of salaried earnings of exempt and nonexempt employees. 

When the $455 per week figure is calculated across the range of salaries today, the amount equates to approximately the twentieth (20th) percentile of weekly earnings for all full-time salaried workers. The Department of Labor reported that it chose the higher percentage of forty percent (40%) because their current analysis evidenced that eighty-five percent (85%) of white collar salaried workers who are classified in executive, administrative, or professional positions earn at least $455 per week, irrespective of whether the employee’s duties satisfied the DOL’s duties test. As a result, only fifteen percent (15%) of the employees are being screened from exemption by the DOL’s duties test. Further, only four percent (4%) of all white collar salaried employees who meet the duties test earn less than the current salary level of $455 per week. The proposed increase, if put into effect, will grow the percentage of all white collar salaried employees who meet the duties test and earn less than the salary level from four percent (4%) to twenty-five percent (25%). Moreover, the DOL noted that currently approximately seventy-eight percent (78%) of all employees exempt through the white collar exemption, those who are paid on a salary basis of at least $455 per week and satisfy the duties test, earn at least $921 per week. 

The Department of Labor believes this figure will provide a clear dividing line between exempt and nonexempt workers. 

Annual Updates to the Salary Level 

There are two (2) methodologies proposed for consideration for the annual updates to the salary compensation thresholds. First, an update to the thresholds based on a fixed percentile of earnings for full-time salaried workers. Alternatively, an update to the thresholds based on changes in the CPI-U. The methodology will be determined through the notice and comment rulemaking process. Regardless of the chosen method, the Department of Labor proposes to update the current salary level using the most recent data provided by the Bureau of Labor Statistics (BLS). Once the Department of Labor determines the new salary level, it will then publish a notice with the new salary level in the Federal Register and the Wage and Hour Division website no less than sixty (60) days prior to the date the revised rates would become effective.

I. The “Fixed Percentile” Approach 

The “fixed percentile” approach applies the same methodology used by the Department of Labor to increase the standard salary level in the proposed rule and is similar to prior rulemakings. Because all salaries of full-time salaried workers are used in the data analysis, a broad pool of workers’ salaries is examined. Moreover, the DOL contends that the BLS data for this pool of workers is readily available and transparent. Like the current proposed salary level, the Department of Labor seeks to keep the fixed percentile at forty percent (40%) due to the Department’s best estimate of the most effective dividing line between exempt and nonexempt workers. 

On a quarterly basis, the BLS publishes a table of data reflecting the weekly wages of full-time salaried workers based on Current Population Survey (CPS) data. This release of information would keep employers aware of changes in wages and allow them to plan and prepare for changes in the salary and compensation level threshold. The Department of Labor’s rationale is that keeping the threshold at forty percent (40%) allows the salary level to fluctuate with the current salary statistics and avoid becoming obsolete. 

II. The CPI-U Approach 

The second approach to determine the salary level increase would be accomplished by updating the level based on changes to the CPI-U (Consumer Price Index for all Urban Consumers). The CPI-U is a commonly used economic indicator for measuring inflation. It calculates inflation through measuring the average change in prices paid by urban consumers for a set of consumer goods and services. That data is published regularly on a monthly basis. 

This approach differs from past salary level computations as it does not review actual salaries or incomes. In addition, previous salary levels did not consider inflation-adjusted amounts. However, the CPI-U will only be used to update the salary level going forward. The Department of Labor believes that because the CPI-U will only be used to update the proposed salary level, which will be determined by analyzing salaries of full-time salaried workers as explained above, the salary level will maintain its efficiency at distinguishing between exempt and nonexempt workers. 

The Department of Labor directly cites two (2) factors that caused it to conclude that updating the salary level using the CPI-U would not harm vulnerable business sectors, such as low-wage industries or geographic areas, or have any other negative economic effects. First, the DOL asserts that setting the salary level at the fortieth (40th) percentile accounts for and protects the vulnerable business sectors. Second, after an analysis of the historical relationship between the fortieth (40th) percentile as a benchmark and the CPI-U, the Department of Labor determined there should be no concern that using an inflation-based updating mechanism will negatively impact low-wage industries and geographic regions. Moreover, when compared to the fixed percentile approach, the DOL believes using the CPI-U should yield a comparable salary level. 

The CPI-U is used in other capacities and would be a familiar method if chosen. For instance, the Internal Revenue Service (“IRS”) uses the CPI-U to update and adjust personal tax brackets. Additionally, several federal agencies use the CPI-U to determine eligibility for various governmental programs. Despite the lack of intention to set a precedent, the Department of Labor set salary levels in 1975 using the consumer price index. Lastly, the fortieth (40th) percentile benchmark and the CPI-U have had comparable growth between 1998 and 2013, which leads the Department of Labor to believe that using the CPI-U to update the salary levels would preserve the effectiveness of the salary level test. 

Next on the Horizon 

The Department of Labor is seeking comments on both the fixed percentile approach and the CPI-U, including whether one approach seems most suited for maintaining the effectiveness of the salary level test. Further, the Department seeks comments regarding whether updates should be scheduled based on January 1, the effective date of the Final Rule, or a different date. The DOL additionally seeks comments on the frequency of the automatic updates. It was proposed to update the salary level on an annual basis to ensure the new salary level is based on the best available data; however, the DOL also seeks comments that discuss an alternative process. Finally, although the DOL did not address the duties test, the DOL seeks comments on possible changes to the duties test to further restrict application of the exemption. 

This Proposed Rule has not been published in the Federal Register as of July 1, 2015. Once it is published, dates regarding the comment period will be specified. 

It is anticipated that his is the proverbial first shoe to drop. President Obama executed Executive Order 13658 on February 12, 2014 requiring a raise in the minimum wage for all workers on Federal Construction or service contracts to $10.10/hour. This took effect on January 1, 2015. The Congressional Budget Office has floated trial balloons for an increase in the current minimum wage, $7.25, to either $9.00 or $10.10. President Obama has previously called on Congress to raise the minimum wage to $10.10. While there have been attempts to raise the minimum wage in Congress, Fair Minimum Wage Act of 2013 (H.R. 1010), the efforts have not gained significant support. Currently, twenty-nine (29) states, plus the Department of Labor, have minimum wages above the federal minimum of $7.25. We anticipate that a proposed change to mandate increase to $10.10 will be submitted by the end of 2015. Taking these proposed changes into consideration with the possible change in the duties test, more change is sure to come.