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California Can No Longer Ignore Federal Classification Rules

August 11, 2016 Hilary Weddell

The U.S. Department of Labor recently announced its highly anticipated federal overtime rule under the Fair Labor Standards Act (FLSA).  The new rule updates the minimum salary requirement for employees to be considered exempt from FLSA’s overtime provisions.

Until recently, the federal rule governing classification of employees as exempt was generally irrelevant to California employers because the state’s salary-basis test exceeded federal standards.  The new federal rule is now very important, as the new federal salary threshold is higher than California’s minimum.  Because employers must comply with the law that gives the most protection to employees, employees will only be considered exempt if they earn more than both the state and federal minimum requirements.

Salary-Basis Test Under California Law

California’s test, codified in California Labor Code Section 515, requires that an exempt employee earn at least two times the state minimum wage for full-time employment. Full-time employment is defined as 40 hours per week; the minimum wage threshold cannot be prorated if an employee works part-time.

The current California minimum wage is $10 per hour, making the current minimum salary for an exempt employee under California law $800 per week, or $41,600 per year.

Minimum Salary Threshold Under Federal Law

Since 2004, the federal regulations required a minimum salary of $455 a week, or $23,660 a year, for exempt employees.  Starting December 1, 2016, the new rule raises the minimum salary threshold to $913 per week, or $47,476 per year.  To ensure the salary threshold will not become outdated again, a provision automatically updates the amount every three years, beginning January 1, 2020.

The new rule also increases the annual compensation requirement for the special exemption for “highly-compensated” employees who meet a minimum duties test from $100,000 to $134,004 annually.  California law does not contain a similar rule.

Compliance Options for California Employers

Employers who have employees classified as exempt but whose salary levels are below the new federal minimum level have a number of options for compliance.  To maintain an exempt status the employees’ salaries must be increased to an amount greater than that required by the new federal regulations ($47,476 per year).

Alternatively, the employee may be converted to nonexempt, and be paid either a set salary or a set hourly rate.  Importantly, the nonexempt employee must keep track of hours worked, and is entitled to overtime for hours in excess of 40 hours per week or eight hours per day.  Employers that wish to reduce overtime pay may want to reevaluate the workloads of employees previously classified as exempt and hire additional workers.

This is not a static area, so employers should pay close attention to the salaries of exempt employees to comply with California minimum-wage increases and increases to the federal threshold.  California’s minimum wage will increase in 2017, with annual increases each year reaching $15 an hour in 2022.  When California’s minimum wage hits $12 an hour in 2020, the minimum yearly salary for exempt employees under state law will be $49,920 per year, surpassing the new federal requirement.  However, remember that 2020 is also the year the federal threshold automatically increases to match the 40th percentile of weekly earnings of full-time salaried workers in the lowest wage Census Region (currently the South).  Therefore, until at least 2020, but possibly thereafter, the federal minimum salary for exempt employees will be higher than that required by California law.

Employee morale is often a concern when reclassifying employees.  Workers may feel the “exempt” status is prestigious and newly nonexempt employees may feel they have been demoted when asked to start punching a time clock.  Misclassification of workers as exempt however is one of the most litigated issues in the employment realm, and some of the largest awards of back pay by the courts stem from misclassification.

Opportunity for Audit

Remember, to qualify for the exemption, employees must not only be paid a certain amount, but must also fulfill certain tests regarding job duties.  This change in the law provides employers with an opportunity to review exempt employees’ job duties and ensure they are properly classified.  If an employee is classified as exempt but does not meet the duties test, the employer must convert the employee from exempt to nonexempt.  Such a conversion may raise red flags, alerting the employee that he or she may have previously been misclassified and thus potentially have a claim for unpaid overtime or meal and rest-break premiums.  The change in the federal salary test, however, provides employers with a window of opportunity to audit their classifications and make any necessary changes.

Hilary Weddell is an attorney with McManis Faulkner whose practice focuses on employment law.  She relies on her business background to help counsel and represent clients ranging from small businesses to Fortune 500 companies in a wide variety of industries.