Anyone who's been paying attention to state and federal politics this 2016 election cycle knows that wage and hour laws have been a big topic in the news. Much of this focus has been on raising the minimum wage at both federal and state levels, and there's been a lot of discussion over clarifying the classification between employees and independent contractors. But one topic that has flown somewhat under the radar has been one that can affect employee paychecks and employer bottom lines in significant ways: overtime rules.
While the discussion of the laws affecting overtime often takes a backseat to talk of the minimum wage (potentially due to the fact that overtime is a far more complicated conversation that can't be boiled down to a single number), employers across the country need to take notice of a new overtime policy announced just this week by the Obama administration that will affect the pay of millions of employees.
Under new regulations promulgated by the Department of Labor, employers must pay overtime pay (at least time-and-a-half a worker's regular pay for hours worked over 40 hours) to most employees who make up to $47,476 a year, a new threshold that is more than twice as high as the previous threshold of $23,660. In addition, the threshold for "highly compensated employees" – meaning those workers who will generally be exempt from earning overtime unless they do not pass a minimal skills test – will be raised from $100,000 to $134,004. Both numbers will be adjusted for inflation every three years.
Approximately 4.2 million workers will be affected by the rule. Below, we'll get into the how these rules came about, who they will affect, and where we might go from here.
Wait, How Is This Legal?
President Obama has had a tough time working together with Congress on just about anything, and his attempts to raise federal minimum wage from $7.25, as outlined in his 2015 State of the Union speech, have gone nowhere. Which might lead you to ask how the Obama administration was able to change the overtime laws if it can't unilaterally raise the minimum wage.
Although the administration has come under fire for its use of executive orders in areas such as immigration and gun control, and David French of the National Retail Federation referred to the overtime change as an "executive fiat," the specific applicability of what employees are subject to the overtime laws has long been a matter under executive control, promulgated through the administrative authority of the Department of Labor.
The Wages and the Fair Labor Standards Act (FLSA), passed by Congress and signed into law in 1938, mandates that all employers engaged in interstate commerce must limit employees to a 40-hour work week, "unless such employee receives compensation for his employment in excess of the hours above specified at a rate not less than one and one-half times the regular rate at which he is employed." (Fun fact: the FLSA's original author, future Supreme Court Justice Hugo Black wanted to limit employees to a 30-hour work week, but was rebuffed by opponents.) Under the FLSA, however, Congress delegates the power to determine what employees are subject to that rule to the Department of Labor.
Thus, no Congressional approval is required to change the regulations issued by the Department of Labor, and the department is, in essence, making more employees subject to Congress' law. Congress, of course, has the power to attempt to strip the department of this power by amending the FLSA, but such an action would be unlikely to be ratified under the current administration.
Explaining the "Old Rules"
With that history lesson out of the way, the question then becomes who exactly is affected by this change in law. Which might be better explained by discussing the previous rules first.
Under the old rules, most employees making under $23,660 a year (or roughly $11.83/hour based on a 40-hours a week, 50-week work year) were required to be paid overtime. Those making an annual salary of between $23,660 and $100,000 were required to be paid overtime unless they fell into one of a number of exemptions listed by the Department of Labor. The most common exemption was the so-called "EAP" exemption, referring to those workers whose primary duties consisted of executive, administrative, or professional duties (more on what those mean below). Workers making $100,000 or over a year were considered "highly compensated employees" and these employees were exempt so long as they passed a much more broad test of performing at least one executive, administrative or professional duties in their work.
The EAP distinctions can get tricky, and have thus been the subject of numerous employment litigation matters over the years. The Department of Labor regulations provide the following guidance on what workers are considered as exempt based on their duties
- Executive Employees: Workers who have managerial authority and the power to influence hiring and firing decisions.
- Administrative Employees: Workers whose primary duties are office or non-manual tasks involving discretion and independent judgment with respect to significant matters.
- Professional Employees: "Learned" or "creative" professionals requiring advanced knowledge in an intellectual field or performance in an artistic or creative endeavor.
The regulations also indicate that Computer Professionals (employees working as computer systems analysts, computer programmers, software engineers or other similarly skilled workers, and Outside Salespersons (employees whose primary duty is making sales outside of the office) are also exempt.
Where things get even more complicated is that some employees are considered exempt from the overtime rules under both the old and the new rules, regardless of their salary. These include the following employees:
- Certified Teachers
- Outside Salespersons
- Licensed Doctors
- Licensed Attorneys
So Who Is Affected by the New Rules?
