On April 23, 2024, the U.S. Department of Labor (“DOL”) announced a new final rule through which it has significantly raised the bar for businesses to continue to classify their employees as exempt from overtime pursuant to the executive, administrative and professional (“EAP”) and “highly compensated employee” exemptions. Specifically, the DOL announced substantial increases to the salary threshold requirements for these exemptions, which will take effect on a staggered basis on July 1, 2024, and again on January 1, 2025.
The New Salary Thresholds
The salary threshold for the EAP exemptions is currently $684 per week ($35,568 annually), which the DOL is increasing to $844 per week ($43,888 annually) beginning July 1, 2024, and then to $1,128 per week ($58,656 per year) beginning January 1, 2025, which represents an ultimate increase of nearly 65%.
The annual salary threshold for the highly compensated employee exemption is currently $107,432, which the DOL is increasing to $132,964 beginning July 1, 2024, and then to $151,164 beginning January 1, 2025, which represents an ultimate increase of over 40%.
The final rule also provides for automatic increases to these compensation thresholds every three years, beginning July 1, 2027.
What Does This Mean for Employers?
For exempt employees who do not currently earn enough to satisfy the new salary thresholds, businesses must decide whether to increase employee salaries or reclassify employees as non-exempt, i.e., overtime eligible. These decisions are important, as they will not only impact the employees at issue but will likely also affect company budgets and compensation structures, which could result in salary compression and other significant financial ripple effects for businesses.
The viability of increasing salaries to maintain exemption will likely largely depend on the number of employees whose salaries must increase, as well as the amount by which these salaries must increase. For example, assume an exempt employee currently earns an annual salary of $58,000. It might be an easy decision for a business to increase that employee’s salary by $656 to meet the January 1, 2025 increase. The decision becomes more difficult, however, where an exempt employee earns $50,000 per year. That employee would require a raise of nearly $9,000 to maintain the exemption. In this latter example, it would certainly be reasonable for a business to decide to reclassify that exempt employee to non-exempt status, especially if there are multiple exempt employees with comparable annual salaries that require significant increases. Consider a scenario where a business needs to provide that $9,000 raise to 50 exempt employees to maintain the exemption. That adjustment will cost the business $450,000. Now assume a business needs to provide that same raise to 500 employees. That’s a $4,500,000 price tag—incurred on an annual basis, which will increase every three years. As one can see, this can snowball quickly.
If maintaining exempt status is too expensive, then reclassification may be the preferred option; however, this choice also presents a financial challenge, as now overtime premium pay comes into play.
With the reclassification to non-exempt status, these previously exempt employees now become eligible for overtime premium pay, meaning that they must be paid time and a half for all hours worked over 40 in a workweek (or daily overtime premium pay in certain states). For example, an employee who works just 10 hours of overtime per week, i.e., 50 hours, could undermine the employer’s financially motivated rationale for reclassifying employees in the first place.
The logical assumption would be to calculate the employee’s new hourly rate based on an expectation that they will work more overtime than is realistic. But, in doing so, an employee may earn less—and, in some cases, significantly less—than before. Employers may then potentially face a morale issue among employees.
As for the exempt employees whose compensation already satisfies the new salary thresholds, nothing may need to be done to comply with the final rule; however, this does not mean businesses should ignore the potential impact on these employees. Companies that increase other (presumably more junior) employees’ compensation may face morale issues for those employees whose salaries are not also being adjusted. Situations may occur where complying with the final rule may result in a lower-level employee earning as much, or nearly as much, as a higher-level employee, or where a higher-level employee’s salary increase is not commensurate to that of a lower-level employee’s salary. In such situations, businesses may choose to also increase the salaries of employees otherwise unaffected by the final rule, which, again, can come with a hefty price tag.
There Likely Will Be Legal Challenges to the Final Rule
Legal challenges to the Final Rule are almost a certainty. As we explained in our August 30, 2023 blog first reporting on the DOL’s proposed rule, the DOL has arguably exceeded its rulemaking authority by establishing a salary threshold that excludes millions of workers whose duties the DOL otherwise considers exempt.
In addition, the DOL’s provision setting triennial updates to the salary levels eschewing the required notice-and-comment periods for each cycle may violate the Administrative Procedure Act, which is what caused the Obama Administration to scrap a similar automatic update from its 2016 final rule that likewise sought to increase the exempt salary thresholds.
The final rule also invites a challenge to the FLSA’s broad delegation of rulemaking authority to the Secretary of Labor to prescribe all the standards for these exemptions under the non-delegation doctrine. The statute itself arguably provides little to no guidance to the DOL with respect to defining these exemptions, which may amount to an unconstitutional delegation of legislative authority to the Executive Branch.
We should also expect a challenge to the DOL’s authority to require a salary at all considering the FLSA’s clear reference to an employee’s employment in a bona fide executive, administrative, or professional capacity. Justice Kavanaugh raised this very concern during the October 2022 oral argument in Helix Energy Solutions Group, Inc. v. Hewitt, which may prompt lower courts presiding over any legal challenge to the final rule to focus on this argument.
Lastly, it is interesting to note that a “severability clause” included in the new rule may help the DOL ward-off potential legal challenges. The severability clause states that any provisions of Part 541 of the FLSA are “separate and severable and operate independently from one another.” This is relevant to the DOL’s staggered salary increases in the final rule reflecting the DOL’s intent for the increases to operate separately, such that if the July 1, 2024 increase were to be stayed or otherwise invalidated, then the January 1, 2025 increase and any of the automatic increases could still take effect.
Takeaways for Employers
Because of the expected legal challenges, businesses should not hastily implement any modifications to their exempt workforce. Businesses should not, however, wait to consider potential modifications based on the salary increases prescribed by the final rule, as it is better to be prepared with a plan that can be put in place quickly, if needed, without scrambling at the last moment. Human resource teams should work with employment counsel to audit their company’s exempt employee census to determine which salaries fail to qualify for the upcoming January 1, 2025 threshold increase, or come close enough that it may make sense to rethink exempt classifications for such positions while, of course, keeping in mind the company’s bottom line.