Overtime Rule: Should Employers Raise Wages or Reclassify Workers?

​The proposed federal overtime rule isn't expected to take effect until January 2020, but employers may need to start planning now if they have exempt employees who are earning less than $35,308 a year.

Employees must perform certain duties and earn a minimum salary to be classified as exempt from overtime pay under the Fair Labor Standards Act's executive, administrative and professional exemptions. The Department of Labor (DOL) is seeking to raise the threshold to $679 a week ($35,308 a year) from $455 a week ($23,660 a year)—though nothing has been finalized yet.

FLSA Overtime Rule Resources

· Don't Forget to Review Duties for OT Exemptions
· Employers Can’t Ignore State Exemption Rules
· Resources: FLSA Exemption Classification
· ​Timeline: Overtime Rule History

If the proposal is adopted, exempt employees who currently earn less than $679 a week would need to be given a raise to meet the new threshold. Otherwise, they would have to be reclassified as nonexempt and paid overtime premiums for any hours worked beyond 40 in a workweek.

The DOL expects that more than a million currently exempt workers would be reclassified to nonexempt. "The proposal would impact employers in numerous industries, particularly those in the retail, education, health services, leisure and hospitality industries," noted Russell Bruch, an attorney with Morgan Lewis in Washington, D.C.

"Employers should not forget that the DOL's proposed rule has no bearing on state law," said Ryan Mick, an attorney with Dorsey & Whitney in Minneapolis. "If applicable state law imposes a higher minimum salary requirement or a more onerous duties test, employers in that state must continue to comply with state law."

Here are some tips to help employers decide whether to reclassify workers or increase their pay.

Calculate the Costs

The main consideration is the amount of anticipated overtime the employee would be paid if reclassified to nonexempt, said Alex Stevens, an attorney with McGinnis Lochridge in Dallas. If the employee would earn more in overtime premiums than he or she would earn with a salary increase that preserves the exemption, then a salary increase probably makes business sense.

Keep in mind that nondiscretionary bonuses and commissions paid on an annual or more frequent basis could be used to satisfy up to 10 percent of the standard exempt salary threshold under the DOL's proposal.

[SHRM members-only resource: FLSA Proposed Salary Increase Impact Analysis Guide and Calculator]

Note that reclassifying an employee to nonexempt can create administrative costs, because employers would need to track workers' hours and calculate overtime pay. And reclassified employees may have to adjust to new procedures. "Previously exempt employees may not be used to tracking their time or seeking permission to work outside their regular schedule and will need to be reminded of the company's timekeeping policies for nonexempt employees," Stevens said.

Employers should also consider whether reclassifying employees would cause morale issues, especially if the affected employee would interpret the reclassification as a demotion, he added. "The employer should be clear that employees are not being demoted or punished and will in fact be eligible for overtime."

Look at the Bigger Picture

Employers should examine whether reclassifying employees who fall below the new salary threshold would result in some employees in the same job being exempt while others are nonexempt. "Having certain employees in the same job earn overtime pay while others are not eligible for overtime pay can create employee-relations issues," Bruch said.

But giving raises only to workers who need an adjustment to meet the new exempt salary threshold can also cause problems. "Word of the increases is likely to travel and may cause morale issues for those not getting the bump in pay," Bruch said. Although employers can explain that the increases were driven by a change in the law—and that not all employees are affected by the change—this explanation may do little to appease disgruntled workers, he noted.

Employers might want to consider increasing pay for employees in the same job who are paid more than the new minimum salary, but they may also want to take this opportunity to review their pay practices and determine the reasons for any pay disparities before any increases are finalized.

"These kinds of changes provide a good opportunity to examine how employees are paid and whether any other changes might be in order with respect to pay disparities, potential employee misclassification and timekeeping issues," according to Stevens.

"We recommend that companies consider auditing their current employee population to determine the impact on staffing and compensation models and review the classification of 'close-to-the-line' positions," Bruch said.

Develop a Communication Strategy

"Having a robust communication strategy is key to a successful reclassification," Bruch said. He recommends creating talking points and FAQs for reclassified employees and their managers and developing an explanation of why the change will impact employees.

Reclassified employees are often concerned about how their level of compensation and benefits may change, how to record time worked in the timekeeping system, and how the reclassification may impact their opportunity for advancement. 

Managers will want to know how the change may impact how they interact with their employees. For instance, managers may not have previously been as concerned with how much time it took employees to get a job done or whether employees were working after hours or on weekends. 

"Planning ahead is critical to managing the risks associated with reclassification," Bruch said.

[Visit SHRM's resource page on FLSA exemption classification.]