GT Alert

Department of Labor Proposes Revisions to Fair Labor Standards Act Overtime Exemptions

April 2003
By John Scalia, Craig Etter, Mary Pivec, and Scott Johnson, Greenberg Traurig, Tysons Corner Office

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For the first time in decades, the U.S. Department of Labor ("DOL") has proposed significant changes to the regulations that govern the executive, administrative, professional, outside sales, and computer professional exemptions (often called the "white collar" exemptions) to the Fair Labor Standards Act ("FLSA" or "the Act"). The overtime pay requirements of the FLSA require that an employee be paid overtime at a rate of one and one-half times the employee’s regular rate of pay for all hours worked over 40 in a given workweek. However, the overtime requirements do not apply to employees who are "exempt" from the Act. Primary categories of exempt employees include executive employees, administrative employees, professional employees, outside sales employees, and certain computer personnel. In order to fall within one of these exemptions, generally three requirements must be met. First, the employee must be paid a predetermined salary, rather than an hourly wage subject to reduction based upon the quantity or quality of the employee’s work (the "salary basis" test). Second, the employee must receive a certain minimum salary. Third, the employee must primarily perform the types of duties defined by the regulations (the "duties" test).

"The U.S. Department of Labor ("DOL") has proposed significant changes to the regulations that govern the executive, administrative, professional, outside sales, and computer professional exemptions."

On March 31, 2003, the DOL issued proposed regulations that would modify all three requirements of the white collar exemption test. The proposal would increase the minimum salary necessary to fall within the exemption, change some aspects of the salary basis test, and broaden the definition of exempt duties, allowing more employees who meet the minimum salary requirements to fall within an overtime exemption. A new exemption for highly compensated employees also would be created. The proposed changes would modify some areas of the present regulations that have been the subject of frequent litigation, likely limiting further litigation of these issues. However, there are also several provisions in the proposed regulations that would probably spawn new areas of litigation. The DOL has invited public comment on the proposed regulations and expects to issue final regulations in late 2003 or early 2004.

The DOL’s Proposed Increase of the Minimum Salary Requirements

One of the most significant proposed changes to the rules is the increase in the minimum salary requirement. Executive, administrative, and professional employees must receive a minimum salary level in order to be exempt. Under the present regulations, that minimum level varies depending on the duties test to be used. The so-called "long" test is applied if an employee earns at least $155 per week (if considered for the executive or administrative exemptions) or at least $170 per week (if considered for the professional exemption). However, the "short" test is applied if an employee earns a salary of over $250 per week. The short test generally provides for a more lenient standard (making it more likely that an employee is exempt). These minimum compensation levels have remained unchanged since 1975 and have obviously not kept pace with inflation over the years. As a result, under the present regulations, the minimum salary level is almost always easily met, and an employee’s exempt status is largely decided by the duties he or she performs rather than his or her salary level.

Under the proposed regulations, an across-the-board minimum weekly salary of $425 per week would be necessary for the executive, administrative, and professional exemptions, as well as the exemption for computer-related employees. This would raise the annualized salary bar to $22,100. According to the DOL, the proposed changes would guarantee overtime pay for 1.3 million more low-wage employees who are presently classified as exempt employees.

Changes to the Salary Basis Test

The salary basis test generally requires that employees receive a salary, which is a predetermined amount constituting all or part of the employee’s compensation and which is not subject to reduction based on variations in the quality or quantity of the work. The present scheme provides employers only limited ability to make deductions from an exempt employee’s salary. Deductions are allowed, for example, for absences of a day or more for personal reasons or for sickness and disability if taken in accordance with a bona fide plan, policy, or law providing wage replacement benefits. Also, employers may make deductions for hours taken as unpaid FMLA leave.

The proposed regulations relax the requirements of the salary basis test. For example, the new regulations allow an employer to dock an exempt employee for a full-day’s pay for disciplinary reasons (the present regulations only allow such deductions for violating major safety rules).

More important, the proposed regulations to some extent limit the effects of improper pay docking. Under current rules, an employer can lose the exemption for an entire class of employees by making an improper deduction, unless the employer properly takes advantage of the "window of correction" and rectifies any underpayment that may have occurred. The proposed regulations indicate that the "window of correction" should be widely available to avoid loss of the exemption to a whole category of employees – unless it can be proved that there is a pattern and practice of improper deductions with respect to the employees who are in the particular job category in question and who are working for the same manager who was responsible for the improper docking.

Similar to the judicial rule adopted by the Supreme Court in the landmark Farraher case dealing with employer liability for co-worker sexual harassment, the DOL has proposed a new "safe harbor" provision for employers that adopt a written policy against improper deductions, notify employees of that policy, and reimburse employees for improper deductions. These proposed regulations may present tremendous opportunities for employers to limit their exposure to overtime lawsuits, and the liquidated damages and attorney’s fees typically implicated by such suits.