By raising the salary threshold for the EAP exemption, workers who were previously ineligible based on the EAP exemption and salary threshold of $23,600 will be newly eligible for overtime if they make up to $47,476 a year, even if they are an employee with a primary executive, administrative, or professional duty or were a computer professional (but not if they are a certified or licensed doctor, lawyer, teacher, or outside salesperson).
Furthermore, by raising the highly compensated employee threshold up to $134,004, workers who may have one EAP duty, but do not have a primary EAP duty are eligible for overtime, so long as they do not make over that amount (again, the previous threshold was $100,000).
The Department of Labor will raise the threshold for both the EAP exemption and the highly compensated threshold every three years to match the 40th and 90th percentile of average annual rates, respectively.
What About Independent Contractors?
As for independent contractors, such workers are not considered employees under the law and therefore are not subject to the overtime rules. In recent years, however, the question of who is an employee and who is an independent contractor has become the subject of some high-profile class action matters, including a series of cases against Uber, the technology company that works with hundreds of thousands of drivers across the country. Simply calling workers independent contractors does not make them so in the eyes of the law, and if a court determines that a worker is properly classified an employee (based on factors such as controlling the manner in which the worker completes the work, and having an indefinite, continuous working relationship with the worker), then that worker may later be able to bring a lawsuit for unpaid overtime. In two recent class actions against Uber on behalf of drivers in Massachusetts and California pursuing unpaid overtime wages and damages for other alleged violations, the company settled the matters out of court for $100 million in exchange for, among other things, the agreement that drivers would continue to be classified as independent contractors, not employees.
Employer Options Under the New Law
Putting this into practice, if an employee whose primary duties are executive, administrative, or professional makes a $40,000 a year salary, but regularly works 50 hours a week, then the $40,000 would be apportioned to the first 40 hours of work, and the employee would have to be paid time-and-half for the extra 10 hours each week. Based on a 50-week work year, the employee's per-hour wage would be around $20, meaning the employee should get $30 (1.5 x $20) for each of the 10 hours over 40 hours. That's $300 extra a week, which, over the course of 50 weeks, is an extra $15,000, giving the worker an annual gross income of $55,000.
What this means is that the employer would be better off taking one of the following three options:
- Raising the Employee's Wage Above the Threshold: By simply raising the employee's annual salary to $47,500, then the employee would not be subject to overtime, and the company would save the $7,500 difference between that and the overtime-inflated $55,000 figure.
- Lowering the Employee's Wage to Account for the Difference: I won't go through the math here, but if the employee received a new base annual salary of around $29,000, and worked 50 hours a week for 50 weeks, that employee's salary would even out back up to $40,000 a year. Obviously instituting an $11,000 pay cut would not be popular, but employers will certainly consider this when setting salaries for new workers, at the very least.
- Hiring an Extra Worker to Pick Up the Slack: If the employer reduces the $40,000 a year worker down from 50 hours a week to 40 hours a week, the employer could hire another part-time worker at the same $20/hour rate to cover the other 10 hours a week. In total, this would come out to $50,000 a year, still lower than the $55,000 a year number if the employer takes no action in response to the new overtime rules.
These numbers are, of course, rough and do not take into account issues such as benefits, tax rates, and bonuses, but they get the general point across. Employers of previously exempt employees below the new threshold who work over 40 hours a week may either need to pay more in overtime, hire new workers, increase productivity within a workers' 40 hour week, or lower base salaries.
Will California Go Even Higher?
As discussed on our podcast last summer when the Obama administration first proposed the new overtime rules, the higher overtime threshold puts the state of California in the unusual situation of being behind the federal curve with regard to worker pay.
With regard to the minimum wage, California's current minimum wage is already at $10.00/hour, or 38% above the federal $7.25 figure, and is set to go up to $15.00/hour by 2022, more than double the federal standard. Prior to the new federal overtime hike, California also had a higher threshold, requiring non-exempt workers making under $41,600 to be paid overtime wages. Now, however, California – generally the national leader in pro-worker legislation – is below the new federal standard of $47,476. Based on constitutional principles of federal supremacy, the federal threshold will apply in California, superseding the state threshold.
But this raises this question – will California respond to the new rules by going even higher with its overtime threshold? Gov. Brown's administration has not announced any such plans, but given the state's history, don't be surprised if we see an even higher threshold in California. In the meantime, based on the new federal rules, around 146,000 new workers in California may be eligible for overtime pay.