Payroll in Practice: 5.6.2024

Question: The new salary-level rules from the Labor Department significantly increase the amount of salary necessary for employees to qualify as exempt under the executive, administrative, and professional exemptions. Among other options, the fluctuating workweek method has been suggested as an alternative to increasing salaries. How does this method work?

Answer: The change in the minimum salary level for exempt employees affects employers that have employees with salaries that fall within the gap between the current minimum salary level of $684 per week and the new, higher rate. On July 1, the minimum salary level for FLSA exempt employees will rise to $844 per week. On Jan. 1, 2025, the minimum salary level will rise again to $1,128 per week and is scheduled to be updated every three years. Employers are advised to identify currently exempt employees whose salaries are less than minimum weekly salary and determine the best way to deal with the change.

Certain employees, such as doctors, lawyers, teachers, and outside sales employees, are not subject to either the salary-basis or salary-level tests but may still qualify for exemption as long as they meet the qualification and duties requirements specified for their occupation in the regulations. For example, exempt computer professionals must be paid at least the minimum standard salary or an hourly rate of at least $27.63. The regulations also provide an alternative test for certain highly compensated employees who are paid a salary, earn at least a specified annual compensation level, and satisfy a minimal duties test.

Employers may want to review compliance with the duties tests for all employees classified as exempt, including those not affected by the salary level changes. Misclassification of nonexempt employees as exempt can be costly in terms of penalties and backpay awards.

Employers have several options for complying with the increase in the standard salary level. This includes increasing exempt employee pay to meet the new requirements, converting currently exempt employees to nonexempt status and compensating for overtime hours, or adjusting the number of hours employees work so that overtime hours are minimized. Conversion from exempt to nonexempt generally involves an adjustment of compensation packages that considers both employee earnings and employer costs.

Fluctuating Workweek Method

Employers also may consider paying formerly exempt employees using the fluctuating workweek method. Under a fluctuating-workweek plan, an employer pays an employee’s full salary each week regardless of the number of hours worked. Hours worked that exceed 40 in the week are paid at half the regular hourly rate for the week. The regular rate is determined by dividing the weekly salary by the number of hours the employee worked that week. That is, the weekly salary covers all regular pay but none of the overtime premium for all hours worked during the workweek.

For example, an employee is paid $700 a week under a fluctuating workweek plan. If the employee works 40 hours, the regular rate of pay is $17.50 per hour ($700 / 40 hours). If the employee works 50 hours, the regular rate of pay is $14 per hour ($700 / 50 hours) and the employee is entitled to an additional $70 in overtime compensation ($14 x 0.5 x 10 hours), resulting in $770 total pay for the workweek.

Under traditional overtime rules, assuming a fixed workweek of 40 hours and a regular rate of pay of $17.50 per hour, employee compensation for 50 hours would total $962.50, consisting of the $700 salary plus $262.50 ($17.50 x 1.5 x 10 hours) in overtime compensation.

An employer may use the fluctuating workweek method to compute an employee’s regular rate of pay and overtime compensation under specified circumstances. The hours the employee works must fluctuate from week to week, and the employee must be paid a fixed salary that is not based on the number of hours worked. The fixed salary must be sufficient to pay at least minimum wage for all hours worked during the workweeks in which the employee works the greatest number of hours.

The employer and employee must have a clear and mutual understanding that the fixed salary constitutes straight-time compensation for all hours worked during the workweek. This understanding pertains to fixed salary for all hours worked and need not include an understanding of the method used to calculate overtime compensation.

The employee may also receive bonuses, premium payments, commissions, hazard pay, or other additional pay of any kind that is not excludable from the regular rate of pay. For purposes of computing the overtime premium, these payments are included in the regular rate of pay for the workweek in which the payments are received. However, some additional pay is exempt from regular-rate-of-pay calculations.

Since the salary is fixed, the regular rate of pay for the employee will vary from week to week. It is determined by dividing the amount of the salary plus any non-excludable additional pay received during the workweek by the number of hours worked in the workweek. In addition to the fixed salary, the employee receives overtime premium pay at a rate not less than half the employee’s regular rate of pay for that workweek.

The half-rate payment satisfies the overtime pay requirement because the straight time rate for each hour worked is included in the fixed salary and nonexcludable additional pay. The hours have already been compensated at the straight time rate by payment of the fixed salary and nonexcludable additional pay.

Employers are not required to pay the salary for a workweek if the employee does no work during that time. However, if any work is performed during the workweek, the employee must receive the full salary as regular pay for the week.

This column does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., or its owners.

Author Information

Patrick Haggerty is the owner of a tax practice in Chapel Hill, North Carolina, and an enrolled agent licensed to practice before the Internal Revenue Service. The author may be contacted at phaggerty@prodigy.net.

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