New Rules for "Exempt" Employees

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More employees may soon qualify for overtime. In newly proposed rules under the Fair Labor Standards Act (FLSA), the Obama Administration aims to substantially increase the minimum salary requirements for qualification as an “exempt” employee.  The new limits should concern both nonprofit and for-profit employers alike, as the current salary threshold is $23,660 and the proposed rules more than double this amount.  Under the proposed rules, an employee must earn at least $50,440 per year to qualify as “exempt” and therefore not be subject to otherwise mandatory overtime requirements.  Exclusions may apply for certain nonprofit activity, but all employers need to understand the proposed rules’ implications and remain attentive to further developments. 

Background:  FLSA Employee Classification – Exempt Versus Non-Exempt

The proper classification of employees for FLSA purposes is an ongoing consideration for many nonprofits.  The FLSA imposes significant requirements for non-exempt employees, including minimum hourly wage requirements, “time-and-a-half” overtime pay obligations for more than 40 hours worked per week, and recordkeeping requirements to comply with the foregoing.  An employer’s misclassification of its employees as exempt can result in serious liability under the FLSA when an employer fails to properly pay overtime wages and related penalties.  Under the Department of Labor’s (DOL) longstanding rules, the test for determining whether an employee is exempt is three-fold. 

First, an exempt employee must perform a specific type of work.  Exempt employees include only executives, administrators, professionals, and certain computer or outside sales employees.  However, title alone does not classify the worker as exempt; the DOL maintains guidelines for exempt classification under each of these types of work.  While factors differ for each, the guidelines generally focus on the employee’s primary duty.

Second, an exempt employee must be salaried.  Workers paid by the hour are generally treated as non-exempt.  An exception occurs only if an employee is highly compensated – that is, receiving compensation of over $100,000 per year when considering certain bonuses and other compensation, with at least $455 per week of this compensation being salary or fees.  In that case, the type of work and salary requirements do not apply.

Third, and at stake in the new proposed rules, is a requirement regarding the amount of the salary.  Currently, an exempt employee must be paid at least $455 per week ($23,660 per year).  This amount has not been updated since 2004.  Notably, the current rules do not provide for inflation or other automatic annual adjustment.

Some categorical exclusions may apply.  For example, as explained more fully below, certain employers with annual gross “business” revenues of less than $500,000 may be excluded from FLSA coverage.  In addition, some local churches and similar religious institutions have argued that the FLSA does not apply to them because they do not engage in interstate commerce (a legal prerequisite for FLSA applicability).  However, serious problems exist with this argument because they usually conduct interstate business activities through the internet and other avenues.

New Rules Proposed for Salary Element

The DOL released its newly proposed rules on July 6, 2015.  The rules increase the annual compensation requirement to the 40th percentile of average earnings for full-time, salaried workers.  For 2016, this amount is $970 per week ($50,440 per year).  For a full-time employee working an average of 40 hours per week, this translates to approximately $24 per hour.  The compensation required for an individual to be considered a “highly compensated employee” – and therefore exempt regardless of type of work – also increases under the proposed rules.  Additionally, the proposed rules would automatically update the foregoing amounts by linking them either to earnings percentiles or to changes in inflation.

As with the current rules, the proposed rules do not include any geographic modifier to account for differences in cost of living and average salaries from region to region or from urban communities to rural communities.  Nor do they include any adjustments based on differing career fields (e.g., an office manager, an executive director, and a restaurant manager must all earn salaries at or above the threshold before being treated as exempt under the FLSA).  The increase in the compensation amount to approximately double the current amount would be immediate upon the effective date, with no gradual increase over time to allow organizations to adjust their practices.  The lack of distinctions and the abrupt shift make the proposed rules highly problematic. 

