Employers Rethink Pay Practices After Overtime Rule

Challenges include using bonuses to push employees over the exempt threshold

By Stephen Miller, CEBS May 23, 2016
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Recap: Final Overtime Rule Takes Effect Dec. 1, 2016

The Department of Labor’s final rule revising the Fair Labor Standards Act overtime regulations was released on May 18, 2016. The new rules take effect on Dec. 1, 2016.

Under the final rule:

• The annual salary threshold for exempt positions will jump from $23,660 to $47,476 (or from $455 to $913 per week), and will be updated every three years. That’s more than double the old threshold.

• There will be no change in the duties test used to determine whether employees earning more than the salary threshold must be classified as nonexempt from overtime, including the exemptions for executive, administrative and professional positions, among others.

• For highly compensated employees (HCEs), the final rule raises the annual HCE salary threshold from $100,000 to $134,004. At or above that threshold, HCEs are exempt from the overtime requirements of the FLSA if they meet a more relaxed duties test than is required for employees paid the standard salary level.

(See SHRM Online’s FLSA Overtime Rule Resources page.)

The Department of Labor’s final rule on overtime pay under the Fair Labor Standards Act (FSLA), released May 18, will mean adjusting numerous compensation practices to comply with the new rule, HR managers and advisors say.

The pay-related issues raised by the new rule extend beyond reclassifying millions of employees as nonexempt—and thus entitled to paid overtime at an hourly rate of time and a half when working over 40 hours a week (see SHRM’s FLSA Overtime Rule Resources page.) Compensation managers also are grappling with challenges such as whether to use bonuses to push employees over the exempt-pay threshold of $47,476 annually or $913 weekly, whether workers who have lost exempt status should be treated as “salaried but nonexempt,” how to confront the risks of pay compression, and how to deal with strained compensation budgets.


Each Workweek Stands Alone

Employers who are covered under the FLSA must establish a workweek (7 consecutive 24-hour periods) and must pay overtime when hours worked exceed 40 in the workweek. When calculating overtime pay, each workweek must stand alone. For example, an employee works 35 hours one week and 45 hours the next week for a total of 80 hours. Even though the total hours averages to 40 hours worked each week, the employee must still be paid for the five overtime hours worked during the second week.

New Role for Incentive Pay

The final rule amends the salary basis test to allow employers to use nondiscretionary bonuses and incentive payments (including commissions) to satisfy up to 10 percent of the new standard salary threshold, provided these payments are made on a quarterly or more-frequent basis. Previously, there had been no regulatory provision to count incentive pay toward the salary threshold.

At companies that offer such incentives and bonuses, employees can earn a nondiscretionary bonus if they meet performance or productivity goals set by the employer. If the goals are met, “there’s no question about whether it’s going to be paid out or not,” said Meg Ferrero, assistant general counsel at payroll and HR services firm ADP in Parsippany, N.J.

“If we’re talking about commissions or bonuses that might not be earned from period to period, then relying on those payments to get an employee over the salary threshold could put the employer at risk,” she noted.

Under the final rule, if an employee does not earn enough in nondiscretionary bonuses and incentive payments in a given quarter to retain his or her exempt status, the employee would be entitled to overtime pay for any overtime hours worked throughout the quarter—or, alternatively, employers are permitted to make one “catch-up” payment to the employee at the end of the quarter to compensate for the shortfall.

Morris Communications Co., a newspaper and magazine company based in Augusta, Ga., has about 1,800 employees nationwide, and just under 300 of those employees hold professional positions that will lose their exempt status under the new rules, said Sally Roberts, SHRM-SCP, director of HR. Using bonuses and other types of incentive pay to keep employees above the threshold is “an idea our compensation manager and I have kicked around a bit because it could be a win-win,” she said. “If employees are productive or saving money and we’re able to give them a quarterly bonus that will help toward the threshold, then we might be more eager to do that versus increasing base pay” to maintain their exempt status.

Ten percent of the threshold is $4,747.60, which would be the maximum amount that could be applied, “but if you’re awarding a bonus based on performance metrics, you’d have to structure the incentive so that, if the top target is missed, the payout would still be sufficient to get those employees over the threshold. It’s a little tricky, and we’ll need to carefully model it and see if it’s appropriate. But it’s intriguing,” Roberts said.

Elizabeth Hays, SHRM-SCP, director of human resources at Mars Home for Youth (MHY) Family Services, a Mars, Pa., nonprofit organization that serves at-risk youth, said her organization has about 150 employees, of which around 65 are currently exempt. “Probably 50 of these will be affected, as most of them are making $30,000-plus, well under the new $47,476 threshold.”

MHY doesn’t currently pay bonuses, but “perhaps down the road that’s something we could consider, if we have adequate funding to do so,” she said. “A small bonus doesn’t feel like much once it’s taxed, so it’s got to be big enough to feel like some type of reward.” And, as with many nonprofits and small businesses, she doubts that her compensation budget is large enough to keep these employees exempt, whether by raising their base pay or making incentive awards.

Comp budgets may not be able to keep employees exempt,
 whether by raising base pay or making incentive awards.

Salaried, Hourly or Salaried Nonexempt?

Some employers are planning to keep newly nonexempt employees as salaried even though they will be entitled to overtime based on their actual hourly rate if they work over 40 hours a week, but “I don’t believe it to be a best practice,” said Ferrero. “I think the best practice still is to pay your nonexempt employees on an hourly basis and to pay them for all time worked, included partial hours down to the minute.”

She added, “It’s almost more work for the employer, because they have to do the calculations around what the hourly rate actually is.”

