Prepare for FLSA’s New Salary Thresholds for Highly Compensated Employees

A recent final rule that will significantly increase the Fair Labor Standards Act’s (FLSA’s) annual salary thresholds for the highly compensated employee (HCE) exemption from overtime pay is causing a dilemma for many employers.

Under the new rule, the total annual compensation requirement for HCEs will increase from $107,432 per year to $132,964 per year on July 1 and will rise to $151,164 per year on Jan. 1, 2025. Earnings thresholds will be updated every three years starting July 1, 2027.

This “substantial increase … is expected to affect nearly 300,000 currently highly compensated employees dependent on the relaxed job duties test,” according to Natalie Bare, an attorney with Duane Morris in Philadelphia. The increase presents employers with a tough decision to make if they have HCEs who are dependent on the relaxed job duties test for this exemption and who earn more annually than the current threshold of $107,432 but less than the new threshold of $151,164, she said.

Overview of HCEs Under ‘White-Collar’ Exemptions

To be exempt from overtime under the FLSA’s “white-collar” executive, administrative, and professional (EAP) exemptions, employees must be paid a salary of at least the threshold amount—which will rise to $43,888 as of July 1 and then to $58,656 effective Jan. 1, 2025—and meet certain duties tests. If they are paid less or do not meet the duties tests, they must be paid 1.5 times their regular hourly rate for hours worked past 40 in a workweek.

When the white-collar exemption regulations underwent a major overhaul in 2004, the Department of Labor (DOL) took the opportunity to add the HCE exemption. Under this exemption, employees performing office or nonmanual work who meet the annual salary threshold for HCEs and who are paid on a salary basis are exempt from the FLSA if they customarily and regularly perform at least one of the duties of an exempt executive or administrative employee.

In the preamble to the 2004 rules, the DOL referred to the highly compensated worker rule as a “short-cut test” for employees who are likely to meet other EAP duties tests. “The test for highly compensated employees is intended to provide an alternative, simplified method of testing a select group of employees for exemption,” the department said.

Who Is an HCE?

A common example of an HCE is a managerial employee who customarily and regularly directs the work of at least two or more other full-time employees but does not have the authority to hire or fire other employees, so they can’t meet the full job duties test for the executive exemption, Bare explained.

“This may be the case for some first- or second-line managers and supervisors who are earning enough to meet the annual salary threshold for highly compensated employees,” Bare said.

She added that another common example is an administrative employee, perhaps a quality control professional, whose primary duty is the performance of office or nonmanual work related to the management or general business operations of the employer, but who doesn’t exercise sufficient discretion and independent judgment with respect to matters of significance because they must rely significantly on well-established procedures within closely prescribed limits.

Other examples of employees who might qualify for the relaxed HCE duties test include paralegals, accounting staff, junior engineers, and even highly paid executive assistants. These types of employees could be exempt under the HCE exemption, even though their primary duties standing alone may not always qualify for a standard EAP exemption.

Criteria for Classification as an HCE

An employee must meet several criteria before being classified as an HCE.

First, the employee must be paid a total annual compensation of at least $132,964 as of July 1, which includes at least $844 per week on a salary basis. Effective Jan. 1, 2025, the total compensation threshold will increase to $151,164, which includes at least $1,128 per week paid on a salary basis.

The weekly salary amount of $844, or $1,128 as of Jan. 1, 2025, must be paid in its entirety. Employers may not use nondiscretionary bonuses and incentive payments—including commissions—to satisfy any portion of the weekly standard salary level for HCEs.

The required total annual compensation may consist of commissions, nondiscretionary bonuses, and other nondiscretionary compensation earned during a 52-week period. However, the total compensation does not include credit for board or lodging, payments for medical or life insurance, or contributions to retirement plans or other fringe benefits.

There are special rules for prorating the annual compensation if employees work only part of the year. These allow payment of a single lump-sum, make-up amount to satisfy the required annual amount at the end of the year as well as similar make-up payments to employees whose employment terminates before the year ends.

Second, the employee’s primary duty must include performing office work and/or nonmanual work. In other words, the work must be of the “white-collar” variety as opposed to “blue-collar” manual labor.

