Tammy McCutchen, of ComplianceHR and Littler Mendelson, joins The HR Risk Podcast to discuss upcoming regulatory changes to the white-collar overtime exemption, overtime rate of pay, and joint employer definition. Subscribe to The HR Risk Podcast on iTunes/Apple Podcasts, Stitcher, or your favorite podcast app!

Jennings: Our topic today is How to Handle 2019’s Big Overtime Changes. On this show, we’re all about HR risk—the things that can go wrong in the workplace and how to avoid them. And we take a pretty broad view of what is risk in the HR context—risk, to put it briefly, is everywhere. But this episode is about one of the more classic and potentially expensive forms of risk HR leaders face: are we paying our employees in accordance with the law?

Jennings: At the federal level, that question primarily is driven by the Fair Labor Standards Act, or FLSA. Right now, the U.S. Department of Labor is pursuing several significant updates on overtime and other work-hour regulations. To discuss that topic, we’re so fortunate to have Tammy McCutchen as our guest today. In 2001, Tammy was nominated by President George W. Bush and confirmed by the Senate to become the Administrator of the Department of Labor’s Wage & Hour Division. And so it’s wonderful to have her on the show to talk about new rulemaking from the agency she formerly led.

Jennings: Tammy, welcome to The HR Risk Podcast.

McCutchen: Well, thank you for having me.

Jennings: Tammy, before we begin our conversation, could you give our listeners a little bit more background on your legal career and your current practice?

McCutchen: Well, certainly. I grew up in Illinois, law school at Northwestern, and clerked on the Seventh Circuit and then I practiced for 12 years in Chicago before I moved east to take a position as an in-house employment counsel at The Hershey Company. That’s where I was when I was nominated by President Bush in 2001 to serve as as DOL’s Wage and Hour Administrator. And while I was at DOL, I made revisions to the part 541 white-collar overtime exemption regulations that we’re going to be talking about today. And that was really my top priority while I was there. Some of your listeners may remember in 2004 when we increased the minimum salary level for exemption from $155 per week, to $455 per week. And then we also revised the duties test. Since then I’ve been back in private practice at Littler and I’m also VP of strategy for ComplianceHR, which is a Littler joint venture where we create compliance applications using artificial intelligence that apply the results of thousands of court cases to your particular facts to provide an instant assessment of risk of classifying your workers as independent contractors or classifying an employee as exempt from the overtime requirements.

Jennings: Thank you. And it’s great that we have you on for today’s episode because our topic is on regulatory developments coming out of the Wage & Hour Division. And I can’t think of anybody better to offer insights on that than the former administrator of the division. We’re going to talk about three big developments that are sort of percolating right now. One is the white-collar overtime exemption. The other one that’s also related to overtime is the regular rate of pay, and then the joint employer definition. Just taking those one by one with the white-collar exemption starting off, the Wage & Hour Division has recently announced some rulemaking to update that rule that you were previously involved in the early 2000s. Could you give us an overview, where is it now and where is the Department of Labor proposing to take it?

McCutchen: In some breaking news this morning for me to share with you, DOL posted a proposed rule to increase the minimum salary level for the SLSA overtime exemptions that cover executive, administrative, professional, computer, and outside sales employees. That happened on March 8. Currently the required salary level for exemption is $455 per week. That’s $23,660 annually. That was what we set in 2004, almost 15 years ago now. As you may recall, in 2016 DOL issued a final rule that would have raised that level to $913 per week, almost $48,000 annually. But a court in Texas invalidated and enjoined that rule stating that the salary level was so high that it exceeded the DOL’s authority by replacing the duties tests with a salary test as the primary indicator of exempt status. Remember the FLSA does not include any salary requirements in the statute itself. In response to that decision, DOL has now proposed to raise the minimum salary level to $679 per week. That’s $35,308 annually. And this morning, March 21st, we have gotten notice that these proposed rules will be officially published in the Federal Register tomorrow, March 22nd, and that is when our 60-day period to provide comments on the proposed regulations to DOL will start. Comments should be due then somewhere around May 21st, but we’ll have the official date tomorrow, including the 60-day period that we all have to comment on those proposed rules.

