Overtime Rule: Raise Salaries or Reclassify Employees?

Employers with exempt employees making less than the new minimum salary requirements for exempt workers will need to decide whether to raise salaries or reclassify employees as nonexempt. HR should consider the economic and morale impacts of reclassification.

Background

The overtime rule raises the standard salary threshold in two phases. Workers who do not earn at least $43,888 ($844 a week) as of July 1, 2024, will have to be paid overtime, even if they’re classified as a manager or professional. The salary threshold rises to $58,656 a year ($1,128 a week) as of Jan. 1, 2025. After that, there are automatic increases to the salary threshold every three years.

Nondiscretionary bonuses and incentive payments (including commissions) paid on an annual or more frequent basis may be used to satisfy up to 10 percent of the standard salary level.

To be exempt from overtime under the Fair Labor Standards Act’s (FLSA’s) executive, administrative, and professional (EAP) exemptions—the so-called white-collar exemptions—employees must be paid a salary of at least the threshold amount and meet certain duties tests. If they are paid less or do not meet the tests, they must be paid 1.5 times their regular hourly rate for hours worked in excess of 40 in a workweek.

To qualify for the highly compensated employee exemption, an employee must be paid a total annual compensation of at least $132,964 (effective July 1, 2024) and then at least $151,164 (effective Jan. 1, 2025), paid on a salary basis. For the highly compensated employee exemption, the exempt worker only has to satisfy one job duty instead of the entire EAP job duties test, said Dena Sokolow, an attorney with Baker Donelson in Tallahassee, Fla.

[Related Resource: SHRM Annual Conference & Expo 2024 concurrent session “Wage and Hour Compliance: A DOL Update and Ways to Avoid Common FLSA Overtime Liability Landmines”]

Economic Impact

“In deciding exempt versus nonexempt classification, HR will want to initially consider the economic impact of classification decisions,” said Laura O’Donnell, an attorney with Haynes Boone in San Antonio and Austin, Texas.

For example, does an impacted employee often work overtime? If so, and the employee is reclassified as nonexempt, the employee’s total compensation would likely increase, she said. “And if the compensation, with overtime, will likely increase, will this increase exceed the new salary minimums?” O’Donnell asked. “If so, increasing the salary may be a better option than reclassification. Conversely, if the employee rarely works overtime, it may make more economic sense to reclassify the employee as nonexempt.”

Whether salaries can be increased to satisfy the new threshold may depend on how close the workers’ pay is to the new threshold, said Rob Boonin, an attorney with Dykema in Ann Arbor, Mich.

Morale Considerations

The analysis should not be limited to economic impact, O’Donnell said.

“Many employees view their exempt classification as recognition that they are performing more sophisticated and important duties than their nonexempt peers,” she said. “Even if their ultimate compensation does not change or even increases, employees may view reclassification as a demotion.”

Overtime eligibility doesn’t necessarily translate into hefty overtime earnings for all newly reclassified employees. Employers might choose to reduce the hours in some positions. Employers would still have to pay for all earned overtime but could discipline workers who worked unapproved overtime, which could further hurt morale.

In addition, businesses might respond to the raised salary threshold for exemptions by conducting layoffs, said Tim Taylor, an attorney with Holland & Knight in Tysons, Va.

Nonexempt employees must record their work time so they can be paid any earned overtime.

“If impacted employees have not previously had to record time, the employees may resent this new requirement,” O’Donnell said. “The cost of negative morale is often difficult to quantify but can lead to many negative consequences such as a loss of productivity, decreased employee engagement, eroding of culture, turnover, and increased HR time addressing concerns.”

Disgruntled employees are more likely to sue. “Therefore, HR will also want to evaluate whether the potential morale impact of converting an exempt employee to nonexempt is worth any potential economic savings,” O’Donnell said.

If a company decides to reclassify exempt employees, HR should think strategically about how to communicate and implement that change to realize the best possible employee experience, she said.

Boonin said some salary compression is inevitable, which may impact those whose pay is above the new threshold. Pay compression occurs when the pay difference between employee levels shrinks so that higher-level workers feel that their pay advantage is no longer significant. Pay compression may require an overall evaluation of an employer’s entire compensation structure, he said.

Salaried Nonexempt Employees

“The ability to retain a salary but reclassify employees as nonexempt could be a useful tool to mitigate the potential morale concerns with converting an exempt employee to nonexempt,” O’Donnell noted.

Nonexempt employees are often thought of as hourly employees, Sokolow said. However, the FLSA does not require that nonexempt employees be paid on an hourly basis. A salaried nonexempt employee is a worker who is paid a fixed salary for all hours worked but is still eligible for overtime pay for any hours worked beyond 40 in a workweek.

The vast majority of nonexempt workers are paid hourly and are not salaried, said David Barron, an attorney with Cozen O’Connor in Houston and Chicago.

“Irrespective of how a nonexempt employee is paid, the employer needs to track the employee’s time and pay the employee overtime, if applicable,” O’Donnell said. “There could still, therefore, be negative employee experiences if a previously exempt employee is suddenly told that the employee needs to start recording time.”

Employers also will need to train reclassified employees and their managers on the ways in which the reclassification could impact work habits, including telling nonexempt workers not to respond to emails if they are not on the clock, said Brett Coburn, an attorney with Alston & Bird in Atlanta.

A California assemblymember has proposed giving workers a right to disconnect in that state, a proposal SHRM opposes. The bill, AB 2751, might restrict the natural flow of work that occasionally necessitates overtime, according to SHRM.

Prepare vs. Wait and See?

Employers should prepare for the first salary-threshold increase on July 1, said Taylor, a former deputy solicitor of labor. “That increase simply adjusts for inflation,” he said.

Employers might want to wait and see over the next few months whether the second, much larger increase planned for Jan. 1, 2025, is likely to occur, he added: “That second increase is legally aggressive, and its fate in court is uncertain.”