Roger Vozar

One law small businesses frequently underestimate is the misclassification of employees as being exempt from Fair Labor Standards Act (FLSA) overtime rules, an oversight that could cost millions in employee misclassification lawsuits.

Minimum wage rates also pose problems because there may be different standards at federal, state and local levels.

“Companies need to know the basics of the FLSA in order to determine if they’re in compliance,” says Tracy Baskin, payroll compliance analyst in Wage and Hour Compliance at TriNet, Inc.

Smart Business spoke with Baskin about FLSA issues and how to stay compliant.

What are typical FLSA compliance issues?

Many businesses have problems keeping in step with minimum wage rates. An employee, having worked a year or so at a given rate of pay, may be due retroactive payments because of an increase in state or local minimum wage rates. Employees paid at the lower rate of the previous calendar year could file a complaint with the Department of Labor (DOL), which could lead to an audit.

It can be even more of a problem with exempt employees — many companies aren’t even aware there is a minimum salary basis. Exempt employees paid at a rate less than minimum wage would need to be increased to at least $16 an hour to be in compliance with California’s requirement for executive, administrative and professional (exempt) employees. For example, computer professionals are employees who typically write or modify programming have their own minimum, which is $39.90 per hour.

The most impactful item is overtime compensation. Companies are not accurately calculating overtime pay because they aren’t including additional earnings such as bonuses or commissions, which need to be included to comply with the FLSA.

How do you determine if an employee should be classified as exempt and nonexempt?

The FLSA provides general guidelines. You’ll need to concentrate first on the employee’s primary duties. Are they managers who customarily and regularly direct the work of two or more employees? Do they set company policies, or authorize, suggest or recommend the hiring and firing of others?

Employees who have advanced knowledge in a field of science, whether college or beyond, may qualify for certain professional exemptions. However, college graduates are not necessarily exempt. In California, the professional exemption is reserved for those licensed or certified by the state, generally in the fields of law, medicine, dentistry, architecture, engineering, teaching and accounting. Typically, exempt employees must also be paid at least $455 per week on a salary or fee basis.

Nonexempt employees have to be paid a certain amount per hour. If they’re tipped, they must earn enough in tips to bring them up to minimum wage. They’re the average employee and are paid time and a half if they work in excess of 40 hours in a workweek.

While most exempt employees are required to receive salaries, not all salaried workers are necessarily exempt. As a rule of thumb, you can say that an employee whose duties include supervising two or more employees; authority to hire, fire and promote; and giving job assignments to others are usually exempt. But it’s not the job title that matters, it’s the actual job duties that determine whether an employee is exempt or not.

What are the penalties for noncompliance?

Penalties vary depending on what the employee has presented to the DOL, whether it’s an overtime violation, he or she wasn’t paid the minimum wage or a simple miscalculation. If the DOL considers the violation to be willful because a business has had this offense before and not corrected it, fines can be doubled or tripled.

Our recommendation is to pay employees what they are due. If you don’t, you should expect someone will eventually reach out to the DOL, which will open the company up to a much larger audit. The DOL will examine the status of all employees and ask for the documentation to see the criteria the business used to determine their status as exempt or nonexempt. So it’s best for everyone to make sure employees are classified properly and paid what they are owed.

See TriNet clients that have mitigated their HR risks.

 

Tracy Baskin is a payroll compliance analyst, Wage and Hour Compliance, at TriNet, Inc. Reach her at tracy.baskin@trinet.com

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It’s not easy to keep a company going for 100 years — there are going to be a lot of challenges to address along the way.

“There has to be a willingness to change and take chances,” says Roger Weninger, Southern California regional managing partner at Moss Adams LLP. “When I think of longevity, I think of growth. Not purely as it relates to size but also ingenuity, the willingness to change and remain relevant. The company that can continue doing the same thing and remain successful is the exception.”

Smart Business spoke with Weninger about common characteristics of companies that stand the test of time.

What are the keys to longevity for companies?

It’s very important to develop leaders, plural. Companies, no matter how successful they are, get to a point where they need to provide opportunities to others. That can be hard for an individual in charge to understand — the concept that he or she can do less and it will result in more. By allowing others to make decisions and feel a part of the success of the organization, you create a strong culture of growth and change. People thrive in these settings, and so will the business.

You also need to have leaders and decision-makers at all levels. To think that leadership takes place only at the highest levels within any organization is a mistake. Instill a culture of risk taking and empowerment where people at all levels feel they can make a difference and aren’t afraid they’ll be punished for making a mistake. You’ll be amazed at the ideas and the level of ownership people will take when they’re asked, and even expected, to contribute to organizational change and success.

Every organization should have strategic plans and goals that have application to every employee. In addition, each employee should know what contribution he or she can make to reach those goals.

http://vimeo.com/57251311

How can a company stay relevant in changing times?

It sounds trite, but it goes back to your mission and focus — self-awareness of your strengths and weaknesses, as well as how you fit into the needs of your clients and customers. Creating this awareness within your organization will provide a clear decision-making and prioritization path for your people. If there’s doubt as to what your value proposition is, or what it isn’t, you can waste a lot of time and send confusing messages to your people and to existing and prospective clients. Being the best at something is always a good goal.

