Proposed Amendments to the FLSA: A Primer

The FLSA generally requires employers to pay their employees at least the federal minimum wage (currently $5.15 an hour), and overtime premium pay of time-and-a-half the regular rate of pay for all hours worked over 40 in a week. But the FLSA includes a number of exemptions from these requirements. The best known and most significant of these is for “any employee employed in a bona-fide executive, administrative, or professional capacity … or in the capacity of outside salesman,” exemptions included when the FLSA originally was enacted by Congress in 1938, and which commonly are dubbed the “white-collar” exemptions. Congress has never defined the terms “executive,” “administrative,” “professional,” or “outside salesman” as used in the FLSA, leaving that task to the DOL. The proposed revisions would alter the application of these exemptions in the following significant ways:

Salary Levels

The DOL has set a minimum salary level for an employee to be classified as exempt under one of the white-collar exemptions. The current minimum salary level is $155 per week. That level has not been adjusted since 1975, and obviously is low. Indeed, a non-exempt employee who works a 40-hour week must be paid a minimum of $206 for that week, a level well above the minimum salary level for an exempt employee. The DOL proposes to raise the minimum salary level to $425 per week, an annualized salary of $22,100. How many employees this would affect remains to be seen. Due to market pressures, many employers in many parts of the country already pay all their exempt employees a weekly salary already above $425 and therefore this would not be a significant change for most employers.

Salary Basis Test

A more significant change to the exempt status regulations are the DOL's revisions to the salary basis test. To qualify as an exempt executive, administrative, or professional employee, an employee must be paid on a “salary basis,” under which the employee must receive regularly a predetermined compensation amount (salary) on a weekly or less frequent basis, that “is not subject to reduction because of variations in the quality or quantity of the work performed.” With a few exceptions, therefore, an exempt employee must receive his or her full salary for any week in which he or she performs any work without regard to the number of days or hours worked. This requirement – and some of the highly technical exceptions to it – has resulted in substantial litigation, particularly throughout the 1990s, with sometimes disastrous results for employers.

The DOL proposes to make two changes to the salary basis test, both of which could provide employers some relief from potential salary basis lawsuits. The first revision would allow an exception to the so-called “no disciplinary docking” rule. Under the current test, an employer generally may not suspend an employer without pay for disciplinary reasons in any increment other than a full week without violating the salary basis test. The proposed revisions would allow an employer to suspend an exempt employee without pay in full-day (but not partial-day) increments, instead of merely in full-week increments. This will allow employers to hold exempt employees to the same standards of conduct as nonexempt employees without violating the salary basis test.

The second proposed revision greatly reduces the potential for “gotcha”-type salary basis litigation. Throughout the 1990s, employers faced claims by groups of employees alleging that they were rendered nonexempt (and thus owed overtime) because a few of the employees in that group suffered improper deductions, and thus all employees in that group who were subject to these improper deductions also become non-exempt. Where an improper deduction occurred, sometimes the employer's only defense was to utilize the “window of correction” under which an employer who inadvertently makes impermissible deductions can, in some circumstances, retain the exemption by reimbursing the employee for any improper deductions. But that window of correction has been the subject of several lawsuits, and some courts have interpreted it narrowly. The DOL's proposed regulation expands the window of correction by stating that an employer who makes improper deductions from salary loses the exemption only “if the facts demonstrate that the employer has a pattern and practice of not paying employees on a salary basis,” and that isolated or inadvertent deductions will not result in loss of the exemption. It specifically provides that where an employer has a written policy prohibiting improper pay deductions from exempt employees, notifies employees of that policy, and reimburses employees for any improper deductions, the employer does not violate the salary basis test unless it repeatedly and willfully violates such a policy. This proposed revision would remove the mystery from the salary basis test, and would not unduly penalize employers for innocent violations.

Duties Test

Perhaps the most significant body of proposed changes is to the “duties test.” Each white-collar exemption has its own duties test, most of which have been the source of confusion to employers, employees, DOL investigators, and courts. With the exception of the computer professional exemption — to which no material substantive changes are proposed — the DOL proposes to alter the duties test for each of the major white-collar exemptions.

As to all of the white-collar exemptions, the DOL proposes to eliminate the distinction between the “short test” and the “long test.” Under the current regulations, the executive, administrative, and professional exemptions contain two duties tests: a long test for employees who make less than $250 per week, and a shorter, more simplified test for those who make $250 or more per week. The short test has been the one under which nearly all exempt employees' classifications have been analyzed. The DOL proposes to create one standard test, for each white-collar exemption, so long as the employee is paid the minimum salary of $425 per week.

