Payroll in Practice: 4.29.2024

Question: What should employers consider as a result of the updated overtime rule, and how should payroll departments prepare?

Answer: On April 23, 2024, the US Labor Department announced a final rule updating exemption requirements under the Fair Labor Standards Act. The rule increases the standard salary level required for FLSA exemption and the total annual salary compensation threshold for exemption as a highly compensated employee. It also provides for periodic updates of the earnings thresholds.

The FLSA requires that each of three tests be met before an exemption can apply to a particular employee. First, the salary-basis test requires that the employee be paid a predetermined and fixed salary that is not subject to reduction because of variations in the quality or quantity of the work performed. Second, the salary-level test requires that the amount of the salary paid meet a specified amount. Third, the duties test requires that the employee’s job duties primarily involve executive, administrative, or professional duties as defined by the regulations.

The rule is set to take effect in stages. The first update takes effect on July 1, 2024, with an update to the minimum salary requirements. A second increase will occur on Jan. 1, 2025. The rule provides for additional adjustments to take place on July 1, 2027, and every three years thereafter. Adjustments will be determined based on available salary level data and the methodology for setting the salary level that is in effect at the time the update occurs.

Effective July 1, 2024, the 2024 final regulations require a standard salary of $844 per week (equivalent to $43,888 annually) and annual compensation for the highly compensated employee exemption of $132,964 including at least $884 per week from salary and fees.

Effective Jan. 1, 2025, the 2024 regulations require a standard salary of $1,128 per week (equivalent to $58,656 annually) and annual compensation for the highly compensated employee exemption of $151,164 including at least $1,128 per week paid on a salary or fee basis.

Computer professionals have a special rule where the salary level test may be met by either payment at least the standard weekly salary or by payment at an hourly rate of not less than $27.63. This hourly rate is not indexed and has not changed under the rules issued for 2004, 2020, or 2024.

The changes in the 2024 final rule relate primarily to the amount of salary required for an employee to be considered exempt from overtime compensation. The duties tests and the salary-basis tests were not changed under the final rule. For many companies, the salary level changes may involve revisions to employee compensation policy or reclassification of currently exempt employees to nonexempt status.

While policy and contract changes are the responsibility of a company’s owners or top-level managers, payroll departments need to ensure they have the resources to handle changes in processing and record keeping due to employee status changes. Reclassified employees may require training in time tracking and reporting procedures.

The timing of the changes may also be a concern. Employers have just two months to implement the July 1, 2024, changes. The January 2025 salary level change occurs during year end processing when payroll departments are particularly busy with year-end closing, reconciliation of accounts, and information reporting,

Payroll may be asked to help identify employees classified as exempt whose salaries fall between the current salary requirement of $684 and the $1,125 required on Jan. 1, 2025. This information would assist management in determining the best way to ensure compliance for each employee.

Payroll processing systems may have to be expanded or updated for changes in volume or payment method. For example, if the employer intends to convert some previously exempt employees to the fluctuating workweek method of computing overtime compensation, the affected employees will have to be notified and trained prior to the changes. Any required systems updates must be tested before going live.

The payroll department should be included in the planning of policy and procedures for implementation of the new rules so that it is aware of its responsibilities and resource requirements. This may prevent or mitigate unworkable timelines or policies. Payroll professionals may help management understand the new rules and the requirements, effects, limitations, and potential consequences of certain decisions.

Payroll may also provide information that helps ensure that any changes made by the employer comply with state requirements as well as the FLSA.

Modern History of FLSA Changes

The last major change to the exemption tests occurred in 2004 when a two-tier duties test was in effect. Each tier had its own salary-level requirement with the lower salary level paired with a longer, more stringent duties test, while the higher salary level was considered as part of the basis for exemption and a less stringent “short” duties test was used in applying the test. The 2004 rule adopted the features of the short duties test and discontinued the alternative long duties test and salary level.

The 2004 changes set the standard salary level at $455 per week (equivalent to $26,660 per year) and the annual compensation for highly compensated employees at $100,000.

A final rule issued in 2016 increased the standard salary level to $47,476 ($913 per week) but was blocked by federal court before it became effective. Although the new rate was written into the regulation, the WHD adopted a nonenforcement policy and the 2004 rates remained in effect until Jan. 1, 2020, when rules issued in September 2019 became effective.

The 2020 rule changes are currently in effect. The standard salary level is $684 per week (equivalent to $35,568 annually) and $107,432 for the highly compensated employee exemption. This rule also permits the inclusion of nondiscretionary bonus amounts of 10% the standard salary in reaching the $684 required weekly salary. This means that the test may be satisfied with salary and fee payments of at least $616 supplemented by $68 from bonus payments.

For the highly compensated employee exemption, the employee must be paid at least $684 per week in salary and fees, but the remainder of the annual salary requirement can be met using nondiscretionary bonuses and other nondiscretionary compensation including commissions.

This column does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., or its owners.

Author Information

Patrick Haggerty is the owner of a tax practice in Chapel Hill, North Carolina, and an enrolled agent licensed to practice before the Internal Revenue Service. The author may be contacted at phaggerty@prodigy.net.

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