In May 2016, the Department of Labor issued new final overtime rules that update the thresholds for classifying workers as nonexempt and highly compensated. The controversial changes will increase pay for more than 4 million workers, setting the income threshold for exempt workers to the level it would have reached if the threshold hadn’t been frozen more than a decade ago.

That’s good news for lower- and middle-income families, but it could be costly for employers who are forced to foot the bill and implement changes to their payroll systems. Here’s what you need to know to comply by the final rule’s effective date of December 1, 2016.

Exempt vs. nonexempt

Under the Fair Labor Standards Act (FLSA), “nonexempt” employees must receive pay for hours worked in excess of 40 in a workweek at a rate of not less than one and a half times their regular rates of pay. In other words, a nonexempt worker who’s regularly paid $12 an hour would earn $18 for each hour in excess of 40 in a given workweek. Who’s nonexempt? The answer requires employers to apply a two-part test.

The first part is a simple income threshold. Under existing law, employees who earn less than $23,660 a year (or $455 a week) are nonexempt and must be paid overtime. The new rules more than double the income threshold for nonexempt workers to $47,476 a year (or $913 a week).

Conversely, employees who are highly compensated are automatically exempt from overtime pay. The current threshold for highly compensated employees of $100,000 a year will increase to $134,004 a year under the updated DOL guidance. This income threshold generally includes nondiscretionary bonuses, incentive pay and commissions that occur at least quarterly and don’t exceed 10% of the employee’s compensation. Both income thresholds (for nonexempt and highly compensated employees) will be adjusted every three years, starting in January 2020.

The second part of the overtime test is for employees who earn between $23,660 and $100,000 (which will increase to between $47,476 and $134,004 under the new rules). Classifying these middle-level employees as exempt vs. nonexempt depends on a duties test. Employees who “primarily perform executive, administrative or professional duties” are exempt and don’t require overtime pay.

Critical impacts

Millions of workers will be reclassified under the new DOL rules. The results of these changes are twofold:

  1. More workers earning $23,660 to $47,475 a year will be eligible for overtime pay. It doesn’t matter if the worker is salaried or performs managerial or administrative duties; nonexempt workers below the threshold automatically qualify for overtime pay.
  2. Workers earning $100,000 to $134,003 a year may also qualify for overtime pay under the new rules, depending on the type of work they perform.

These changes will affect most manufacturers. Their payroll costs will likely increase, and the changes could end flexible work arrangements that factory workers value. For example, under the new guidance, you can’t allow nonexempt employees to work 45 hours one week to make up for a week in which they work only 35 hours without paying overtime pay for the workweek that exceeds 40 hours.

Legitimate ways to avoid overtime pay

Diligent employers can minimize overtime costs without violating the FLSA. For example, you can closely monitor how many hours nonexempt employees work and limit their hours to 40 per week. If you need extra help during peak times, you can hire temporary or part-time workers or independent contractors to fill the gaps.

Also consider giving slight raises to employees near the nonexempt and highly compensated thresholds. Doing so may actually decrease your compensation costs after you factor in the incremental costs of overtime pay. You can also cut back on benefits and perks to offset these costs.

Over the long run, you may decide to automate certain functions, instead of relying on human labor. You may have previously crunched the numbers on investing in automated equipment and decided against it, but the decision may be worth revisiting now that the cost of direct labor is rising.

The clock is ticking

Employers must comply with the DOL’s new overtime rules by December 1, 2016. If you haven’t already updated payroll systems to comply with the changes, contact your tax and payroll advisors immediately. There’s still time to help you comply with the FLSA, brainstorm ways to reduce (or eliminate) overtime pay and evaluate how the new rules will impact your bottom line.