Legal Update - July - 2004
Major Changes in "White Collar" Exemptions May Affect Your Payroll

The United States Department of Labor (the "DOL") has issued final regulations regarding the so-called white collar exemptions of the Fair Labor Standards Act (the "FLSA"). The new regulations, which are the first significant revamp of the exemption duties in 55 years, will go into effect on August 23, 2004. They change the salary levels and the "salary basis" and "duties" exemption tests for white collar employees with regard to both overtime and minimum wage compensation. This Legal Update provides an overview of the changes.

Background

The FLSA requires that most U.S. employees be paid at least the federal minimum wage (currently $5.15 per hour) and overtime pay at one and one-half times their regular rate of pay after 40 hours in a workweek. The FLSA, however, provides an exemption from both minimum wage and overtime pay for bona fide executive, administrative, and professional employees. To qualify for exemption, employees must meet three tests for each exemption. First, an exempt employee must ordinarily earn a minimum amount. Second, the minimum amount must be paid on a salary basis. Third, exempt employees must perform certain executive, administrative or professional job duties. Outside sales employees and certain computer employees are also exempt.

Minimum Salary Level

Under existing regulations, the minimum salary required to be considered an exempt employee can be met under either a "long" or a "short" test. Those tests are being eliminated. Moreover, the new regulations increase the minimum salary requirement for exempt status nearly three-fold to $455 per week on a "free and clear" basis. The $455 may not include the value of any non-cash items that an employer may furnish to an employee, like board, lodging or other facilities (for example, meals furnished to employees of restaurants). For employers that have adopted pay periods longer than one week, the equivalent of the $455 per week salary level is $910 for biweekly pay periods; $985.83, for semimonthly pay periods; and $1,971.66, for monthly pay periods. Thus, virtually all employees who earn an annual salary under $23,660 must be paid overtime.

Salary Basis

In addition to the minimum salary level, most exempt employees also must be paid on a salary basis. Generally, "salary basis" means that an exempt employee must regularly receive, each pay period and on a weekly or less frequent basis, a "predetermined amount" of compensation that cannot be reduced because of variations in the quality or quantity of work performed. Except for identified exceptions, the exempt employee must receive the full salary for any week in which he or she performs any work, regardless of the number of days or hours worked. Exempt employees, however, need not be paid for any workweek when they perform no work. Prior to the new regulations, it was difficult to suspend exempt employees for less than a full workweek. The new regulations contain seven exceptions to the salary basis, "no pay-docking" rule, including for violations of workplace conduct rules that prohibit sexual harassment and workplace violence.

Safe Harbor

The DOL takes the position that a nominally "salaried" employee whose wages are docked for absences of less than a full workday more closely approximates an hourly-paid employee and is thus entitled to overtime pay just as an hourly employee would be. The rationale is that if an employer can require an exempt employee to work more than 40 hours in a week without paying the employee more, the employer should not be able to pay the employee less if the employee takes time off during a particular day. The new regulations modify what may occur if an employer makes improper deductions. Under existing regulations, a single improper deduction from salary could result in an employer-wide loss of exempt status for an entire classification of employees. Under the new regulations, however, an improper deduction will result in the loss of the exemption only for employees in the same job classification and working for the same manager responsible for making the improper deduction.

The existing regulations only allow a limited opportunity to correct an employer's improper deductions from salary. The new regulations, however, offer a "safe harbor." If an employer has a "clearly communicated policy" that (a) prohibits improper pay deductions, (b) contains a complaint mechanism, (c) reimburses employees for inappropriate deductions, and (d) makes a good faith commitment to comply in the future, then the employer will not lose the exemption for any employees unless the employer willfully violates the policy by continuing to make improper deductions after receiving employee complaints. The best evidence of a clearly communicated policy is a written one distributed to employees before the improper pay deductions occur, for example, by providing a copy of the policy to employees when they are hired, publishing it in an employee handbook or distributing it to employees over the employer's Intranet. In view of this new "safe harbor" approach, it behooves employers to review their existing policies and to issue a written policy prohibiting improper deductions from salaries of exempt employees.

