Federal and state laws generally require that employees are paid minimum wage, as well as overtime compensation when they work more than 40 hours in a week. Many white-collar workers are exempt from these rules, but employers need to be careful about how they classify employees.
“There is no system to ask the federal government if a certain position is exempt. So, employers need to make educated guesses about the duties of a particular job and, based on language in the regulations, decide if that position is exempt,” says Stephen P. Bond, a partner at Brouse McDowell.
Smart Business spoke with Bond about how to properly classify employees as exempt or nonexempt, and the risks involved with improper classification.
Does paying a salary mean a position is exempt?
No, although that’s a common misconception among employers. The first test is that the salary must be at least $23,660. Then, the employee’s job duties — not title —must also fall under one of the exemptions in the regulations. The title doesn’t matter because it doesn’t necessarily mean the same thing at different companies.
What job duties can be exempted?
There are three main exemptions:
? Executive — Exactly what it sounds like: primarily being the head of a business or a department, and supervising other employees.
? Administrative — White-collar, management-level worker whose job involves discretion or independent judgment. Clerical work wouldn’t qualify because it isn’t directly related to management of the business operations.
? Professional — This is the most ambiguous area. It requires that the worker have special knowledge or expertise, typically based on a college degree. However, a college degree doesn’t necessarily make a person exempt.
There also are exemptions for certain duties in the computer field and outside sales, as well as one that covers any employee making $100,000 who regularly performs at least one of the duties of an executive, administrative or professional employee.
How can an employer lose an exemption?
One way is by not being consistent about paying the employee a salary. If you dock someone for missing part of a day, that demonstrates that he or she was not really a salary employee, and cannot be exempt.
However, there is a separate provision that applies if an exempt employee is off work for Family and Medical Leave Act purposes, and allows for deductions that do not affect exempt status.
What are the penalties for incorrect classification?
If an employee’s claim is deemed correct and an exemption did not apply, he or she may be able to claim unpaid overtime for the past two years, as well as collect damages and attorney fees. A disgruntled employee could contact the Department of Labor’s (DOL) Wage and Hour Division and trigger an audit that could result in back pay awards for several employees.
Even when employees are correctly classified as nonexempt, companies can run into trouble in terms of hours worked. If employees work at their desks during lunchtime, that counts as paid time. If you give an employee a smartphone and say he or she has to respond to emails even when at home, that also is work time. Those types of claims can cost a lot of money because employees typically have a record of their hours and the employer doesn’t have anything to contradict it.
How can companies avoid misclassification?
You need to have a qualified human resources person conduct an analysis. It has to be someone who understands all of the implications, and will take the time to consider the various positions and where they fit.
Also, it’s a good idea to re-evaluate exemption status as job duties change, especially if you’re going through a reorganization.
A lot of times, management makes decisions based on what makes economic sense at the time. That’s fine as long as everyone is getting along. But then an employee is fired or disgruntled for some reason and files a claim with the DOL
Stephen P. Bond is a partner at Brouse McDowell. Reach him at (440) 934-8110 or firstname.lastname@example.org.
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The IRS has a complicated set of guidelines for determining whether a worker should be treated as an employee or independent contractor for payroll tax purposes. It may be tempting for business owners to just classify people as independent contractors and save payroll taxes, but it’s not worth the risk, says Jim Forbes, CPA, a principal with Skoda Minotti.
“The IRS is conducting more payroll tax audits of small businesses, but the risk is always there with any audit. No matter what triggers the audit, the IRS will ask for all of your W-2s and 1099s and will be suspicious if a contractor is being paid like an employee,” Forbes said.
Smart Business spoke with Forbes about the process of determining whether a person is an employer or an independent contractor and why it poses such problems for businesses.
How do you determine if a worker is an employee or independent contractor?
The IRS uses 13 factors; some employers will look at a couple and think a person is clearly an employee or a contractor, but you have to look at all 13. Even then, there’s no set number you have to pass, it’s all a matter of facts and circumstances. That’s why it’s tricky for companies to figure out how to classify workers.
The 13 factors are:
• Type of instructions given. An employee is generally subject to follow instructions about when, where and how to work.
• Degree of instruction. The key consideration is whether the business retains rights to control details of a worker’s performance.
• Evaluation system. If the system measures details of how work is performed, that points to the person being an employee.
• Training. On the job training indicates a particular way of performing the job is desired and is strong evidence the worker is an employee.
• Significant investment. Independent contractors often have invested in the equipment used for work. However, that is not required for independent contractor status.
• Unreimbursed expenses. Independent contractors are more likely to have unreimbursed expenses.
• Opportunity for profit or loss. Having the potential of incurring a loss indicates a worker is an independent contractor.
• Services available to market. An independent contractor is generally free to seek out business opportunities.
• Method of payment. An employee is generally guaranteed a wage for hourly, weekly or other period of time. Independent contractors are usually paid a flat fee for jobs.
• Written contracts. The IRS is not required to follow a contract stating that a worker is an independent contractor; how the parties work together determines how the worker is classified.
• Employee benefits. Insurance, pension plans and other benefits are generally not given to independent contractors. However, absence of benefits does not necessarily means the worker is an independent contractor.
• Permanency of the relationship. If a worker is hired for an indefinite time, that is generally considered evidence of an employee/employer relationship.
• Services provided as a key activity of the business. Companies are more likely to have the right to control activities when the services are a key aspect of the business.
Why would companies attempt to classify employees as independent contractors?
With smaller companies, there is a greater impact from the additional payroll taxes. If the person is an employee, you have to pay 7.65 percent payroll taxes for Social Security and Medicare. There are other taxes, including unemployment, but that is the primary motivation.
There could be more incentive in 2014 with the employer mandate under health care reform. A business with 49 employees that needs to add two more people might want to bring them on as independent contractors to avoid the rules that kick in when you reach 50 full-time equivalents.
Still, most companies will try to do the right thing; it’s just difficult sometimes to figure out what that is. You can meet 10 of the 13 tests, but there’s no guarantee that means the person is an independent contractor. Ultimately, that answer rests with the IRS.
Jim Forbes, CPA, is a principal at Skoda Minotti. Reach him at (440) 449-6800 or email@example.com.
Follow up: If you’d like to schedule a confidential consultation regarding employee classification concerns, call Jim at (440) 449-6800.
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