What poses the biggest threat to longevity?

Complacency. When things are going well, there’s a tendency to become satisfied and convince yourself that things will never change. The willingness to listen and actually hear what’s being said, rather than simply assuming you already have all the answers, is crucial. Again, you must have multiple decision-makers and leaders, and this highlights the need for ongoing succession analysis. Succession isn’t something that should be dusted off and practiced when the owner is ready to retire.

People want to see the opportunity to grow into leadership positions from the time they walk in the door. That doesn’t mean they want to take over the top spot in the organization within their first year of employment, but it does mean they want to feel relevant, appreciated and impactful. If they have to wait for someone to die or move on, they may not stick around very long. New leaders bring different ideas and knowledge, and not having that will restrict your ability to grow and sustain the organization through good times and bad.

There’s no such thing as staying flat — you’re either on an incline or decline. You have to always be working to get better. If you’re willing to listen, your people and your clients will tell you how.

Roger Weninger is the Southern California regional managing partner at Moss Adams LLP. Reach him at (949) 221-4047 or roger.weninger@mossadams.com.

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Many aspects of the Patient Protection and Affordable Care Act (PPACA) become effective Jan. 1, 2014, but preparing for that date is difficult for businesses because not all of the rules and regulations have been written.

“As of last month, there were still 1,200 regulations yet to be written by the end of the year. I don’t think anybody has it figured out yet — that’s the biggest problem,” says William F. Hutter, president and CEO of Sequent.

Nonetheless, there are steps businesses can take now to be ready for 2014. “The first thing to do is to understand the PPACA. Unfortunately, there is no definitive source of information on how it will impact companies because of the yet-to-be written regulations. So you need to read a variety of materials, starting in July — that’s when we should see those rules and regulations start to manifest,” says Hutter.

Smart Business spoke with Hutter about strategies small and midsize businesses can take to deal with the uncertainty surrounding health care reform.

Is there a chance that the effective date of PPACA provisions might be delayed?

Some factors already have. The Small Business Health Options Program (SHOP), an exchange for small businesses to purchase health insurance, has been delayed for a year. Also, nothing has been presented showing how the federal health care exchange, a marketplace for individuals to purchase insurance, is going to work.

Since everything is in flux, what can companies do in preparation?

A number of strategies are going to emerge, and many might have questionable structure. If someone presents an opportunity too good to be true, it probably is. Be careful about vetting companies offering creative strategies to avoid some of the impact of health care reform.

One legitimate strategy on the increase is the use of cell captives. Companies will self-insure, but with minimal exposure. There are good self-insurance options for businesses in the 60- to 70-employee range that will exempt them from certain aspects of the legislation, such as unlimited rehabilitative services. An employee can go to rehab for 30 days, come back and four months later have another drug problem that sends him or her back to rehab — there’s no limitation and it’s covered under the Family and Medical Leave Act. A company can design a plan that doesn’t allow that because it’s not required in a self-funded plan, even though it is part of the minimum essential coverage required under the PPACA in the fully insured environment.

All of these self-funded plans will become high deductible health plans with three layers of risk. The first is the employee deductible, which will pay the first layer of claims. The second layer will be an amount of self-retained insurance risk a company insures. The insurance company will pay the third layer. That setup protects insurance companies from a lot of the smaller claims. In Ohio, about 70 percent of claims are less than $8,000.

What impact will reform have on health care costs?

It will not bring down the cost of insurance because there’s nothing health care reform can fix relative to the aging demographics of the workforce. There’s been a dramatic increase in recent years in the use of medication and cost of defensive medicine. As baby boomers continue to age, those costs will only increase. There are not enough 20-somethings coming into the workforce to compensate for the aging demographic in the state of Ohio.

If anything, the cost of regulation just keeps increasing. A recent study stated that fines and penalties are expected to total $88 billion. All kinds of alternative strategies are being considered, not to avoid the intent of providing good coverage for employees, but because of uncertainty with the legislation. If you can create certainty by having a new health care plan design, that’s good for business. At least you know what you have.

We’re not going to see the conclusion of how health care reform is going to be implemented for a decade. It’s going to be a really long time.

William F. Hutter is president and CEO at Sequent. Reach him at (888) 456-3627 or bhutter@sequent.biz.

Website: Understand your legal obligations when sponsoring a health plan for your employees. Download a checklist.

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When acquiring a company, it’s important that there are no surprises after an agreement has been signed. That’s why it’s critical to do your due diligence to ensure that there are no unknown problems that might arise after the closing.

“Companies that conduct a volume of transactional work — a lot of acquiring of businesses — understand the importance of getting information on the target company and assembling the proper team to review it,” says Patricia A. Gajda, partner and chair of the Corporate Group at Brouse McDowell.

Smart Business spoke with Gajda and Rachael Mauk, an associate at Brouse McDowell, about what areas to look at and the potential pitfalls in the due diligence phase of an M&A transaction.