Exception

The salary level and salary basis requirements described above do not apply to outside sales employees, licensed or certified doctors, lawyers and teachers. Employees in these occupations are exempt regardless of their salary. In addition, the FLSA exempts hourly paid employees in certain computer-related occupations if they are paid at least $27.63 per hour.

Exemptions

With regard to the exemptions, the new regulations focus on a "primary duty" test rather than on the antiquated and confounding "duties test." A summary of the "primary duty" tests for the various exemptions follows:

Executive Exemption: In addition to the salary requirements, the executive exemption applies only if the following three duties requirements are met: (1) the employee's primary duty must be to manage the enterprise in which he or she is employed or a customarily recognized department or subdivision thereof; (2) the employee must customarily and regularly direct the work of two or more employees; and (3) the employee must have the authority to hire or fire other employees, or have her suggestions and recommendations as to hiring, firing, advancement, promotion or any other change of status be given particular weight. The new regulations abandon the old prerequisites that executive employees exercise discretion or independent judgment and spend certain percentages of their time performing exempt as opposed to non-exempt duties. The DOL enumerates several factors to consider when determining whether an employee's recommendations are given "particular weight." The new regulations permit an executive employee to perform both exempt management duties and non-exempt work. Generally, exempt executives themselves make the decision regarding when to perform nonexempt duties.

The new regulations also recognize certain business owners as exempt executives. Employees who own at least 20-percent equity in a business and are actively engaged in the management of the enterprise are exempt executives. The salary requirements do not apply to such business owners.

Administrative Exemption: In addition to the salary requirements, the administrative exemption applies only if the employee's primary duty is (1) the performance of office or non-manual work directly related to the management or general business operations of the employer or the employer's customers; and (2) the employee's primary duty includes the exercise of discretion and independent judgment with respect to matters of significance. The standards have not changed, but the new regulations contain considerable assistance as to which administrative duties are exempt and non-exempt. The new regulations do add "matters of significance" to the test. The term refers to the level of importance or consequence of the work performed. In determining whether or not an employee exercises discretion and independent judgment, all the facts involved in the particular employment situation must be considered. The term implies that the employee has authority to make an independent choice, free from immediate direction or supervision. Employees, however, can exercise discretion and independent judgment even if their decisions or recommendations are reviewed, and occasionally reversed, at a higher level. The regulations list a number of factors to consider in determining whether an employee exercises discretion and independent judgment with respect to matters of significance.

Professional Exemption: There are two general types of professional exemptions: learned professionals and creative professionals. In addition to the salary requirements, the learned professional exemption applies only if three tests are met: (1) the employee's primary duty is the performance of work requiring advanced knowledge (i.e., work that is predominately intellectual in character, and which includes work requiring the consistent exercise of discretion and judgment), (2) the advanced knowledge is in a field of science or learning, and (3) the advanced knowledge is customarily acquired by a prolonged course of specialized intellectual instruction. The word "customarily" means that this exemption is also available to employees in such professions who possess substantially the same knowledge level and perform substantially the same work as the degreed employees, but who attain the advanced knowledge through a combination of work experience and intellectual instruction. Such employees may include the occasional lawyer who has not gone to law school, or the occasional chemist who does not have a degree in chemistry. The new regulations discuss the exempt status of some specific occupations for the learned professional exemption.

In addition to the salary requirements, the creative professional exemption applies only if the employee's primary duty is the performance of work requiring invention, imagination, originality or talent in a recognized field of artistic or creative endeavor. The recognized fields of artistic or creative endeavor include music, writing, acting and the graphic arts. Thus, exempt creative professionals include musicians, composers, conductors, novelists, screen writers, actors, painters and photographers. The requirement of "invention, imagination, originality or talent" distinguishes the creative professions from work that primarily depends on intelligence, diligence and accuracy. The creative professional exemption also does not apply if the employee's work can be produced by a person with general manual ability and training. Since the duties of employees vary widely, the determination of exempt creative professional status must be made on a case-by-case basis, based on the extent of the invention, imagination, originality or talent exercised by the employee.