Jennings: So we’re looking at some possible changes to this white-collar overtime exemption probably looking at the early part of next year, it sounds like. As a general matter, what are these new thresholds going to mean for employers? And are there any industries that are likely to see a bigger impact than others?

McCutchen: If DOL finalizes its proposed rules at that $679 per week level—$35,000 a year is the proposal—then any employee paid a salary below that $679 per week will not be able to qualify for exemption and will have to be paid overtime when they work more than 40 hours per week. So for exempt employees below that level, employers are going to need to decide whether to increase the salary or reclassify the employee as nonexempt and begin paying them overtime. As to impact, I think it will be far less than we saw from the 2016 final rule that’s been invalidated at that $48,000 level. But the industries that may see the most impact will likely be lower profit margin industries such as retail, restaurants, hospitality, and also industries that have fixed budgets or no options for raising prices to offset the increased cost of paying more people overtime. That includes companies like Medicaid-dependent healthcare employers—because Medicaid reimbursement rates are not going to increase—nonprofit employers whose funding comes from grants and donations and they can’t raise prices in order to make up the money, and also, colleges, universities and other public employers.

Jennings: There are no—correct me if I’m wrong—there are no regional differences across the board. It’s national?

McCutchen: That’s right. They’ve decided on one rate nationally, that $679 per week, $35,380 annually. They have been considering doing regional differences or even differences by industry. Personally, I think that would add complexity, much like state and local minimum wage laws. Employers don’t really need any more complexity in their lives. But at this level, at the $35,000 level, I don’t think regional differences are necessary because that’s a level that should work all over the country. It doesn’t seem like a rational level for employees in California and in New York, but individual states can adopt a higher minimum salary level for exemption. California and New York are already above $35,000. They’ve decided on a salary level that works in those states, and this is meant to be a national level, so it needs to work and not cause undue economic harm in the rural south and Midwest. And I think that’s the focus of DOL on these proposed regulations.

Jennings: How does this interplay with the highly compensated employee threshold?

McCutchen: I’m glad you said “threshold” rather than “exemption,” because the highly compensated issue, that’s not a separate exemption; it’s a separate test. The highly compensated test, which we added in 2004, provides a more streamlined way to do these tests if you’re paid total compensation annually over a certain level. Currently that’s $100,000 a year. That again was set in 2004. It’s almost 15 years since we set that number in 2004, so I think everybody agrees both the minimum salary level and the highly compensated level are due for an increase. So if you have an employee who earns over that highly compensated level, they have to meet less stringent duties tests. The rationale behind that is the higher your pay, the more likely you are to qualify for the exemptions. And so this was just a shortcut. Now, here’s what’s interesting about the proposed regulations. In 2016, the final rule would have increased that level from $100,000 a year to about $137,000. In this proposed regulation, they’re proposing to actually go even higher.

McCutchen: They have proposed to go from $100,000 to $147,000. So they are actually higher than the 2016 final rule. I think that a lot of businesses and trade associations probably will question going to that high a level and how they got there. And now this is a little bit complex, but here’s how they got there. For the $35,000 minimum salary level, they went back and used the methodology that we used 2004 and that is for the minimum salary. They are setting it at the 20th percentile of all salaried workers in the lower-wage South and retail sector. As you may recall in 2016, they used a 40th percentile level for the highly compensated test. You use the same methodologies they used. In 2016 they set it at the 90th percentile of all salaried employees across the nation. I think the challenge to that is it means that employers in the rural South and Midwest and then the restaurant and retail industries basically will be priced out of even trying to use that highly compensated test. So I don’t know. I’m hoping to see that lower in the final rule. I’m hoping for them to use a methodology in the final rule that looks only two salaries in the South and in retail sector, just as they did on the minimum salary level.

Jennings: To close up this topic of the white-collar overtime exemption, what are some risks that employers could face assuming this rule goes into effect?