The highlights of the DOL's proposed duties test changes as to each white-collar exemption are as follows:

Executive employees. Under the current short test, an exempt executive employee must 1) have a primary duty of the management of the enterprise or a recognized department or subdivision; and 2) customarily and regularly direct the work of two or more other employees. Additional requirements exist under the long test, including the requirement that the employee have the authority to hire or fire other employees, or at least make effective recommendations as to the hiring and firing of other employees. The DOL's proposed rule would place all three of these requirements from the short and long tests into one standard test. Under the proposed revisions, greater emphasis is placed on disciplinary authority.

Administrative employees. Among the more significant aspects of the proposed regulations is the modification to the administrative exemption. The current short test provides that an employee is exempt if he or she 1) has a primary duty of performing office or non-manual work directly related to management policies or general business operations of the employer or the employer's customers; and 2) regularly exercises discretion and independent judgment. This exemption has been the most difficult to apply of all the white-collar exemptions, stemming mainly from questions about whether an employee exercises sufficient “discretion and independent judgment.” This exemption has generated significant confusion and litigation, most notably with respect to insurance adjusters. Indeed, a California court recently held that an insurance company owed in excess of $90 million to its current and former claims adjusters due to their misclassification under the administrative exemption.

Accordingly, the DOL proposes to eliminate the discretion and independent judgment requirement. It proposes to retain the requirement that an exempt administrative employee have a primary duty of office or non-manual work directly related to management policies or general business operations, and add the requirement that the employee hold a “position of responsibility.” A position of responsibility is defined as performing work 1) “of substantial importance;” or 2) “requiring a high level of skill or training.” This revision would help ensure that the administrative exemption is not denied to an employee merely because he or she uses a procedures manual or computer program to aid in his or her duties.

Learned Professional employees. The DOL proposes to revise the learned professional exemption in two ways. The current short test for that exemption provides that no overtime compensation need be paid to those who have 1) a primary duty of performing work requiring knowledge of an advance type in a field of science or learning customarily acquired by a prolonged course of specialized intellectual instruction and study; and 2) consistently exercise discretion and judgment. The main source of concern to employers from the current professional exemption test has been uncertainty about the treatment of some “knowledge workers” who are more prevalent in an information- and technology-based economy and who, on occasion, lack formal degrees of higher learning.

The proposed revision to the professional exemption would make clear that such employees are not necessarily excluded from the exemption. It explicitly states that advanced knowledge “may be acquired by alternative means such as an equivalent combination of intellectual instruction and work experience.” Consistent with the administrative exemption, the proposed revision also would eliminate the discretion and judgment requirement.

Highly compensated employees. The proposed regulations include a special rule for so-called highly compensated employees. Employees paid $65,000 or more annually and performing non-manual work would be exempt if they have one identifiable executive, administrative, or professional function as described in the standard duties tests. They would not have to meet all of the duties tests under either the executive, administrative, or professional exemptions. Rather, they would only have to meet one of the requirements set forth in one of those exemptions in order to be exempt provided they make at least $65,000 per year excluding commissions and non-discretionary bonuses. It also appears that such employees would need not be paid “on a salary basis.”

What These Revisions Will Not Do

No one should bank on the DOL's proposal as the agency could modify them substantially after the notice and comment period, or withdraw them altogether. Further, these revisions — if enacted — may well not have retroactive application.

Moreover, employers must not forget the impact of state wage-and-hour laws. States often have their own overtime laws, some of which diverge from the FLSA in significant respects, especially in the details of the white-collar exemptions. While some states' exemptions to their overtime laws provide that they change as the FLSA's overtime exemptions change, other states define the white-collar exemptions in their own ways. Merely because the federal regulations on the white-collar exemptions change does not necessarily mean that certain states' white-collar exemptions will change as well, or at the same time. Accordingly, employers should continue to determine their employees' exempt status under both federal and state laws.

The most substantial changes in more than 50 years to the way employers determine whether they are obligated to pay overtime compensation could well become reality. The United States Department of Labor (DOL) issued proposed revisions to its regulations on the “white-collar” exemptions to the Fair Labor Standards Act (FLSA) on March 31, 2003. If enacted in a version close to their present form, the way you do business could change considerably.

