By: Kevin M. Young

Seyfarth Synopsis: With the DOL’s new overtime exemption rule weeks from taking effect, employers must consider the impacts of reclassifying exempt employees. Some potential impacts are obvious, others not so much. Proactive, thoughtful planning is key for employers to navigate these waters for their business and impacted employees alike.

With the U.S. DOL’s final overtime exemption rule taking effect in a few weeks, many employers are deciding whether to reclassify certain salaried exempt employees. Because the DOL’s primary change—a moderate increase to the salary threshold for exempt executive, administrative, and professional employees on July 1, followed by a substantial increase on January 1—seems simple on its face, an employer’s decision-points may seem simple, too. But like most things relating to employee classification and pay, reclassifying an exempt employee presents rippling impacts that must be accounted for—some obvious, others less so. We explore five potential impacts below.

1. Reclassification + Budget Impacts

Employers who reclassify exempt employees to nonexempt status will need to decide how, and how much, to pay the impacted employees.

There are plenty of options available to employers for paying non-exempt employees, from a traditional hourly rate, to a weekly salary, to day or piece rates—and various other options (or combinations of options) in between. Whatever the method, however, as a general matter the employee must accurately record their hours worked, and the employer must pay at least minimum wage plus a statutory premium for any overtime hours worked.

With the flexibility available to them, employers can craft a compensation plan aimed at maintaining cost neutrality after reclassification. But an employer’s ability to realize that goal depends on their ability to accurately forecast impacted employees’ overtime work. If the employees work more overtime than expected—whether on a weekly basis, or on a daily basis in states with daily overtime requirements—labor costs will grow. If they work less than expected, the employer will fall short in its effort to ensure a cost neutral impact for the employee.

In short, employers reclassifying employees to nonexempt status have decisions to make with respect to how and how much they will pay impacted employees. Their ability to accurately budget for overtime costs depends not only on the method and rate of pay they choose, but also on their ability to accurately forecast their employees’ workloads going forward.

2. Reclassification + Work Habits

Many exempt employees enjoy freedom to manage their schedule as they deem fit, as long as they get the job done. And especially post-pandemic, many also are entrusted to work remotely. This flexibility aligns not only with the discretion that defines many exempt roles, but also with the notion that an exempt employee’s salary is intended to cover all of their time worked each week, whether it’s a light week or a heavy one.

That flexibility is not consistent, however, with the traditional image of a nonexempt worker. Allowing an overtime-eligible employee to make their own schedule on the fly each day, working whenever and wherever they please, can be a recipe for an “off the clock” claim.

Consequently, employers are more likely to control when and where a nonexempt employee is allowed to work, for example by establishing a work schedule for the employee, carefully managing deviations from the schedule, and, of course, requiring the employee to accurately record and submit their working time each day. Most also establish guardrails regarding who may work remotely (and under what circumstances) and when meal/rest breaks are to be taken.

Telling a reclassified employee that they are now nonexempt and must accurately record their time is a good start. But if they carry with them the habits from their salaried-exempt days—e.g., the mindset that they can work where and when they want, with the only concern being to get the job done—they risk running up large overtime costs (or a thorny “off the clock” claim).

New habits aren’t just important for impacted employees. If a reclassified employee’s manager will be managing nonexempt labor for the first time, they will likely need education on the policies they are expected to enforce with respect to their subordinates, such as policies concerning timekeeping, overtime, and meal/rest breaks.

These impacts are manageable, but they require careful planning and comprehensive strategies that go beyond deciding who will be reclassified and messaging that decision to impacted employees. A well-rounded strategy must also account for the communications, trainings, and other change management efforts necessary to ensure that the impacted employees’ habits evolve appropriately with their new classification.

3. Reclassification + Morale

The shift from exempt to nonexempt status can impact employee morale and retention. Many salaried-exempt employees are prone to viewing their classification as a proxy for prestige. Having that classification taken away, particularly if coupled with a relative restriction on their autonomy and flexibility (as discussed above), may cause them to feel like they have been demoted—even if their target total compensation remains the same.

Employers should aim to account for these concerns by establishing a thoughtful communication plan and inviting dialogue—and the engagement that dialogue cultivates—with impacted employees. Also, in addition to accounting for employee morale, a well-thought communication plan must account for requirements in some states regarding how, and how far in advance, an employee must be made aware of a change to their rate or method of pay.

4. Reclassification + Fair Workweek/Predictive Scheduling Requirements

Jurisdictions across the country have implemented fair workweek laws (also referred to as predictive scheduling laws. These laws are incredibly thorny, and depending on industry and location, reclassified employees may be covered by their requirements.

Fair workweek laws differ by jurisdiction, but they typically include requirements such as: the provision of a good faith estimate of hours worked upon hire; advance posting of work schedules, usually at least 14 days before the start of the schedule; premium payments for most types of schedule changes within the advance posting window; and restrictions on “clopening” (i.e., requiring an employee to return to work within a certain period after their last shift ends). Some laws go further than this.

Importantly, an employee’s classification can impact whether they are covered by these laws. For example, Philadelphia’s fair workweek law applies to overtime-eligible employees of covered employers in the retail, hospitality, and food services industries. Likewise, New York City’s fast food fair workweek law applies to hourly managers, but not salaried-exempt managers.

Fair workweek laws present the opportunity for massive penalties for unwary businesses—fines can rack up easily and multiply quickly. Employers in industries and jurisdictions covered by these laws must assess these laws’ potential impacts on reclassified employees in order to ensure smooth operational transitions and avoid compliance concerns.

5. Reclassification + Restrictive Covenant Nuances

Even if the FTC’s non-compete ban never goes into effect, plenty of states restrict employers’ ability to enter non-compete and other restrictive covenant agreements with their employees. Some of these laws apply to certain employees and not others depending on how and/or how much the employee is paid. Nevada, for example, provides that “a noncompetition covenant may not apply to an employee who is paid solely on an hourly wage basis, exclusive of any tips or gratuities.” Massachusetts law likewise provides that “a noncompetition agreement shall not be enforceable against … an employee who is classified as nonexempt under the [FLSA].”

Bottom line: Employers that rely on restrictive covenant agreements will need to consider how their agreements might be impacted by a given employee’s reclassification.

Takeaway: It’s Not That Simple; Proactivity and Forethought Are Key

While the new exemption rules may seem simple on their face, the decision to reclassify an employee is rarely so. Reclassification presents myriad ripple effects impacting compliance, operations, and employee morale and retention. By anticipating and accounting for the potential impacts—from the obvious to the not so obvious—businesses can effectively manage the transition, promote compliance, and maintain a satisfied workforce.

Please feel free to connect with the author or your favorite Seyfarth attorney with any questions about this topic or any other compliance concerns.