Labor Department Proposes Changes to 50-year-old Wage and Hour Rules on Exempt Employee Status

June 2003

The U.S. Department of Labor, Wage and Hour Division issued proposed modifications to the definitions of exempt employees under the Fair Labor Standards Act (FLSA). These would affect who can receive the "white collar" exemptions—executive, administrative, professional, outside sales, and computer employees. The Department of Labor estimates that 640,000 employees would be affected by these proposed modifications.

by Paul J. Siegel, Esq.
Jackson Lewis LLP

On March 31, 2003, the U.S. Department of Labor, Wage and Hour Division issued Proposed Rules and Request for Comments regarding modifications to the definitions of exempt employees under the Fair Labor Standards Act (FLSA) (29 C.F.R. § 541). The proposed regulations will be used to determine the exemptions for executive, administrative, professional, outside sales, and computer employees, often referred to as the "white collar" exemptions. "Updating these regulations is long overdue—the types of jobs people do and the skills they need have changed, but the regulations have not," said Wage and Hour Administrator Tammy D. McCutchen when announcing the proposals. "The exemptions have engendered considerable confusion over the years regarding who is, and who is not, exempt," Ms. McCutchen wrote in issuing the proposed regulations.

Why the Rules Needed Changing

It should be noted that the proposed regulations do not change the basic requirements for determining the exempt or nonexempt status of employees. Rather, the changes are designed to respond to the current workplace reality in which the basic requirements must be applied.

Under the current rules, to be exempt from the FLSA’s overtime requirements, an employee: 1) must be paid a guaranteed salary which is not subject to reductions because of variations in the quality or quantity of work performed (known as the "salary basis test"); 2) must receive at least the minimum guaranteed salary set forth in the regulations (known as the "salary level test"); and, 3) must perform primarily "managerial, administrative or professional duties as outlined in the regulations" (known as the "duties test").

Originally established in 1938, the duties tests for the executive, administrative, and professional employees were last modified in 1949. Similarly, the salary basis test has been unchanged since 1954, and salary levels have not been updated since 1975.

Aside from being more than 50 years old, the regulations are functionally outdated. The salary level tests are particularly problematic since they were intended to be the best indicators of exempt status. At current levels, they no longer assist employers in distinguishing between bona fide exempt employees and those who should be considered nonexempt.

As currently written and applied, the complex "duties" tests often result in errors and subsequent misclassification of employees; and the subjective nature of the "duties" tests has resulted in inconsistent application of the exemptions by investigators and by the courts. Additionally, the complex "salary basis" tests and the so-called no docking rule have been the subject of numerous collective court actions brought against employers by highly compensated managerial and professional employees.

Summary of Significant Proposed Changes

As proposed, the new rules would affect nearly every major aspect of the exempt status criteria. A useful side-by-side comparison of the existing rule and proposed changes appears on the Department of Labor Web site.

If the proposed changes are accepted, the final rule would have the following impact.

Increase the Salary Levels Tests. Under the proposed regulations, the minimum salary level for an executive, administrative, or professional employee to qualify for exempt status would be increased from $155.00 to $425.00 per week (see discussion below).

Eliminate Separate "Long" and "Short" Salary Level and Duties Tests. The proposal eliminates the current percent limitation on nonexempt work and the requirement that employees must exercise independent judgment or discretion, and substitutes one standard test.

For Executive Employees, Subpart B, §§ 541.100–107. To qualify as exempt under the duties test, an executive employee must:

1. as a primary duty, manage the enterprise in which the employee is employed or a customarily recognized department or subdivision;
2. customarily and regularly direct the work of two or more other employees; and
3. have the authority to hire or fire other employees or have particular weight given to suggestions and recommendations as to hiring, firing, advancement, promotion, or any other change of status of other employees.

Any employee who owns at least a 20 percent equity interest in the enterprise would be recognized as exempt.

For Administrative Employees, Subpart C, §§ 541.200–207. To qualify as exempt under the duties test, an administrative employee must:

1. as a primary duty, perform office or nonmanual work related to management or general business operations of the employer or the employer’s customers;
2. hold a position of responsibility with the employer. To meet this requirement the employee must customarily and regularly (1) perform work of substantial importance; or (2) perform work requiring a high level of skill or training.

The proposed rules clarify the type of work performed that will be considered to be "office or nonmanual work." Illustrative examples included in the proposed regulations are shown in the following exhibit.

EXAMPLES OF OFFICE OR NONMANUAL WORK

Tax Finance Accounting Auditing Quality Control Purchasing Procurement Advertising Marketing Research Safety and Health Personnel Management Human Resources Employee Benefits Labor Relations Public Relations Government Relations

The proposed rules define the "position of responsibility" requirement. The Department of Labor intends to reduce the emphasis that has been placed upon the "production versus staff" dichotomy when differentiating between exempt and nonexempt workers. To meet this requirement, the employee must customarily perform work (1) of substantial importance or (2) requiring a high level of skill.

