The new regulations on exemptions from overtime are out and they’re going to have a big impact on some small businesses and no impact on others…

I’m not writing this post to argue whether or not the rule change is good or bad…

The new rules on exemptions from overtime are here, and I’m going to help you get through the change.

Here’s the good news…

The new regulations don’t take effect until December 1, 2016. This means you don’t have to make any changes today. You can take some time and plan your move.

In this post we’re going to cover:

1) Who this rule change was designed to catch;
2) What makes an employee exempt from overtime;
3) Which salary (compensation) levels are going to be affected;
4) How bonuses and commissions play into the new regulations;
5) The impact on ‘highly compensated’ employees;
6) Which adjustments you need to make in your small business;
7) Your alternatives to paying overtime;
8) What are the morale and culture effects of this change?

Who are the new rules on exemptions from overtime designed to catch?

There’s a group of employees who supervise others and are not paid what some think they should earn. Many supervisors work 50 – 60 hours a week managing teams that report to them for less than $40,000 a year in salary.

It has been decided that that amount of compensation for that level of effort isn’t good enough. And so new overtime regulations have been created to increase their paychecks. In fact, the percentage of workers covered by the changes in the law will grow from 8% to 40%.

What makes an employee exempt from overtime?

There are two elements that tell you if an employee is exempt from overtime pay.

The first is whether or not they’re paid the same amount of money every week throughout the year. If you used the word salary in their offer letter whether it’s weekly or annually, and you don’t consider how many hours the employee worked when generating their paycheck, you may be attempting to define that employee as exempt.

The second is what kind of work they perform…

Does the employee do work that is designated under the Executive, Administrative, Professional, (EAP) or other smaller exemptions guidelines? This would be things like supervising or guiding the work of other employees, or making business decisions. The Department of Labor didn’t change this part of the definition; only the money.

Who’s affected by the new regulations on exemptions from overtime?

The new regulations basically double the weekly and annual salary ceiling under which everyone is to be paid overtime. The old weekly salary level was $455 and the old annual salary was $23,660. The new weekly salary will be $913 and the new annual salary will be $47,476.

After December 1, 2016 employees who are exempt and make less than $913/week or $47,476/year will be paid overtime after 40 hours in a week.

As an example, if you have a supervisor working for you who is a salaried employee and makes $35,000/yr, under the new regulations on exemptions from overtime pay, that employee will be paid overtime pay.

These salary thresholds will be adjusted according to inflation every three years. The first adjustment is scheduled for 2020. The Department of Labor estimates that the annual salary ceiling at that time will be adjusted up to $51,000/year.

How do bonuses and commissions play into the new overtime rules?

Some people who make policy actually understand that small business will make changes to compensate for these new rules and they’re trying to limit your choices…

The Department of Labor was concerned that some wily employers might apply discretionary bonuses and/or commissions to the salary of an employee in an attempt to state that the employee earned more than the $47,476/year and therefore the employer can avoid paying overtime.

To limit this, the new overtime regulations state that nondiscretionary bonuses and commissions cannot exceed 10% of the $47,476/year ($913/week) threshold.

Here’s an example: If you have an employee who has a base salary of $42,000 per year and they earn commissions of $4,000 that year then that employee will be entitled to overtime under the new rules. If that employee averaged had averaged 5 hours/week of overtime for 50 weeks that year, then that overtime would be worth $7,572.11. This would mean that the employee’s total compensation for the year would be $53,572.11 ($42,000 + $4,000 + 7,572.11).

Without the 10% limit an employer would be motivated to award an additional bonus of $1,477 ($47,476 – $42,000 – $4,000) to raise the employee’s compensation above the threshold and avoid paying $6,096.11 ($7,572.11 – $1,477) in overtime wages.

The Department of Labor took it a step further and will require that bonuses and commissions that can contribute to helping a business owner avoid the rule must be paid at least quarterly and be nondiscretionary. So you can’t pay any kind of bonus (discretionary or nondiscretionary) only on December 31st and cover yourself. Not allowed…

Remember, all of these numbers will change in 2020 when the first cost of living increase kicks in…

How does this impact highly compensated employees?

The “highly compensated employee” classification is still in the new regulations on exemptions from overtime pay. However the salary threshold was raised from $100,000/yr to $134,000/yr.

Which adjustments do you need to make in your business?

You may be moving some employees from the “salaried no-OT” bucket to the “hourly with OT” bucket…

First, take a look at your payroll and find everyone who earns no more than $47,476/year total compensation (base salary + commission + bonus) or $913/week salary. These are the employees that will become “hourly with OT” (non-exempt) on or before December 1, 2016.