The DOL’s Proposed Changes to the Duties Test

The DOL is also proposing changes to the duties test for the various white collar exemptions. The old framework of "long" and "short" tests would be replaced with one test for each category of exemption. As a result, under the proposed regulations, employers no longer would have to deal with the cumbersome and impractical "80/20" test for measuring exempt and non-exempt activities. Employers frequently could not prove compliance with the test in hindsight, because they were not tracking the hours of workers they presumed to be exempt in the first place. The employee challenging his or her exempt classification typically had the upper hand in any administrative or judicial contest, providing self-serving, but difficult-to-challenge, testimony regarding his or her actual job duties.

The following describes the proposed changes to each of the exempt white collar categories:

Under the proposed regulations, the duties test would require that an exempt executive employee must:

(1) Have a primary duty of managing the enterprise in which the employee is employed or of a customarily recognized department or subdivision thereof;

(2) Customarily and regularly direct the work of two or more other employees; and

(3) Have the authority to hire or fire other employees or have particular weight given to suggestions and recommendations as to the hiring, firing, advancement, promotion, or any other change of status of other employees.

68 Fed. Reg. 15560, 15564 (March 31, 2003).

This test is essentially a combination of the short test under the current regulations plus one of the long test’s requirements – that the employee have authority to hire or fire. The proposed regulations also clarify that managers in retail establishments would be deemed exempt even if they spend the majority of their time in any one work week in non-exempt duties, provided their primary duty includes scheduling employees, assigning work, overseeing product handling, ordering merchandise, managing inventory, handling customer complaints, authorizing bill payment or performing similar management functions. In industries where managers frequently lend a helping-hand during peak service periods, such as restaurants, hotels, and entertainment venues, this clarification would go far to preserve the executive exemption in the face of legal challenges.

The proposed regulations also provide executive employee exemptions for site managers and owners. An employee who is in "sole charge" of "an independent establishment or a physically separated branch establishment" may qualify as an exempt executive if paid the minimum salary, regardless of whether he or she meets the other requirements of the exemption. In addition, any employee who "owns at least a 20 percent equity interest in the enterprise in which the employee is employed" would be an exempt executive, regardless of his or her salary level or job duties.

The administrative exemption is one of the most difficult to apply of the white collar exemptions. For example, substantial litigation has resulted from the requirement that administrative employees exercise "discretion and independent judgment." In particular, litigation has occurred when the subject employees are required to follow written corporate instructions in carrying out their duties. Insurance claims adjusters and mortgage loan officers are just two of the occupational categories that have spawned costly class action litigation. The proposed regulations would remove the need to prove the consistent exercise of judgment and discretion – eliminating the dilemma of having to abandon either the overtime exemption or consistency in the adjudication policies. Moreover, the DOL has declared that the number of employees performing the task is irrelevant to the determination of exempt status.

The new test requires that an administrative employee:

(1) Have the primary duty of performing "office or non-manual work related to the management or general business operations of the employer or the employer’s customers;" and

(2) Hold a "position of responsibility" with the employer, defined as either: (a) performing work of "substantial importance;" or (b) performing work requiring a "high level of skill or training."

68 Fed. Reg. at 15587.

The proposed rules provide illustrative examples of "work related to the management or general business operations," including "tax, finance, accounting, auditing, insurance, quality control, purchasing, procurement, advertising, marketing, research, safety and health, personnel management, human resources, employee benefits, labor relations, public relations, government relations, and similar activities." 68 Fed. Reg. at 15587. According to the DOL, the proposed regulations also would reduce the emphasis on the outdated "administrative versus production" dichotomy, which has often been the subject of litigation, while still requiring an exempt administrative employee to be engaged in work related to the management or general business operations of the employer or the employer’s customers. 68 Fed. Reg. at 15566.

Of particular note in the proposed regulations is the assurance that employees who work as consultants and provide management services to third parties on behalf of their employers may be properly classifiable as administratively exempt. Further, the "high level of skill or training" alternative component of the second prong of the administrative exemption does not require college training – simply specialized knowledge or abilities, and not necessarily of an advanced nature. Stock brokers, broker assistants, actuarial assistants, and advertising consultants are among the classes of employees that may now qualify for exempt status under the proposed regulations.

The current regulations pertaining to professional employees provide separate tests for various types of professional employees, including "learned" and "creative" or "artistic" professionals and computer professionals. The proposed regulations modify these tests somewhat, particularly the learned professional exemption, move the computer professional exemption to a separate category, and eliminate the long test.

For learned professionals, the proposed requirements provide that employees would qualify for the exemption if they "have a primary duty of performing office or non-manual work requiring advanced knowledge in a field of science or learning which is customarily acquired by a prolonged course of specialized intellectual instruction, but which also may be acquired by an equivalent combination of intellectual instruction and work experience." 68 Fed. Reg. at 15567. The new test would recognize that some employees gain their expertise on the job, rather than through a particular course of academic study, and would relax the need for an employee to have a particular academic degree. Thus, as noted by the proposed rule, the test would "focus on the knowledge of the employee and how that knowledge is used in everyday work, not on the educational path followed to obtain that knowledge." 68 Fed. Reg. at 15567. The proposed test for learned professionals eliminates the requirement that learned professionals exercise independent judgment and discretion, but adds the requirement that the work involve office or non-manual work.