The requirement that an employee perform work of "substantial importance" has been a part of the interpretive guidelines for the administrative exemption since 1950. Work of substantial importance is defined to mean "work that, by its nature or consequence, affects the employer’s general business operations or finances to a significant degree." The proposed regulations include the following examples of this type of activity.

• Formulating, interpreting, or implementing management policies
• Providing consultant or expert advice to management
• Making or recommending decisions that have a substantial impact on general business operations or finances
• Analyzing and recommending changes to operating practices
• Planning long- and short-term business objectives
• Analyzing data, drawing conclusions, and recommending changes
• Handling complaints, arbitrating disputes, or resolving grievances
• Representing the employer during important contract negotiations

Addressing the other prong of the "position of responsibility" requirement, the proposed rules define "work requiring a high level of skill or training" as work requiring specialized knowledge or abilities or advanced training. The requisite knowledge or abilities can be acquired through academic instruction or advanced on-the-job training. The proposed regulations reverse the Department of Labor’s previous view that use of a reference manual was indicative of nonexempt duties. Under the proposed regulations, use of a manual which contains highly technical, scientific, legal, financial, or similarly complex information that can be interpreted only by those with advanced training or specialized knowledge or skills will be regarded as exempt work.

For Professional Employees, Subpart D, §§ 541.300–304. To qualify as exempt under the duties test, a learned professional employee must as a primary duty, perform office or nonmanual work requiring advanced knowledge in a field of science or learning, which is:

1. customarily acquired by a prolonged course of specialized intellectual instruction; or
2. acquired through equivalent combinations of intellectual instruction and work experience.

The proposed rules clarify the professional exemption by recognizing that, in the "modern workplace," employees can acquire advanced knowledge through a combination of formal college-level education, training and work experience. Under the current regulations, the advanced knowledge requirement was most typically satisfied through academic instruction rather than knowledge gained through work experience.

The proposed regulation also recognizes that the areas covered by the professional exemptions "are expanding." Subpart § 541.301(g) provides that whenever a specialized degree becomes a standard requirement for a particular occupation, that occupation could be considered a "learned profession" and could qualify for the professional exemption.

To qualify for the exemption for creative professional employee, an individual must, (1) as a primary duty, perform office or non-manual work requiring invention, imagination, originality or talent; and, (2) do so in a recognized field of artistic or creative endeavor such as music, writing, acting or the graphic arts.

Uncertainty in the existing rules for creative professional employees has spawned litigation over a number of occupations, including newspaper journalists and radio or television commentators. The proposed rules recognize that writers for newspapers, magazine, television, the Internet, and other media generally perform work requiring originality and talent. In these occupations, exempt work includes conducting interviews, reporting, or analyzing public events and acting as a narrator, announcer or commentator.

For Computer Employees, Subpart E. The proposed regulations relocate the computer-related exemption from within the professional exemption to a separate exemption. The new section consolidates all the provisions from the current regulations, interpretive guidance, and the legislative enactments. The proposal increases the minimum salary requirement to $425.00 per week or, on an hourly basis, requires payment at a rate of not less than $27.63 an hour.

For Outside Sales, Subpart F, §§ 541.500–504. The proposed regulations eliminate the current 20 percent restriction on nonexempt work. Under the proposed rules, the exemption would apply when the employee’s primary duty is making sales, or obtaining orders or contracts for services or for the use of facilities for which a consideration will be paid by the client or customer. The employee also must be customarily and regularly engaged away from the employer’s place or places of business.

Compensation Requirements, Subpart G, §§ 541.600–606. The proposed regulations increase the minimum salary requirement to $425.00 weekly for the new "standard" test for the executive, administrative, and professional exemptions. The Department of Labor established the minimum salary by looking at the Bureau of Labor Standards year 2000 Current Population Survey Outgoing Rotations Data Set. Based upon its review, the Department of Labor has suggested setting the minimums at the lowest 20 percent of the current range of salaries. As a result, the bottom 20 percent of salaried employees would fall below the minimum salary and would be entitled to overtime.

Subpart § 541.601 of the proposed rules introduces a special test for highly compensated employees. Under this "super salary" test, employees would qualify for the executive, administrative, or professional exemptions if they:

1. perform office or nonmanual work;
2. are guaranteed total annual compensation of at least $65,000; and,
3. perform one or more of the exempt duties of an executive, administrative, and professional employee as set forth in the proposed regulations.

When determining whether an employee is highly compensated, the employer may consider base salary, commissions, and nondiscretionary compensation (including bonuses).

For employees who have not worked a full year, the proposed rules allow an employer to prorate earnings and attribute a pro rata portion of the minimum earnings required. Based upon the number of weeks he or she has been employed, the employee may qualify for the "super salary" exemption.

Salary Basis, Subpart G. One of the most contentious areas of exempt status in recent years has involved the loss of exemptions as a result of improper salary deductions. The proposed rules add a provision allowing employers to take deductions for full-day disciplinary suspension for infractions of workplace conduct rules, such as sexual harassment policies.