The DOL has invited interested parties and the general public to submit written comments on the proposals by June 30, 2003. The DOL then will evaluate those comments and perhaps modify the proposed revisions. It hopes to enact these revisions to the white-collar exemptions by the end of this year (and certainly before the beginning of the federal campaign season).

Background

The FLSA generally requires employers to pay their employees at least the federal minimum wage (currently $5.15 an hour), and overtime premium pay of time-and-a-half the regular rate of pay for all hours worked over 40 in a week. But the FLSA includes a number of exemptions from these requirements. The best known and most significant of these is for “any employee employed in a bona-fide executive, administrative, or professional capacity … or in the capacity of outside salesman,” exemptions included when the FLSA originally was enacted by Congress in 1938, and which commonly are dubbed the “white-collar” exemptions. Congress has never defined the terms “executive,” “administrative,” “professional,” or “outside salesman” as used in the FLSA, leaving that task to the DOL. The proposed revisions would alter the application of these exemptions in the following significant ways:

Salary Levels

The DOL has set a minimum salary level for an employee to be classified as exempt under one of the white-collar exemptions. The current minimum salary level is $155 per week. That level has not been adjusted since 1975, and obviously is low. Indeed, a non-exempt employee who works a 40-hour week must be paid a minimum of $206 for that week, a level well above the minimum salary level for an exempt employee. The DOL proposes to raise the minimum salary level to $425 per week, an annualized salary of $22,100. How many employees this would affect remains to be seen. Due to market pressures, many employers in many parts of the country already pay all their exempt employees a weekly salary already above $425 and therefore this would not be a significant change for most employers.

Salary Basis Test

A more significant change to the exempt status regulations are the DOL's revisions to the salary basis test. To qualify as an exempt executive, administrative, or professional employee, an employee must be paid on a “salary basis,” under which the employee must receive regularly a predetermined compensation amount (salary) on a weekly or less frequent basis, that “is not subject to reduction because of variations in the quality or quantity of the work performed.” With a few exceptions, therefore, an exempt employee must receive his or her full salary for any week in which he or she performs any work without regard to the number of days or hours worked. This requirement – and some of the highly technical exceptions to it – has resulted in substantial litigation, particularly throughout the 1990s, with sometimes disastrous results for employers.

The DOL proposes to make two changes to the salary basis test, both of which could provide employers some relief from potential salary basis lawsuits. The first revision would allow an exception to the so-called “no disciplinary docking” rule. Under the current test, an employer generally may not suspend an employer without pay for disciplinary reasons in any increment other than a full week without violating the salary basis test. The proposed revisions would allow an employer to suspend an exempt employee without pay in full-day (but not partial-day) increments, instead of merely in full-week increments. This will allow employers to hold exempt employees to the same standards of conduct as nonexempt employees without violating the salary basis test.

The second proposed revision greatly reduces the potential for “gotcha”-type salary basis litigation. Throughout the 1990s, employers faced claims by groups of employees alleging that they were rendered nonexempt (and thus owed overtime) because a few of the employees in that group suffered improper deductions, and thus all employees in that group who were subject to these improper deductions also become non-exempt. Where an improper deduction occurred, sometimes the employer's only defense was to utilize the “window of correction” under which an employer who inadvertently makes impermissible deductions can, in some circumstances, retain the exemption by reimbursing the employee for any improper deductions. But that window of correction has been the subject of several lawsuits, and some courts have interpreted it narrowly. The DOL's proposed regulation expands the window of correction by stating that an employer who makes improper deductions from salary loses the exemption only “if the facts demonstrate that the employer has a pattern and practice of not paying employees on a salary basis,” and that isolated or inadvertent deductions will not result in loss of the exemption. It specifically provides that where an employer has a written policy prohibiting improper pay deductions from exempt employees, notifies employees of that policy, and reimburses employees for any improper deductions, the employer does not violate the salary basis test unless it repeatedly and willfully violates such a policy. This proposed revision would remove the mystery from the salary basis test, and would not unduly penalize employers for innocent violations.

Duties Test

Perhaps the most significant body of proposed changes is to the “duties test.” Each white-collar exemption has its own duties test, most of which have been the source of confusion to employers, employees, DOL investigators, and courts. With the exception of the computer professional exemption — to which no material substantive changes are proposed — the DOL proposes to alter the duties test for each of the major white-collar exemptions.

