Overtime Rule Puts Focus on Incentive Pay

The Department of Labor's (DOL's) final rule revising the Fair Labor Standards Act overtime regulations takes effect on Dec. 1. Under the final rule, the annual salary threshold for exempt positions will jump from $23,660 to $47,476 (or from $455 to $913 per week) and will be updated every three years.

A separate duties test is used to determine whether employees earning more than the salary threshold must, nevertheless, still be classified as nonexempt from overtime—if they fail to meet the exemption for an executive, administrative or professional position.

Can incentive pay be used to meet the salary test?

The final rule amends the salary basis test to allow employers to use nondiscretionary bonuses and incentive payments (including commissions) to satisfy up to 10 percent of the new standard salary threshold, provided these payments are made on a quarterly or more-frequent basis. Previously, there had been no regulatory provision to count incentive pay toward the salary threshold.

What's a nondiscretionary bonus?

Employees can earn a nondiscretionary bonus if they meet performance or productivity goals set by the employer. It's considered "nondiscretionary" because if the goals are met, "there's no question about whether it's going to be paid out or not," said Meg Ferrero, assistant general counsel at payroll and HR services firm ADP in Parsippany, N.J.

[SHRM members-only HR Q&A: Must bonuses be included in overtime pay calculations?]

FLSA Overtime Rule Compliance

For more overtime compliance news, tips and tools, check out the SHRM resources provided below:

· FLSA Overtime Rule Resources Guide
· Compliance Checklist· Infographic

Examples of nondiscretionary bonuses include bonuses promised in an agreement (such as an employment contract or collective bargaining agreement); bonuses tied to performance evaluations; incentive plan bonuses; or any bonuses based on a set criteria for an employee, a group or an entire company.

Nondiscretionary bonuses also include service anniversary bonuses, attendance bonuses, bonuses tied to working undesirable shifts (sometimes in the form of shift differentials), production-oriented bonuses and retention bonuses.

What determines a "quarter"?

To count toward the standard salary level, nondiscretionary bonuses must be paid at least quarterly. "Quarterly" does not necessarily mean a calendar quarter, however. It is the employer's discretion when the quarter will begin, DOL guidance clarified.

What about holiday bonuses?

An unannounced holiday bonus is considered discretionary because the bonus is entirely at the discretion of the employer and therefore could not satisfy any portion of the $913 standard salary level, the DOL confirmed.

[SHRM members-only HR Q&A: What types of compensation can an employer include in an exempt employee's salary to meet the FLSA minimum salary requirement?]

Are there risks when relying on incentive pay to reach the salary threshold?

Under the final rule, if an employee does not earn enough in nondiscretionary bonuses and incentive payments in a given quarter to retain his or her exempt status, the employee must receive overtime pay for all hours worked over 40 in a workweek during the quarter, at a rate not less than time and a half his or her regular rate of pay. Alternatively, employers are permitted to make one "catch-up" payment to the employee at the end of the quarter to compensate for the shortfall. That's an unplanned expense most employers would prefer to avoid.

"If we're talking about commissions or bonuses that might not be earned from period to period, then relying on those payments to get an employee over the salary threshold could put the employer at risk," Ferrero noted.

According to the DOL, any such catch-up payment will count only toward the prior quarter's salary amount and not toward the salary amount in the quarter in which it was paid. If the employer chooses not to make the catch-up payment, the employee would be entitled to overtime pay for any overtime hours worked during the quarter.

Can you provide an example?

Morris Communications Co., a newspaper and magazine company based in Augusta, Ga., has about 1,800 employees nationwide, and just under 300 of those employees hold professional positions that will lose their exempt status under the new rules, said Sally Roberts, SHRM-SCP, the company's director of HR. Using bonuses and other types of incentive pay to keep employees above the threshold is "an idea our compensation manager and I have kicked around a bit because it could be a win-win," she said. "If employees are productive or saving money and we're able to give them a quarterly bonus that will help toward the threshold, then we might be more eager to do that versus increasing base pay" to maintain their exempt status.

Ten percent of the threshold is $4,747.60, which would be the maximum amount that could be applied, "but if you're awarding a bonus based on performance metrics, you'd have to structure the incentive so that, if the top target is missed, the payout would still be sufficient to get those employees over the threshold. It's a little tricky, and we'll need to carefully model it and see if it's appropriate. But it's intriguing," Roberts said.

[SHRM members-only how-to guide: How to Calculate Bonuses into a Regular Rate of Pay for Overtime Purposes]

Are the rules different for highly compensated employees?

For highly compensated employees (HCEs) who may generally be considered exempt without regard to the duties test, the final rule raises the annual HCE salary threshold from $100,000 to $134,004.

According to DOL guidance, to claim the HCE exemption under the final rule, employers must pay workers at least the standard exempt-employee weekly salary level of $913 per week/$47,476 per year on a guaranteed basis, while the remainder of an HCE's total annual compensation may include commissions, nondiscretionary bonuses and other nondiscretionary incentives.

In other words, employers may fulfill almost two-thirds of the HCE total annual compensation requirement—up to $86,528 annually—with nondiscretionary incentive compensation.

Related Resource:

DOL Fact Sheet: Treatment of Bonuses for Exempt White Collar Employees

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