What overtime standards mean for California

On May 18, the U.S. Department of Labor announced its final rule expanding federal overtime pay protections. The new rule raises the minimum salary requirement to qualify for the white collar exemptions under the Fair Labor Standards Act. While a notice of proposed rulemaking was published in June 2015, the final rule, set to take effect Dec. 1, 2016, differs in a number of ways from the initial proposed regulations.

The Fair Labor Standards Act provides for overtime pay to non-exempt employees at a rate of at least 150 percent of the employee's regular rate for hours worked over 40 in a workweek. Certain employees are exempt from these protections if they meet both a salary test and a duty test under the EAP exemptions. Current DOL regulations set the salary threshold for the white collar overtime pay exemptions at $455 per week and there is no automatic updating of this value. The new rule raises the salary basis for the executive, administrative and professional (EAP) exemptions to a rate per week of at least the 40th percentile of weekly earnings of full-time nonhourly workers in the lowest-wage census region (as published by the Bureau of Labor Statistics. This rate will be $913 per week starting in December (equating to a monthly salary of $3,956 and a yearly salary of $47,476), and the amount will be adjusted every three years starting on Jan. 1, 2020, using BLS data from the second quarter of the year preceding the update.

Similarly, the salary test for highly compensated employees (HCEs) will be raised to $134,004 from $100,000. This rate also will be adjusted beginning in January 2020, and every three years following, to equal the annualized earnings amount of the 90th percentile of full-time nonhourly workers nationally.

What it Means for California Employers

Many California employers likely have not paid much attention to the federal salary basis test over the years, given that historically the equivalent California test has been much higher - currently, the California salary basis minimum is $800 per week (equating to approximately $41,600 per year), almost twice that of the current federal minimum. That will change under the new rule, however. Accordingly, California employer will need to make the same hard choices as employers in other states - having to choose between increasing compensation, stripping employees of desirable exempt status (thereby affecting morale), re-arranging work schedules, etc.

The rule also introduces a new concept to the FLSA salary-basis test. For the first time, employers will be able to satisfy a maximum of 10 percent of the salary basis test through "the payment of nondiscretionary bonuses, incentives, and commissions, that are paid quarterly or more frequently." In other words, an employer may pay an EAP employee a salary of up to 10 percent less than that required by the test, so long as these other payments make up the balance. In addition, if in each quarter the employee is not receiving sufficient payments to make up the balance (perhaps sales are less than forecast, impacting commissions), then the employer can make a catch-up payment no later than the first pay period of the next quarter. This is different than the catch-up payment under the highly compensated employee (HCE) exemption (the latter can account for a broader percentage of compensation, is not limited to non-discretionary payments, and can be made annually). However, just as there is no HCE exemption under California law, there is also no ability to make non-discretionary bonus or commission payments as part of the salary basis under California law. Currently, a California employer could make use of this FLSA principle without creating an issue under California law since reducing the new FLSA minimum salary by 10 percent still results in a salary above the California minimum ($821.70 per week versus $800 per week). This may not be true for long, however, as California continues to aggressively raise its minimum wage per hour for non-exempt employees, which flows through to the minimum salary for EAP employees under California law.

Other Issues

Although the last year's notice of proposed rulemaking solicited questions about possible changes to the duties test, the new rule leaves the duties test untouched. Based on the significant discussion in the analysis accompanying the new rule, it appears that the DOL believed that increasing the salary basis test would undo changes made to the regulations by the Bush administration in 2004, which the current DOL believes "paired a duties test closely based on the less-stringent short duties test with a salary level derived from the lower long test salary level." By increasing the salary basis test, the DOL paired a higher salary test with the "less stringent" duties test, thereby normalizing the overall test without changing the duties test. It is also clear from the DOL's analysis that it takes the position that by increasing the salary basis test, it actually makes it more likely than an employee will pass the duties test. In other words, the "premise behind the standard salary level test and the HCE total annual compensation requirement is that employers are more likely to pay higher salaries to workers in bona fide EAP jobs."

Accordingly, a "high salary is considered a measure of an employer's good faith in classifying an employee as exempt, because an employer is less likely to have misclassified a worker as exempt if he or she is paid a high wage." Nonetheless, employers should realize that there is no official language in the FLSA or the new rule permitting a relaxed test based on higher compensation.

The Upshot

By the DOL's own estimates, the increased salary basis test will result in depriving 4.2 million employees of exempt status. It also introduces the new concept of allowing certain non-discretionary income to count towards the salary basis test - a concept that does not exist under California law and introduces another nuance to the already complicated interplay between state and federal law. Lastly, it will force employers to choose one of several unpalatable options to comply - such as dramatically increasing compensation, changing the spread of work among employees, stripping employees of their desired exempt status, and others.

Adam P. KohSweeney is a Labor and Employment partner based in O'Melveny & Myers LLP's San Francisco office. The opinions expressed in this article do not necessarily reflect the views of O'Melveny or its clients, and should not be relied upon as legal advice.