Additionally, the proposed rules significantly alter the "window of correction" which provides an employer the opportunity to fix a mistake in salary deductions from exempt employees. Under the proposed rules, an employer will lose an otherwise valid exemption if there is a pattern and practice of making improper deductions and, as a result, not paying employees on a "salary basis." In contrast, if the deductions are isolated or inadvertent, an otherwise valid exemption will not be lost. Factors to consider include the following.

• The number of improper deductions
• The time period during which deductions were made
• The number and geographic location of employees whose salary was improperly reduced
• The size of the employer
• Whether the employer has a written policy prohibiting improper deductions
• Whether the employer corrected the improper deductions

Significantly, if the facts show the employer has a policy of not paying on a salary basis, the exemption is lost only during the time period in which improper deductions were made for employees in the same job classifications working for the same managers responsible for the improper deduction.

The proposed rules also provide a "safe harbor" that the exemption will not be lost if the employer (1) has a written policy prohibiting improper pay deductions; (2) notifies employees of its policies; and (3) reimburses employees for any improper deductions. However, if the employer repeatedly and willfully violates its own policy or continues to make deductions after receiving employee complaints, the exemption will be lost.

Definitions, Subpart H. Definitions for the terms used in the proposed regulations are consolidated into one section.

The proposed rules define "primary duty" as the major or most important duty the employee performs. The regulations provide some guidance on the determination of an employer’s primary duty. Some of the factors to be considered include the following.

1. The relative importance of the exempt duties as compared with other duties
2. The amount of time spent performing exempt work
3. The employee’s relative freedom from direct supervision
4. The relationship between the salary the employee receives and wages paid to other employees for the same kind of nonexempt work

Importantly, this definition also provides that an employee is not required to spend more than 50 percent of his or her time performing exempt work to sustain the primary duty test.

Tasks that are "directly and closely related" to exempt duties also may be considered exempt work. This includes physical or menial tasks that arise out of exempt duties, and routine work without which the employee’s exempt duties cannot be performed. Examples include keeping time; preparing production or sales records for subordinates; spot checking the work of subordinates; recordkeeping; monitoring and adjusting machinery; taking notes; using a computer to create documents or presentations; opening mail for the purpose of reading it and making decisions.

Emergencies, § 541.705. This portion of the regulations recognizes that emergencies may arise that require an exempt employee to perform work of a nonexempt nature. If such emergencies (1) threaten the safety of employees; (2) could cause cessation of operations; or (3) present the risk of serious damage to the employer’s property, the work performed to prevent such results will be considered exempt.

Request for Commentary

The Department of Labor has invited comments during a 90-day period beginning on March 31 when the proposed rules were published. Specifically, the Department of Labor is asking for input relative to occupations that have been the subject of confusion and litigation regarding their exempt status. The Department of Labor seeks more information about job duties and responsibilities performed by employees in the following positions and whether such occupations should be treated as exempt.

• Pilots
• Athletic Trainers
• Funeral Directors
• Insurance Salespersons
• Loan Officers
• Stock Brokers
• Hotel Sales and Catering Managers
• Dietary Managers in Nursing Homes

Other specified areas of inquiry include those listed in the following exhibit.

DEPARTMENT OF LABOR AREAS OF INQUIRY

Whether the salary level and/or salary basis requirements should be eliminated as unnecessary for sole charge executives and businessowners. The list of type of work that constitutes office or nonmanual work related to the management or general business operations. The list of activities in § 541.204 that are considered to be of "substantial importance" in terms of additions or deletions to the list. Whether the "discretion and independent judgment" requirement should be deleted entirely, retained as a third alternative for meeting the "position of responsibility" requirement, or retained but modified to provide better guidance. Whether the requirements for professional exemption should include a specific formula for determining the equivalent of intellectual instruction and work experience. Whether the special salary levels should be maintained for American Samoa. The proposed salary levels and any alternative salary level amounts or methodologies for determining appropriate salary levels. Whether the regulations should include a "salary only" test for highly compensated employers, where employees performing nonmanual or office work and earning a specific amount automatically would be exempt without regard to the employee’s duties. Alternative strategies for removing the "salary tests" from the regulations and replacing them with tests that rely solely on employees’ duties.

Conclusion

Raising the salary level test to $425.00 per week is just one of the changes that will impact employers in the classification of employees as exempt or nonexempt under the FLSA. Another is the establishment of the so-called super salary level test automatically to classify an employee as exempt. Perhaps the more far reaching changes involve modifications to the "duties tests." Indeed, the Department of Labor estimates that 640,000 employees would be affected by these proposed modifications, which include eliminating the percentage test for duties performed of a nonexempt nature.

While the response to the proposed regulations thus far has been mixed and the outcome is uncertain—prior attempts to revise the "white collar" regulations have failed—Ms. McCutchen has stated that if she "gets a little bit of screaming" from both labor and business groups, "then I'll think I probably found the right solution."

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Opinions expressed in Expert Commentary articles are those of the author and are not necessarily held by the author’s employer or IRMI. This article does not purport to provide legal, accounting, or other professional advice or opinion. If such advice is needed, consult with your attorney, accountant, or other qualified adviser.