As to all of the white-collar exemptions, the DOL proposes to eliminate the distinction between the “short test” and the “long test.” Under the current regulations, the executive, administrative, and professional exemptions contain two duties tests: a long test for employees who make less than $250 per week, and a shorter, more simplified test for those who make $250 or more per week. The short test has been the one under which nearly all exempt employees' classifications have been analyzed. The DOL proposes to create one standard test, for each white-collar exemption, so long as the employee is paid the minimum salary of $425 per week.

The highlights of the DOL's proposed duties test changes as to each white-collar exemption are as follows:

Executive employees. Under the current short test, an exempt executive employee must 1) have a primary duty of the management of the enterprise or a recognized department or subdivision; and 2) customarily and regularly direct the work of two or more other employees. Additional requirements exist under the long test, including the requirement that the employee have the authority to hire or fire other employees, or at least make effective recommendations as to the hiring and firing of other employees. The DOL's proposed rule would place all three of these requirements from the short and long tests into one standard test. Under the proposed revisions, greater emphasis is placed on disciplinary authority.

Administrative employees. Among the more significant aspects of the proposed regulations is the modification to the administrative exemption. The current short test provides that an employee is exempt if he or she 1) has a primary duty of performing office or non-manual work directly related to management policies or general business operations of the employer or the employer's customers; and 2) regularly exercises discretion and independent judgment. This exemption has been the most difficult to apply of all the white-collar exemptions, stemming mainly from questions about whether an employee exercises sufficient “discretion and independent judgment.” This exemption has generated significant confusion and litigation, most notably with respect to insurance adjusters. Indeed, a California court recently held that an insurance company owed in excess of $90 million to its current and former claims adjusters due to their misclassification under the administrative exemption.

Accordingly, the DOL proposes to eliminate the discretion and independent judgment requirement. It proposes to retain the requirement that an exempt administrative employee have a primary duty of office or non-manual work directly related to management policies or general business operations, and add the requirement that the employee hold a “position of responsibility.” A position of responsibility is defined as performing work 1) “of substantial importance;” or 2) “requiring a high level of skill or training.” This revision would help ensure that the administrative exemption is not denied to an employee merely because he or she uses a procedures manual or computer program to aid in his or her duties.

Learned Professional employees. The DOL proposes to revise the learned professional exemption in two ways. The current short test for that exemption provides that no overtime compensation need be paid to those who have 1) a primary duty of performing work requiring knowledge of an advance type in a field of science or learning customarily acquired by a prolonged course of specialized intellectual instruction and study; and 2) consistently exercise discretion and judgment. The main source of concern to employers from the current professional exemption test has been uncertainty about the treatment of some “knowledge workers” who are more prevalent in an information- and technology-based economy and who, on occasion, lack formal degrees of higher learning.

The proposed revision to the professional exemption would make clear that such employees are not necessarily excluded from the exemption. It explicitly states that advanced knowledge “may be acquired by alternative means such as an equivalent combination of intellectual instruction and work experience.” Consistent with the administrative exemption, the proposed revision also would eliminate the discretion and judgment requirement.

Highly compensated employees. The proposed regulations include a special rule for so-called highly compensated employees. Employees paid $65,000 or more annually and performing non-manual work would be exempt if they have one identifiable executive, administrative, or professional function as described in the standard duties tests. They would not have to meet all of the duties tests under either the executive, administrative, or professional exemptions. Rather, they would only have to meet one of the requirements set forth in one of those exemptions in order to be exempt provided they make at least $65,000 per year excluding commissions and non-discretionary bonuses. It also appears that such employees would need not be paid “on a salary basis.”

What These Revisions Will Not Do

No one should bank on the DOL's proposal as the agency could modify them substantially after the notice and comment period, or withdraw them altogether. Further, these revisions — if enacted — may well not have retroactive application.

Moreover, employers must not forget the impact of state wage-and-hour laws. States often have their own overtime laws, some of which diverge from the FLSA in significant respects, especially in the details of the white-collar exemptions. While some states' exemptions to their overtime laws provide that they change as the FLSA's overtime exemptions change, other states define the white-collar exemptions in their own ways. Merely because the federal regulations on the white-collar exemptions change does not necessarily mean that certain states' white-collar exemptions will change as well, or at the same time. Accordingly, employers should continue to determine their employees' exempt status under both federal and state laws.