Nevertheless, Ferrero said, it’s understandable that some employers might consider using a salaried nonexempt approach “because of the emotional impact, given that employees don’t necessarily want to see their pay rate change from a salary to an hourly rate. Employers are going to have to make some tough decisions from the human relations perspective with some of these issues, and to let their employees know they are valued employees regardless of how they’re classified.”

At Morris Communications, Roberts said, “Our solution is not going to be a one-size-fits-all.” Among those earning less than $47,476, “we are not going to raise everybody up to the new threshold, nor are we going to make everybody hourly. We’ll evaluate those people and positions to see how far away they are from the threshold, and evaluate the time that they’re currently working. Then we’re going to make decisions based on those assessments.”

As for using the salary nonexempt approach, “I think there is a place for it,” Roberts said. “It depends on the industry. In some categories of jobs, it works.”

To make the approach effective, she suggested that HR “prepopulate those employees’ timecards, since you’re assuming they’re going to work 40 hours per week. However, if there’s an occasion that warrants their working overtime, you would certainly have to pay them for that.”

Hays, at MHY Family Services, was more skeptical. “I have never in my life understood why you would classify someone as salaried and then pay them overtime,” she said. “You’re exempt or you’re nonexempt.”

Hays acknowledged that this approach allows nonexempt employees to say they’re salaried, “which makes them feel they have a certain status.” But, she added, “what really makes you feel that you have status in the organization is your title and your autonomy, and in particular it’s autonomy—the ability to control your own time—that indicates you’ve achieved a certain status. Now a good chunk of that is going to be diminished.”

Confronting Pay Compression

Pay compression occurs when salaries for those earning somewhat below the threshold are raised to keep those employees exempt, causing pressure to realign salaries up the ladder to maintain internal valuations within the salary structure.

“It’s something that employers are going to have to take into account,” Ferrero said. “Employers should consider those employees earning above the threshold who are now going to get compressed as the organization raises lower-tier salaries.” As a result, “the financial impact on the company can be greater than just the cost of bumping salaries on those employees who fall in the gap” between the old threshold of $23,660 and the new threshold of $47,476.

“Pay compression isn’t going to affect us because we don’t have the means or anticipate increases in funding to offset these changes in pay ranges,” said Hays, sharing a sentiment that other nonprofit organizations and small businesses, in particular, have expressed. “If we had the funding to raise our pay ranges, we would have done so already.”

Roberts, too, isn’t anticipating problems with pay compression since, with few exceptions, her company isn’t planning to raise pay to meet the new threshold. “I would say that’s one reason we don’t want to bump up people, because of that fear of compression. We’d have to also look at what their boss is making,” she noted.

(To learn more, see SHRM Online’s article “Put a Lid on Salary Compression Before It Boils Over.”)

Budgets Under Pressure

“It’s going to be a big budget hit,” said Hays. “We can’t avoid all overtime, and we are not going to prohibit it at the risk of our clients’ safety.” But even so, “if therapists want to take on new clients but doing so pushes them into working 50 or 55 hours a week, we’re not going to allow that, we can’t have it.”

Strained compensation budgets could limit salary increases going forward, said Roberts. “We have people who are accustomed to getting their job done working 45 or 50 hours a week. We’re going to ask that they become more efficient. There’s going to be more time management, which hasn’t been part of our culture.” For instance, “supervisors will need to be sensitive about assigning tasks late in the afternoon. We’ll be training our managers on that.”

“Employers only have so many dollars, so they should evaluate how to minimize their costs,” concurred Ferrero. In addition to paying time and a half for overtime, she noted, those costs include FICA taxes—Social Security and Medicare payroll taxes—on any overtime.

“The first step is conducting a financial analysis to determine what these changes will mean from a dollar perspective,” Ferrero advised (see box, below). If estimated overtime hours are significant, “it might make sense to hire another nonexempt employee, even with the added benefits costs.”

An FLSA Action Plan

The Fair Labor Standards Act (FLSA) final rule takes effect on Dec.1, 2016. Meg Ferrero, assistant general counsel at ADP, suggests employers take these steps to prepare for the deadline:

1) Take stock and review classifications. Any exempt employee who earns greater than the threshold amount ($47,476 under the new rules) may remain exempt from overtime pay if that person primarily performs executive, administrative or professional duties as described in the regulations. Also, keep in mind that each state may enact regulations that differ from federal regulations; employers will be subject to whichever set of directives is more generous to employees.

2) Closely manage and monitor employee hours. To better understand the amount of overtime that is currently being worked, monitor employee hours and use appropriate tools to help make educated scheduling decisions. One effective method is to implement an automated time and labor management system that continuously tracks hours worked, helps companies monitor when an employee nears the overtime threshold and makes it easier to create more cost-effective schedules.

3) Compare the costs of various pay options. Weigh the costs of raising employees' salaries to meet the exemption criteria against what it would cost to reclassify them as nonexempt and pay them overtime when they work more than 40 hours per week.

4) Consider the impact on internal pay equity. Beyond the costs of raising exempt employees' salaries, consider the impact on internal pay equity so that employees are paid fairly when compared with other employees within your organization. If you substantially increase some employees' pay, other employees may have questions about why their pay isn't increasing.

5) Proactively control costs. Develop alternative labor strategies that make it possible to shift expensive overtime hours to other workers who can be paid at a regular or lower rate. Monitor fluctuations and patterns in the volume of work, and align employee schedules accordingly, so that work can get done without creating overtime situations.

Stephen Miller, CEBS, is an online editor/manager for SHRM. Follow me on Twitter.

Related SHRM Articles:

Corporations Weigh Overtime Compliance Strategies, SHRM Online Compensation, June 2016

Thoughts on ‘Payroll by Exception’ and Weekly Time Sheets, SHRM Online Compensation, May 2016

Overtime Pay Changes Will Affect Employee Benefits, Too, SHRM Online Compensation, May 2016

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