McCutchen: I see two risks. I feel that some employers may not be able to come into compliance with the final rule by its effective date set by DOL. Now, DOL has stated that they would like to have the new rule go into effect on January 1, 2020, but that’s understandable because of course 2020 is a presidential election year and they would want to get this regulation done well before the election. But they have a lot of work to do before they can publish a final rule. DOL is giving 60 days to file comments on the proposed rule and that gets us to about May 21st as I mentioned. Those hundreds of comments, they have to read them, they have to write the final rule and they want to do that all so that they have an effective date by January 1, 2020. If they can get all of that done by October, November, you may only have two or three months to comply and in my experience coming into compliance, including reclassifying employees from exempt to nonexempt, can take twice that long.

McCutchen: Second, the risk that I want to point out is there is a provision in the proposed regulations that’s carried over from the 2016 final rule that would allow employers to use bonuses and commissions to meet up to 10% of that minimum salary level. So instead paying the $679 in salary, you can pay 10% of $679 in bonuses or commissions. That sounds great, but what I fear is that employers trying to take advantage of that will not implement it correctly and will end up shorting the exempt employees on their guaranteed pay. And if the employees have not been paid the required minimum salary for exemption, then they’re not properly classified as exempt and the employer could be held liable for overtime pay, even if they only shorted a nonexempt employee by a dollar. And so they could face class action lawsuits claiming that these employees not qualify for the exemption because they didn’t get their entire full guaranteed pay. I do intend to file comments with the DOL to urge them to provide some options, better options to ensure that employers do not face large liabilities for very small mistakes trying to use that 10% rule. And to your listeners today, what I would say is don’t try to use that 10% rule without first consulting an expert wage and hour attorney, because you really do need to get it right.

Jennings: So it sounds like there’s a very short window to plan for this and prepare for it and lots of foot faults. Also on the topic of overtime, there’s some development on the regular rate of pay front, some new rules being brought forward there. First of all, what is the regular rate of pay, and what might be changing?

McCutchen: There’s a lot of misunderstanding out there, even among HR professionals, about the overtime pay rates. So let’s go back to that. Overtime is not calculated as 1.5 times an employee’s hourly rate. By statute, it’s 1.5 times an employee’s regular rate of pay. And that’s a defined term in the statute. So the regular rate of pay includes hourly wages, of course, salary if you’re paying your nonexempts on a salary. But it also must include most other types of compensation: shift premiums, on-call pay, bonuses, commission. So regulations on the regular rate is where DOL sets the rules on what types of compensation must be included in the regular rate and how overtime pay must be calculated. And there’s been a lot of confusion for a lot of years about what bonuses do you have to pay overtime on.

McCutchen: We don’t know yet what issues DOL is planning to address with changes to these rules. But you know, it’s an opportunity for them to give us more legal certainty, more clarity about what types of compensation you pay overtime on. There’s been some litigation and legal uncertainty on newer types of benefits such as tuition reimbursement, employee discounts, childcare subsidy. Do you have to pay overtime when you provide your employees with tuition reimbursement benefits? I do hope DOL takes the opportunity to clarify these rules. To me—and you might agree or disagree—I think if employers are told that they have to pay overtime on tuition reimbursement or childcare subsidies, we’re seeing the end of providing that type of benefits to employees. Because it’s just too risky and there’s too much potential liability.

Jennings: Is this something that is going to have a midterm or short term impact, or is it more in a wait and see area?

McCutchen: Well, right now I think it’s a wait and see because we know that DOL has plans to prepare these draft regulations, but that they haven’t yet been sent over to the White House. So it’s on DOL’s agenda, but we really don’t know enough about them for even employers to start to prepare for them. So I think we are in wait and see. But having said that, I always encourage employers to audit their pay codes to determine which pay codes should have been but are not being included in the regular rates and overtime calculations by their payroll systems. Pull up a list of your pay codes, pull up the list of exemptions from the regular rates that are in 29 U.S.C. § 207(e). And corrections are easy, right? You just tell your payroll vendor or you reprogram your payroll system to make sure all types of compensation that you pay overtime on are included in that calculation. So you should always audit. I’m a big believer in auditing and this is one area where auditing, it’s pretty simple.