The proposed regulations make minor changes to the wording of the test for creative professionals, but, according to the DOL, these modifications are not intended to make any material changes from the existing regulations. 68 Fed. Reg. at 15568. The artistic professional exemption would apply to any employee with the primary duty of "performing office or non-manual work requiring invention, imagination, originality or talent in a recognized field of artistic or creative endeavor." 68 Fed. Reg. at 15589. However, the DOL clarifies that certain occupational categories in the news and entertainment industry are properly classifiable as exempt – hopefully bringing an end to numerous class and individual overtime lawsuits involving employees who allegedly have not been able to exercise the degree of independence believed necessary to avoid overtime entitlement.

Professional employees may be paid on a salary or fees basis at the new $425 per week rate.

The proposed regulations regarding computer professionals would streamline the present regulations and would, as with the other exemptions, remove the requirement of "discretion and judgment." In addition, the regulations would no longer cite specific job titles as examples of exempt work because, as the proposed regulations note, the job titles for this category of employee tend to become quickly outdated due to the rapidly changing nature of the information technology industry. 68 Fed. Reg. at 15569. Otherwise, the regulations would not substantively change the present requirements. The proposed regulations would exempt employees who are compensated on an hourly basis of at least $27.63 (the current hourly rate) or on a salary or fee basis of $425 per week.

In order to meet the duties test, computer systems analysts, computer programmers, software engineers, and "other similarly skilled employees" in the computer field must have the primary duty consisting of:

(1) "The application of systems analysis techniques and procedures, including consulting with users, to determine hardware, software or system functional specifications;"

(2) "The design, development, documentation, analysis, creation, testing or modification of computer systems or programs, including prototypes, based on and related to user or system design specifications;"

(3) "The design, documentation, testing, creation or modification of computer programs related to machine operating systems;" or

(4) "A combination of the aforementioned duties, the performance of which requires the same level of skills."

68 Fed. Reg. at 15590.

The DOL proposed rules are intended to simplify the outside sales exemption, in part by removing the 20 percent limit on nonexempt work performed by outside sales employees. The "essential elements" of the duties test would remain basically the same. To meet the outside sales exemption, an employee must:

(1) Have a primary duty of "making sales" or "obtaining orders or contracts for services or for the use of facilities;" and

(2) Be "customarily and regularly engaged away from the employer’s place or places of business in performing such primary duty."

68 Fed. Reg. at 15591. The minimum salary requirement does not apply to outside sales employees.

The proposed regulations contain a new exemption for highly compensated employees. Under this test, an employee who is paid $65,000 or more annually, performs non-manual work, and performs at least one of the executive, administrative, or professional functions would be exempt. The proposed rule does not require that such employee be paid on a salary basis, but rather allows consideration of base salary, commissions, non-discretionary bonuses, and other non-discretionary compensation, so long as the base salary, commissions, and non-discretionary compensation are settled and paid out on at least a monthly basis. An employee who works for only part of a year may be eligible for the exemption so long as the employee is guaranteed a pro rata portion of the $65,000 annual salary based upon the number of weeks the employee is in the position. This new safe harbor may prove tremendously valuable to employers who wish to continue compensating employees on an hourly basis – particularly where the availability of work is linked to client contracts (such as nursing agencies, computer consulting firms, and engineering consulting firms).

Conclusion

If the regulations are promulgated as proposed, the impact on the workplace will be significant. According to the DOL’s estimates, based on the changes which would be made in the white collar duties tests, employers should be able to reclassify between 1.5 to 2.7 million salaried workers as overtime exempt. The DOL further estimates that, based on those same rule changes, up to 644,000 current hourly workers will be converted to salaried exempt employees. These estimates exclude consideration of more protective state and local wage and hour laws that may continue to trump the liberalized federal rules, particularly in those states with wage and hour laws more restrictive than the federal scheme. They also exclude the effect of existing collective bargaining agreements, which may continue to bind employers to higher overtime payments.

There is a 90-day public comment period on the proposed regulations. The DOL has invited comment upon a wide variety of issues raised by the proposed regulations and expects to issue final regulations in late 2003 or early 2004. In the meantime, given this delay in the final promulgation of the new regulations, and in light of the recent explosion in the number and size of wage and hour cases being brought by employees, employers are well-advised to perform a FLSA white collar exemption audit to assess their compliance with, and limit their potential liability under, the current regulations.

If you or your organization would like to comment on these proposed regulations or would like more information on compliance with the present regulations, please contact John Scalia at (703) 749-1380, scaliaj@gtlaw.com; Craig Etter at (703) 749-1315, etterc@gtlaw.com; or Mary Pivec at (202) 452-4883, pivecm@gtlaw.com.  Additional information regarding the FLSA exemptions is available at the DOL’s website, www.dol.gov.

© 2003 Greenberg Traurig

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