Applicability of Proposed Rules on Nonprofits

As stated above, nonprofits should note that the new rules are only proposals at this point.  The DOL is currently accepting public comments on the proposed rules at (Rule Identification Number 1235-AA11) until September 4, 2015.  Some legislators and others have called for an extension that would change the deadline to November 3, 2015, arguing that the proposed rules may significantly affect businesses and that organizations will need time to thoroughly review the proposed rules.  As of August 5, 2015, over 1,200 public comments had been filed, including about 105 that specifically referenced nonprofits (approximately 80 of which were letters from local divisions of the YMCA seeking the two-month extension).

Second, while there is no explicit exemption for nonprofits, the FAQs from the DOL (available online) indicate that many nonprofits are not covered by the FLSA because it only applies to organizations with more than $500,000 in annual business revenues.  The DOL has indicated that only business activities over $500,000 determine coverage:  “In determining coverage, only activities performed for a business purpose are considered and not charitable, religious, educational, or similar activities of organizations operated on a non-profit basis where such activities are not in substantial competition with other businesses.”  It is possible that many nonprofits will not be subject to the new FLSA salary requirements since they do not engage in substantial “business” activities. 

While the DOL response is encouraging to a certain extent, it may prove challenging in application.  Nonprofits will need to consider not just their overall annual revenues but also each activity that brought in those revenues. For example, a nonprofit religious radio station will need to assess whether each of its revenue-making activities is or is not in substantial competition with for-profit radio stations.  Many nonprofits engage in activities that may in fact “compete” with businesses offering similar services, such as child care, tutoring programs, sports activities, fine arts, and a plethora of other activities, so they may in fact be covered by the FLSA’s new rules.  Nonprofit supporting organizations that turn over all revenues (e.g., charitable thrift stores) to a specific supported charity may also have trouble determining the applicability of the new rules.  Notably, hospitals, schools, and residential programs for the care of the sick, elderly, or mentally ill are covered by the FLSA, no matter their total revenue or its sources.  In practical terms, the DOL’s guidance regarding business activities is of limited value to these types of organizations.

Recommendations for Nonprofit Leaders

If approved, the new proposed rules could become effective late this year or in early 2016.  Some have asked for an extension of the public comment period, so the timeframe for implementation could be delayed further.  However, with no phase-in time to adjust practices, nonprofits should be prepared to act quickly if the proposed rules are finalized as proposed.  Here are some key considerations for what lies ahead.  

First, nonprofit management may wish to adopt new time-keeping methods, such as tracking all workers’ hours.  Thorough time-keeping may contribute not only to legal compliance (in case persons understood to be exempt are later determined to be non-exempt), but also to improved accountability and project management. 

Second, be attentive to written job descriptions.  Documentation is important for the “type of work” first element of FLSA applicability.  And it likewise may well contribute to employee accountability and other workplace improvements.

Third, salaries may need to be increased in order to keep employees exempt.  Alternatively, additional staffing may be warranted for positions that normally require more than 40 hours for one employee and are paid at levels lower than the newly proposed salary threshold.  Still another alternative is for nonprofit leaders to take a hard look at their overall staffing and related financial needs.  E.g., in what areas can work be made more efficient?   Should certain (or all) employees be encouraged to work no more than 40 hours per week?  If not, what due diligence is warranted for compensation evaluation in connection with potential salary increases?  Where can the funding be obtained for increases? 

Fourth, “volunteering” for overtime is not an option.  As a legal matter, extra time that employees spend on the job for the same type of work as they regularly perform cannot be treated as volunteer service; wages must be paid.  While nonprofit workforces often have highly dedicated and skilled nonprofit workers who work long hours, these hours may result in overtime wage obligations.

Fifth, ignoring these new rules (and accompanying state counterparts for violation of non-exempt employees’ wage rights) is not an option, either.  Employees whose rights are violated may generate massive organizational liability, especially if a now-positive employment relationship later sours. Penalties are extremely high for violations, including possible personal liability for directors and officers. 

Sixth and last, nonprofit leaders should consider filing a public comment, using the link, and explaining the detrimental effect on their organizations.  The process is quick and simple.  Now is the time to speak up!