Ask the Expert, Compensation, Compensation Administration, Q&A

Q&A: FLSA Overtime Exemption Regs Create Pay Compression

Question: We are currently evaluating a number of exempt positions with our company in respect to forthcoming FLSA overtime exemption changes.  Their salaries range below the new salary threshold and above (all depends on tenure and experience). We are looking at bumping everyone to the minimum amount.  How are most companies handling the individuals who are already making that amount? For example, it doesn’t seem good for morale or even ethical to have two employees making the same amount when one has been here less than a year and another who has been there 3-4 years.

Answer: Thank you for your inquiry regarding increasing exempt employees’ pay in response to the new FLSA overtime exemption requirements.

You have identified an interesting problem related to increasing employees’ pay in order to comply with the new the new Fair Labor Standards Act (FLSA) salary increase for exempt employees – salary compression.  Salary compression generally occurs when there is little difference between the pay of less experienced employees and the pay of more experienced employees as a result of a pay increase.

The new FLSA exemption salary increase more than doubles the salary requirement for exempt employees, raising it from the current rate of $455 ($23,660 annually) a week to $913 a week ($47,476 annually) beginning on December 1, 2016.  As a result, employers are faced with the choice of either raising salary levels for exempt employees making less than $47,476 a year to maintain their exempt status or maintaining their current pay rate and making them nonexempt salaried employees.

The first approach will raise employers’ payroll costs and, as you pointed out, likely result in salary compression between less experienced and more experienced exempt employees.  The second approach may have less impact on employers’ payrolls initially, but likely will result in increased overtime expenses and recordkeeping requirements.

There are only a few surveys that have been done indicating what exactly employers are planning to do to comply with the FLSA exemption salary increase, and we could not find any that discussed whether employers will raise other employees’ pay to account for any increases to lower-paid exempt employees.  Many employers do not seem to be preparing for the salary increases, even though the Department of Labor has estimated that approximately 4.2 million workers will be affected.

For example, a recent Paychex survey found that a whopping 49% of surveyed employers did not know about the changes, and of those that did, 67% believe the changes will have “little or no impact” on their business.

The survey did not address specifically the issue of salary compression, but instead it suggests employers are planning to make their formerly exempt employees nonexempt instead of increasing pay.  Of the 33% of surveyed employers who believe the overtime rule will have some or a major impact on their business, 36% say they’ll be transitioning impacted employees to nonexempt status, 21% will choose to redistribute hours to minimize overtime hours worked, while only 7% plan on making adjustments to employee salaries in light of the new rule.

Clearly, if you do not increase salaries and instead make currently exempt employees nonexempt, then salary compression will not be an issue.  However, if you do want to raise your exempt employees’ salary levels to maintain the exemption, then you should consider how you will deal with the resulting salary compression.  The FLSA requirements do give employers an “out” to simply raise the salary of employees to meet the new exemption rate without raising other exempt employees’ salaries and to explain the pay increases as required to comply with the new law.

Anecdotally, in articles about the FLSA changes, some employers are reporting they are only planning to make the required increases and not worry about potential salary compression.  However, you still could have longer-term employees who are disappointed in the outcome if they do not receive any raise and should be prepared to deal with that possibility if your budget does not allow for an across-the-board increase.  It will be important for your organization to explain effectively any increases or changes to nonexempt status to affected employees and to answer questions about the changes.