Second, take a look at how much overtime they work each year to calculate the impact to your payroll liabilities.

So like we did above, you could have a $36,000/year salaried supervisor to whom you pay a $3,000 discretionary bonus at the end of the year. This employee is wonderfully loyal and routinely works 50 hour weeks. Under the new rules, you now have to pay this person overtime…

Would it be worth it to raise this person’s salary to $45,000/year and pay them a commission of $750 every quarter?

Let’s see…

Assuming this person works 50 hours a week 50 weeks a year their overtime would be valued at $12,980. Their total mandatory compensation would come in at $48,980/year before you pay the bonus (which you might not be able to afford after the new rules kick in)…

So changing their compensation to what I suggested a few sentences earlier would save you $980/year…

Do you have any alternatives to paying all this overtime?.?.?…

Absolutely.

Why not limit their overtime to 5 hours each week. Their compensation before bonus would come to $42,490. That would save you $6,490 each year. You’re still going to have to decide whether or not you can afford to keep paying a bonus after this change. And then you’ll have to have that conversation with your employee.

You might be thinking, “I still have 10 hours of work that has to get done every week. This doesn’t really help me much.”

There’s another alternative…

This supervisor’s overtime will pay one half-time employee $12.00/hr.

How can you redefine your supervisor’s duties and shift some work around so that you can mandate zero overtime and add the half-time employee?

Do you have other employees who have overtime that would allow you to also put them on a zero overtime rule and perhaps give your next employee more than 1080 hours each year?

Still looking for other alternatives?

Are there steps you could automate with new machinery or software to reduce the labor costs you’re going to absorb? How much should you invest to avoid the overtime?

If the 10 hours of overtime is mandatory you have $12,980/year for two years to invest in equipment. So $25,960 maximum which would include any finance charges as well. Your crystal ball can’t see more than two years into the future. Yes, this new overtime rule is a permanent structural change, but you need to get a return on your investment sooner rather than later. And don’t forget, you’d need to mandate a “Zero OT” policy for this employee.

If you think this employee could still end up putting in 2 hours of OT each week then your capital investment budget just shrank 20% to roughly $20,000…

A fourth option would be to outsource some of your work to another company. Do you have something you do that maybe isn’t part of your core competency that someone else might do just as well for a fixed fee? You have until December 1, 2016 to find that company. This might allow you to shift some responsibilities and reduce your overtime.

Here’s a fifth option. Grow sales enough in the next 6 months that you can add an employee, shift some duties around and cut overtime. A slight twist on this would be to find a friendly competitor who might move some work to you giving you more revenue and hours to work so that you can shift responsibilities and you both avoid the pain of the new regulations on overtime.

How will the new regulations affect morale and culture in your business?

If you hadn’t already started tracking hours worked to comply with the Affordable Care Act, the new overtime rules should motivate you to do this. You’re going to need to track hours worked to forecast how much this rule is going to cost your business.

Start tracking time immediately for all of your employees.

Why?

You’re going to be forced to move someone from salary to hourly. For some people, being a salaried employee is a status symbol. They won’t like becoming an hourly employee even if it’s not your idea.

Track time for every employee so that no-one feels singled out.

You may also have to move around some responsibilities. Be very thoughtful and deliberate about this. Don’t be wishy-washy…

And when you change your job descriptions, you could be changing some of the processes inside your business. Take your time and think through everything.

I have no doubt that you will have an employee that fits into the situation we’ve been talking about asking you how this is going to work. They may have already sat down and started looking forward to how they’re going to spend all that overtime pay…

You need to address this NOW rather than on November 30th. Have an open and honest conversation with your affected employees. Explain that your responsibility to them is to manage the business properly so that everyone has a job after this rule goes into effect…

That means you’re going to be evaluating how to manage the transition and how to limit the expense of the new overtime rules. Tell them that they shouldn’t expect to receive all the overtime that the new overtime regulations say they will be paid. Let them know that you’ll keep them informed when you have your choices narrowed down, and that they will certainly know your plans on or before December 1st, 2016.

Lastly, make sure you let them know how much you value their contributions to your business and that’s why you want to have an open and honest discussion about this change before it arrives on your doorstep.

If you have any questions about this, leave a comment below or get in touch with me directly from my about page or on Twitter or Facebook. I’m more than willing to help you through this transition.

Also keep in mind that different states have different rules about overtime. You should certainly talk with a lawyer to specializes in wage & hour and labor issues to make sure you’re doing things properly.

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