In May, the Department of Labor (“DOL”) announced its final rule to increase the minimum salary for white collar exemptions. With little more than two months to go before that new rule takes effect on December 1, 2016, employers still have time to decide how to address those otherwise exempt employees whose current salaries would not satisfy the new rule by either increasing their salaries or converting them to non-exempt status.

But some of those decisions may not be easy ones.  And they may create some unexpected challenges, both financially and operationally.

New Salary Thresholds

Effective December 1, 2016, the salary threshold for the executive, administrative, and professional exemption will effectively double, increasing from $23,660 ($455 per week) to $47,476 ($913 per week).

The total annual compensation requirement for “highly compensated employees” subject to a minimal duties test will also increase from $100,000 to $134,004. The salary basis test will be amended to allow employers to use non-discretionary bonuses and incentive payments, such as commissions, to satisfy up to 10 percent of the salary threshold.  And the salary threshold for the white collar exemptions will automatically update every three years to “ensure that they continue to provide useful and effective tests for exemption.”

Impact Upon Compensation Structures

For otherwise exempt employees whose compensation already satisfy the new minimum salaries, nothing need be done to comply with the new DOL rule.  But that does not mean that those employees will not be affected by the new rule.

If employers are raising the salaries of other employees to comply with the new thresholds, it could create operational or morale issues for those whose salaries are not being adjusted.

Take, for instance, an otherwise exempt senior manager who currently earns $48,000 per year.  Her salary need not be adjusted to comply with the new rule.

But if she is higher in the  organizational hierarchy than a manager who currently earns $36,000 per year, and if that lower-level manager is given a salary increase to meet the new $47,476 threshold, it is not difficult to see how there could be an issue with the senior manager.  The senior manager would now earn only a little more each year than the manager who falls beneath her in the hierarchy.

If the employer then adjusts her salary – and everyone else’s – to maintain its compensation structure, the impact of increasing the salary of a single manager to comply with the new rule will not be just the amount of the increase in his salary to meet the new threshold; it will be the increases in all of the salaries that it triggers.

That is but one example.  It is not difficult to conceive of situations where complying with the rule by only addressing the compensation of those who fall below the threshold would result in a lower level employee leapfrogging over a higher level employee in terms of compensation, or where it results in unwanted salary compression.

And that is to say nothing of the impact that salary shifts could have upon any analysis of whether the new compensation structure adversely affects individuals in protected categories.  In the example above, the female senior manager who is now being paid only several hundred dollars per year more than the lower-level male manager might well raise a concern about gender discrimination if her salary is not also adjusted.

Impact of Increasing Salaries

For otherwise exempt employees who currently do not earn enough to satisfy the new minimum salary thresholds, employers have two choices: increase the salary to satisfy the new threshold or convert the employee to non-exempt status.

Some of those decisions may be relatively simple, particularly when viewed in a vacuum, but some may be more difficult.

If an otherwise exempt employee currently earns a salary of $47,000 per year, the employer may have an easy decision to give the employee a raise of at least $476 to satisfy the new threshold.

And if any employee currently earns $24,000 per year, an employer may have an easy decision to convert the employee to non-exempt status rather than give the employee a raise of more than $20,000.

But what about the employee earning $40,000 per year?  Should that employee be given a raise of more than $7,000 or should she be converted to non-exempt status?  It is not difficult to see how one employer would choose to give an employee a $7,000 raise while another would choose to convert that employee to non-exempt status.

And what if the amount of an increase seems small, but it would have a large impact because of the number of employees affected?  A salary increase of $5,000 for a single employee to meet the new salary threshold may not have a substantial impact upon many employers.  But what if the employer would need to give that $5,000 increase to 500 employees across the country to maintain their exempt status?  Suddenly, maintaining the exemption would carry a $2,500,000 price tag.  And that is not a one-time cost; it is an annual one that would likely increase as the salary threshold is updated.

Impact of Reclassifying an Employee As Non-Exempt

If an employer decides to convert an employee to non-exempt status, it faces a new challenge – setting the employee’s hourly rate.

If the employer “reverse engineers” an hourly rate by just taking the employee’s salary and assuming the employee works 52 weeks a year and 40 hours each week, it will result in the employee earning the same amount as before so long as she does not work any overtime.  The employee will earn more than she did before if she works any overtime at all.  And if she works a significant amount of overtime, the reclassification to non-exempt status could result in the employee earning significantly more than she earned before as an exempt employee.  If she worked 10 hours of overtime a week, she would effectively receive a 37% increase in compensation as a result of her reclassification.

But calculating the employee’s new hourly rate based on an expectation that she will work more overtime than is realistic would result in the employee earning less than she did before.  If, for instance, the employer calculated an hourly rate by assuming that the employee would work 10 hours of overtime each week, and if she worked less than that, she would earn less annually than she did before – perhaps significantly less. That, of course, could lead to a severe morale issue – or to the unwanted departure of a valued employee.

In calculating the new hourly rate for employees they are reclassifying, employers should be careful to do so based upon realistic expectations of the overtime each of those employees will work such that it does not end up paying them significantly more – or significantly less – than they intend.

Whatever employers decide to do, the December 1, 2016, deadline is getting closer each day.