How to Pay Formerly Exempt Employees Under the New Rules

Financial Stewards.BLOGLast July, the U.S. Department of Labor (DOL) issued proposed regulations to change how employers determine who is exempt from overtime. The changes are intended to increase the number of employees eligible for overtime and simplify the identification of nonexempt employees. Most employers are already aware of the DOL’s proposal to more than double the salary level. Currently, the threshold is set at $455 a week, or $23,660 annually. The DOL’s proposal seeks to increase the threshold to $970 a week, or $50,440 annually (although a recent rumor suggests the final threshold will be around $47,000).

If such a proposal is implemented, many employers will need to transition exempt employees to nonexempt status and determine how to pay these newly reclassified employees. The most common and administratively easiest approach is to simply divide employees’ current salary by 2,080 (40 hours times 52 weeks) to determine an hourly rate. However, such an approach could result in a significant pay raise for an employee who regularly works overtime if no operational changes are made to reduce or eliminate overtime work. While employees will be happy to receive such a raise, more cost-effective approaches exist. In fact, other pay alternatives cannot only be more cost-neutral, but provide greater scheduling flexibility to employees: a win-win. As such, employers would be wise to consider the following payment options:

A cost-neutral and perhaps the least administratively burdensome approach is to estimate the number of overtime hours an employee is expected to work and then calculate an hourly rate that will match the employee’s current salary. In other words, lower the hourly rate to offset any overtime you expect the employee to work. Given that many employers do not track exempt employees’ hours, this may be difficult. Employers may therefore want to begin observing and documenting at-risk exempt employees’ work hours. Alternatively, employers can monitor employee pass-key entries and exits as well as computer log-ins and log-outs to formulate an estimate of overtime hours regularly worked.

Another option is to pay nonexempt employees a salary. That nonexempt employees cannot be paid a salary is a common misconception. Employers may, in fact, pay nonexempt employees a salary and designate, in writing, how many hours the salary is intended to compensate. The salary need not be payment for 40 hours a week, but can be for any number of hours the employer chooses. Paying nonexempt employees a salary, however, does not eliminate the requirement to pay overtime for any hours worked over 40 in a workweek. That being said, an employer need only pay an employee “half-time” for any overtime hours worked for which the salary was intended to compensate. For example, if an employee’s salary represents payment for 50 hours of work each week and the employee works 45 hours one week, the employer need only pay the employee half-time for the five hours of overtime worked. However, if the salary represents payment for 40 hours of work each week, the employer must pay time-and-a-half for the five hours of overtime worked. An employee’s regular rate of pay is determined by dividing the employee’s weekly salary by the number of hours the salary is intended to compensate.

Employers can also pay by the “fluctuating workweek” method. This method may only be used for employees whose work hours actually fluctuate from week to week below and above 40 hours. An employee must agree and understand that the salary constitutes straight-time pay for all hours worked each workweek regardless of whether the employee actually works 15, 30, or 70 hours. Because the salary provides straight-time pay for all hours worked, an employer need only pay half-time for any hours worked over 40 in a workweek. An employee’s regular rate of pay is determined by dividing the employee’s salary by the number of hours worked each week. As a result, the more hours an employee works, the lower the regular rate of pay and the lower the employer’s overtime liability. An employee, however, must always be paid at least minimum wage. While this method provides the employee with the greatest work schedule flexibility and can lessen employers’ overtime costs, it does present an administrative burden in that an employee’s regular rate of pay must be calculated for each week in which the employee works overtime.

Because the fluctuating workweek method has strict compliance requirements, members should contact MSEC counsel before implementing the pay method. MSEC is here to assist with all aspects of complying with the forthcoming regulations.