Finally, the employee must “customarily and regularly” perform at least one of the exempt duties or responsibilities of an executive, administrative, or professional employee. For example, they must regularly direct the work of two or more employees, have the authority to hire or fire, perform office work directly related to the management operations of the employer, perform work requiring the exercise of discretion and independent judgment regarding matters of significance, perform work requiring advanced knowledge that is predominantly intellectual in character, or perform work requiring originality or talent in an artistic or creative field. The new rule made no changes to the duties tests for HCEs.

The exempt duty doesn’t need to be the HCE’s primary duty, but it must be done regularly, not just occasionally. The exempt duty must be “normally and recurrently performed every workweek, but does not include isolated or one-time tasks,” a DOL fact sheet specifies.

Challenges in Addressing New Thresholds

Several approaches that employers may consider in addressing the new thresholds are reclassifying an HCE as nonexempt, increasing an HCE’s compensation to maintain their HCE status, or adjusting an HCE’s job responsibilities to meet the full duties test under an EAP exemption. Each of these options presents its own challenges.

“Employers considering reclassification of highly compensated employees need to be mindful that this group in particular has likely grown accustomed to being paid a salary and the flexibility that comes along with exempt status,” Bare said, cautioning that reclassifying HCEs is likely to cause feelings of disappointment around the transition to being paid hourly and having to track time worked.

“As an alternative, employers can consider whether changes to an HCE’s job responsibilities would enable them to meet the full job duties test of the applicable EAP exemption, if it makes sense based on the company’s operational needs,” she said.

Employers may also consider their options for restructuring job roles to transition some of their HCEs to roles where they would be consistently performing work that would meet the full job duties test for their particular exemption, Bare added.

Although the employees’ actual job duties, not their written job descriptions, determine their exempt status, she urged employers who choose to tweak their HCEs’ job responsibilities or restrict their workforce in any way in response to the final rule to “update their written job descriptions to reflect the updates and provide any training or education necessary to ensure a smooth implementation phase,” she said.

Employers who decide to reclassify HCEs as nonexempt have the option to continue paying their salaries but must ensure the proper calculation of these employees’ regular rates of pay for overtime purposes.

“Not paying overtime properly to salaried, nonexempt employees is a common mistake that results in litigation and overtime liability,” Bare cautioned.

Suggested Employer Steps to Prepare for Increase

Bare suggested that employers preparing for the upcoming increases take the following steps:

• Determine the affected positions for both the initial increase effective July 1 and the second increase effective Jan. 1, 2025.
• Evaluate options and the potential impact of each option: If employers raise the salaries of affected employees to meet the new salary thresholds required for exempt status—assuming the job duties test is met—they should consider both the direct and indirect costs, including the cost of future increases and the pressure to raise salaries for other employees higher up on the organizational chart. If employers reclassify employees as nonexempt and pay overtime, they may consider controlling costs by limiting the hours of nonexempt employees consistent with operational needs or reducing hourly rates in light of expected future overtime earnings.
• Make decisions regarding reclassification, compensation, and timing of the increases, especially in light of the DOL’s two-phased approach.
• Develop a strategy to implement the changes, which should include templated communications to employees on the pay change or reclassifications, guidance to managers on handling questions, and updates to current written policies, job descriptions, and other documents.

Finally, Bare emphasized that employers should keep in mind that salary level is only one aspect of the test for determining whether an employee is properly classified as exempt. As the U.S. Supreme Court recently held in Helix Energy Solutions Group Inc. v. Hewitt, the salary basis test also applies to HCEs. Employers should ensure that those employees meet the requirements of the salary basis test, which can be nuanced depending on the pay structure.

Bare said that because “the final rule may require employers to reconsider the exempt status of certain employees, employers may wish to take the opportunity to look at their exempt workforce holistically and confirm the strength of their exempt classifications, including whether employees affected by the final rule still meet the job duties test for their applicable exemption under both the FLSA and state law.”

Rosemarie Lally, J.D., is a freelance legal writer based in Washington, D.C.