One of the greatest challenges facing any company is the ability to attract and retain talent. Companies continually face internal and external pay equity issues, succession planning, diversity, training, development, and everyday management.
In addition to employment-related claims, matters involving these topics have the potential to negatively impact a company’s reputation. Furthermore, all of these human capital considerations come with a steady drumbeat of cost and compliance implications.
The cost impact of the Department of Labor’s (DOL) Overtime Ruling:
Estimates show more than 50 percent of employers have misclassified employees under the Fair Labor Standards Act (FLSA). The cost of non-compliance is significant when considering penalties, legal fees and reputation. A report last year noted non-compliance costs businesses an average of $14.8 million.
Conducting an audit to minimize compliance risk is a proven way to be proactive in avoiding any potential issues. The audit will identify any misclassifications and determine who will be eligible for overtime regardless of any implementation of the proposed rules. The proposed rules only complicate matters by increasing the threshold under one facet of the test, thereby making it even more costly to comply.
Many employers are under the impression that if the DOL’s proposed exemption rules require them to reclassify employees from exempt to non-exempt, they will have to pay those newly reclassified employees on an hourly basis with overtime calculated at a rate of 1.5 times the potential hourly rate. While an hourly rate is the most common way to pay non-exempt employees, the FLSA’s implementing regulations contemplate a number of other pay plans such as a day rate, a piece rate, and a salary.
A review of job duties and responsibilities to determine if there are any warranted adjustments, and if other exemptions are met, needs to be conducted. However, the written changes must be realistic if challenged by an external party.
Unintended Consequences of the Proposed Rules:
If the proposed rules result in an increase in workers’ earnings, employers will have to manage how to handle or offset the anticipated cost of paying overtime or its equivalent. Some possible outcomes and unintended consequences include:
- Adjusting Benefits –Aside from the Affordable Care Act, there are very few laws, federal or state, that require businesses to provide any benefits. Employee Retirement Income Security Act (ERISA) is not a mandate, but simply stated, it provides that certain rules need to be followed if a business decides to render particular benefits. Some exempt employees will be eligible for additional benefits or perquisites that they will lose when reclassified as non-exempt. Higher overtime costs could make it more likely that ancillary benefits such as dental, vision and disability coverage are converted from company-issued benefits to voluntary benefits.
- Compliance with Non-Discrimination Standards – It is difficult to base eligibility for benefits such as medical, dental and vision (typically established in a Section 125 plan) on hourly (non-exempt) or salaried (exempt) status. If a plan is self-insured, it will be even harder to change eligibility status tied to hourly or salaried status.
- Changing 401(k) or Pension Formula – The overtime rule could have implications for sponsors of 401(k) and similar retirement plans, depending on the inclusion or exclusion of overtime pay and/or bonuses in the plan’s formula for employer contributions. If the plan includes overtime pay in the contribution formula, costs could increase, tied to how the employer addresses compliance with the final rule. Plans that have definitions of compensation that exclude overtime pay could experience a bias toward highly compensated employees (HCEs), resulting in nondiscrimination testing failures, as qualified retirement plans are subject to annual nondiscrimination testing to make sure they don’t discriminate in favor of HCEs.
- Altering the Formula and/or Definition of Compensation for Life Insurance or Disability; Changing Eligibility – Similar issues exist under the definition of compensation for benefits such as life insurance and disability. Furthermore, with certain companies, ancillary benefits might only be an offering to salaried employees. Thus, with a potential change in classification, companies may now need to extend to others.
- Impact on Paid Time Off (PTO) – Benefit offerings that can be richer for salaried workers include the number of vacation days and PTO provided. In addition, the cost of PTO may grow because of adjusting compensation.
- Effects on Salary Bands/Compression/Trickle up Effect – Rising employee pay to retain exempt status will not only be potentially expensive but may lead to pay compression throughout the salary structure. This will have the impact of adjusting salaries above those directly affected by the new FLSA. Alternately, as overtime pay comes out of overall compensation budgets, employers may adjust hourly rates lower for reclassified employees to consider the demand to pay them for overtime work. For example, an employer could adjust compensation for an employee making at or close to the new threshold and working 50 hours a week. Under this scenario, an employer could lower his or her wage rate to an equivalent when overtime pay is calculated. The danger to the employee is when the next push for reduced labor costs occurs, an employer limits overtime and the employee may not have the opportunity to work over 40 hours per week.
- Internal and External Pay Equity – Any changes to compensation require a review with an eye to internal and external pay equality considerations.
How to Prepare
Organizations should create an action plan to determine the influence of overtime pay modifications:
- Review employees currently classified as exempt who will fail the new salary tests as well as HCE employees who will also fall below the $122,148 proposed level.
- Review all job descriptions to determine whether they are still accurate, reflect the jobs performed and the skills necessary to perform the job.
- Conduct market study of wage rates to determine overall competitiveness of pay as the data will be useful in establishing solutions.
- Determine if overtime pay for current non-exempt employees is properly calculated.
- Create a list of employees who are currently listed as exempt and earn a base pay slightly above the current threshold and:
- Estimate or determine overtime
- Review incentives or other bonuses paid
- Determine expected pay amounts to maintain the exemption to be used as part of alternate strategy
- Identify employees that will be reclassified as non-exempt and develop appropriate strategies.
Some version of the proposed rules will be adopted. Companies cannot simply view this in isolation and should espouse or continue to follow a total compensation approach that will permit them to offer a package to remain an employer of choice. This should comprise of designing creative and compliant programs aimed at meeting the diverse requirements of the entire workforce. These alternate programs must offer choices without imposing the costs of traditional benefits. Communication plans to carefully share intentions and strategies are also vital to the overall success of the adopted changes.
Written by Elliot Dinkin.
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