Jennings: Moving on to our last topic, the joint employer definition is an area where the Department of Labor has moved to adjust some guidance. The question I would ask is could you give us an overview of what the joint employer definition is, where is it now, and what might be changing?

McCutchen: Joint employer as an issue has gotten a lot of coverage in the context of unionization under the National Labor Relations Board. But frankly I think it’s an even bigger issue for DOL because under the FLSA, a company is jointly liable for all violations by a business partner who’s deemed to be a joint employer. Now just can you imagine this, a national franchise brand being responsible for paying the back wages for all FLSA violations by any and all of its franchisees? Your company being responsible for violations by all of its subcontractors? The law is totally unclear on this issue. There is no definition of joint employment in the FLSA itself. The DOL regulations are vague and outdated and different federal courts have adopted very different tests on when you’re a joint employer and when you’re not. So DOL on this, they have actually sent their draft proposed regulations over to the White House for review. That happened at the end of February. We don’t have any word yet on when the DOL will publish those proposed regulations, but we could see them very soon, in the next month or so even.

Jennings: So it sounds like that’s a little bit of a wait and see pattern, along with regular rate?

McCutchen: I think that’s right. A wait and see. No action needed now, but it is an area of high risk for any employer who has business partners, subcontractors, uses temporary staffing agencies. So employers should keep their eye out for the DOL to publish these proposed regulations. And just in general, you should review your relationships with subcontractors, vendors, staffing agencies to ensure that you minimize your control that you exercise over the employees of your business partners, and prefer business partners who will indemnify you and can pay for any claims brought by their employees against your company as a joint employer. Those are things you should be doing all the time, but on the regulations for now, just keep your eye out for the DOL to publish.

Jennings: We’ve discussed three developing areas: the white-collar overtime pay developments, and developments around the definition of regular rate and joint employer. What should employers—whether they’re HR professionals or in-house counsel—what should employers be doing now to get ready for those changes or those potential changes?

McCutchen: Right now I would like your listeners to focus on the overtime regulation first. Whether you support DOL’s proposal or have objections to their proposal, DOL needs to hear from you. As I mentioned, you can read and file comments on the proposed regulations by going to regulations.gov. You’ll see a big blue button that says “comment.” Now you just click on that and you put your comments in the text box that appears on the screen. You can also easily upload a letter from your computer.

McCutchen: Secondly, I urge your listeners to begin to prepare. Now don’t wait until the final regulations on the salary issue. Pull a list of all of your exempt employees making, say, below $38,000 a year. We might see a slight increase from the proposed $35,000 from DOL in the final rule, but I don’t think it will go higher than $38,000. And although these regulations are just about salary, you should also look to audit your job duties as you are reclassifying employees to come into compliance with the regulations from a salary level. It’s also a great time to reclassify employees that do not also meet the job duty requirements. And I’m sure everybody listening to this podcast can think about a couple of jobs in your company that you’ve always been uncertain about, or you even know that they’re misclassified. So if you do it right now during this regulatory process, there’s going to be less disruption to your business, less risk of litigation if you reclassify everyone at the same time.

McCutchen: In the past, exemption audits have been a lot of work reviewing documents, job descriptions, training materials, etc., conducting interviews of managers who are subject matter experts in the job duties, conducting legal research, drafting an opinion. But now I am pleased to tell everybody at ComplianceHR, we’ve done almost all of this work for you. Just complete an online questionnaire in our Navigator OT app and you will get an instant assessment of the risk of classifying the employee as exempt from overtime. That’s based on a database of over 2,400 decided and published cases. Just let me close with this. If you’d like more information about the Navigator OT app, ComplianceHR, or a free trial, you can visit ComplianceHR.com or you can email me at tammy@compliancehr.com.

Jennings: Great, and I will be sure to put links to those websites on the show notes for today’s episode. Tammy, thank you for joining The HR Risk Podcast.

McCutchen: Thank you for having me.

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