Journalists cannot meet the educational requirements for the learned professional exemption. In addition, journalists, reporters and other employees of newspapers, magazines, television and other media are not exempt creative professionals if they collect, organize and record information that is routine or public or if they do not contribute a unique interpretation or analysis. Journalists also are not exempt if their work product is subject to substantial control. Journalists, however, may be exempt if they perform on-air in radio or television, conduct investigative interviews, analyze or interpret public events, or write editorials, opinion columns or commentary.

Outside Sales Exemption: There is no minimum salary requirement for the outside sales exemption. To qualify for this exemption, the following two criteria must be met: (1) the employee's primary duty must be 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; and (2) the employee must be customarily and regularly engaged away from the employer's place of business. The new regulations do away with the former requirement that outsides sales employees spend at least 80% of their time performing sales activities and related duties. In addition, the regulations clarify that solicitations via mail, telephone, or the Internet do not constitute "outside" sales activities unless they are in connection with calls on customers to their place of business or home.

Computer Employee Exemption: The new regulations craft a distinct exemption for computer employees. They are no longer in the professional exemption. To be exempt, computer employees formerly had to "consistently exercise discretion and judgment;" however, that is no longer required. In addition, the exemption will not be confined to software functions. To qualify for the exemption, an employee must be employed as a computer systems analyst, computer programmer, software engineer or other similarly skilled worker in the computer field, with the employee's primary duty consisting of (1) application of systems analysis techniques and procedures, or (2) design, development, documentation, analysis, creation, testing or modification of computer systems or programs, or (3) design, documentation, testing, creation or modification of computer programs related to machine operating systems, or (4) a combination of the duties described in (1), (2), and (3), the performance of which requires the same level of skills. An exempt computer employee may either be paid on a salaried basis or not less than $27.63 per hour.

Highly Compensated Employee Exemption

The new regulations introduce a new exemption for employees performing office or non-manual work with annual compensation of at least $100,000 (including at least $455 per week paid on a salary or fee basis) and who customarily and regularly perform one or more of the exempt duties or responsibilities of an executive, administrative, or professional employee. Blue collar workers are not exempt, irrespective of how well they are paid. The total annualized compensation may include salary, commissions, nondiscretionary bonuses and other nondiscretionary compensation earned over the course of 52 weeks; however, it may not include credit for board or lodging, payments for medical or life insurance, or contributions to retirement plans or other fringe benefits. If an employer does not designate the 52 week period in advance, the calendar year will apply.

State Law Wrinkles

Employers must not forget state wage and hour laws. They may include more far-reaching coverage or have different duties than those appearing in the new regulations. In such event, employers must obey those laws. For example, fearing that the federal regulations would not be favorable to employees, Governor Blagojevich signed a bill to head them off. Under the Illinois law, employers must comport with the federal definitions of executive, administrative, and professional employees as they existed as of March 30, 2003. Where Illinois law provides greater protection to employees than the new regulations, employers must comply with it. Harmonizing the new regulations with the Illinois law is no easy task, especially because the new regulations are more favorable to employees than anticipated.

Likewise, California law provides some quirks. The new regulations establish a minimum salary of $455 per week; however, California's minimum salary is tantamount to $540 per week. The new regulations indicate that an employee will not lose the executive exemption if he or she performs exempt and non-exempt duties. In California, an employee may be classified as exempt only if or she spends in excess of 50% of the time performing exempt duties.

Moving Forward

The new regulations go into effect soon. Employers ought to evaluate their compensation policies, review their job descriptions to make sure that they are accurately classifying employees as exempt, update their personnel policies to conform to the new regulations, and adopt a policy to take advantage of the new "safe harbor" provisions concerning deductions from salaries.

Funkhouser Vegosen Liebman & Dunn Ltd. publishes updates on legal issues and summaries of legal topics for its clients and friends solely for general informational purposes. They do not constitute legal advice, nor are they intended as a substitute for obtaining legal or other professional advice based upon specific factual circumstances or issues. If we can be of assistance, please call or write Jon Vegosen, 312.701.6860, jvegosen@fvldlaw.com, or consult with your regular FVLD contact.

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