What is involved in the due diligence process?

From a business, legal and financial perspective, you look at everything in the company that could have a risk or liability associated with it.

Usually the buyer will provide a list of documents for the seller to gather, including:

• Organizational documents.

• Financial documents, including three or four years of audited and unaudited financial statements, monthly statements, any audit reports, receivables, etc.

• Contracts with vendors, customers, etc.

• Real property information such as title documents, deeds, title insurance, zoning variances and leases.

• Permits and certifications.

• Environmental testing reports, remediation records, audit information.

• Intellectual property (IP) including patents, copyrights, trademarks, trade secrets, confidentially agreements, and licenses and software agreements.

• Employee information.

You also want to investigate the company to examine past and pending lawsuits, insurance claims, product liability questions, warranty information — how often there were product warranty claims — and delve into the history.

Due diligence can play an important role in determining the final transaction price. For example, if you find out the target company you intend to buy has a $5 million lawsuit pending against it, you will want to determine if and how that will negatively affect the company, even if you’re not going to take the liability for the lawsuit.

Are there things you find that might cause you to back out of a deal?

It will depend largely on your motivation for acquiring the target company. You may be buying a company because they have the latest product, which you want to incorporate into your product line, only to discover that the target company doesn’t own the IP or the IP associated with the product was not protected. Alternatively, you might uncover product warranty issues that bring into question whether the product works, or review the financial records and find out it’s not a profitable line of business.

It’s not just attorneys who do the due diligence. A company will put a team together to look at the various segments of the business. Accountants will look at the financial statements and tax returns. If there are environmental issues, you might have an environmental consultant do additional testing.

What pitfalls do companies experience in doing due diligence?

They do not allow for adequate time for due diligence. A strategic buyer is generally familiar with the business, so it may think it already knows everything. Things can fall through the cracks, so leave enough time for adequate review, testing and follow up. The process can take from a few weeks to 30 days or more if it’s a complicated business.

Typically, due diligence is done simultaneously with negotiating the purchase agreement. It might result in a purchase price reduction because something discovered doesn’t add up to the price that was originally discussed. You might find there’s the potential for environmental liability and seek an indemnification for that specific item — due diligence can lead to specific requests in the purchase agreement.

Once you’ve completed the due diligence, you’re close to signing the transaction agreement and the purchase can go as planned.

Patricia A. Gajda is a partner and chair of the Corporate Group at Brouse McDowell. Reach her at (216) 830-6830 or pag@brouse.com. Rachael E. Mauk is an associate at Brouse McDowell. Reach her at (216) 830-6846 or rmauk@brouse.com.

FOLLOW UP: Pat Gajda and Rachael Mauk are based in Brouse McDowell’s Cleveland office.

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A global company that started out as a provider of telecommunications equipment, TelStrat was founded in 1993 in Plano, Texas to take advantage of the Dallas-Fort Worth Metroplex’s Telecom Corridor.

“Being in the middle of the telecom industry is very important to us because of the engineering and product development talent that is available,” says Jennifer Slack, CFO of TelStrat.

When the company sold off a division a couple years ago to focus solely on software, the Plano site was leased to another business and TelStrat needed to find a new location. TelStrat celebrated its 20th anniversary this past February and is focused on providing call recording and workforce optimization solutions.

Smart Business spoke with Slack about the decision to move the company’s headquarters to nearby Allen, Texas.

What were the key factors favoring Allen?

It was the location and the local talent pool. We knew we wanted to stay in the same general vicinity. Employees love the Allen area because of the good schools and housing that is available. The quality of life that’s in Allen makes it very easy to find employees.

How has the Allen Economic Development Corporation assisted TelStrat?

They helped with incentives that made it more affordable to change locations. Moving can be very disruptive, as well as expensive, and the financial incentives they provided definitely helped.

The city of Allen and the economic development corporation also sponsor many programs for businesses. They provide many opportunities for networking and encourage businesses within Allen to build on the synergies available, or just talk to each other for advice. They certainly promote that spirit of cooperation.

At one of their events, I met a representative from a local company that was able to help with our recruiting efforts. We’ve probably not taken full advantage of what Allen and the economic development corporation offer, but it did help with recruiting.

What is the nature of TelStrat’s operations in Allen?

It’s a complete headquarters facility; we have about 50 employees working in departments from sales order entry to engineers for software development and support and maintenance of our product with customers. There are also some sales staff, accounting and HR personnel.

The landlord was very helpful in remodeling the site. We predominately needed office and lab space and the building had served as a call center or back office. We’re in a five-year lease and it’s a very convenient location right off of the North Central Expressway.

What’s the best thing about your new location?

It’s the convenience — it’s very easy to get around for meetings, or if we have clients or partners visiting us. There are plenty of nearby options for lunches and shopping, which employees enjoy because it saves them a lot of time and helps with developing a good work/life balance. It‘s great when you have children and you need some flexibility if they have something special going on or are sick. You can pick them up for a dental appointment and get back fairly quickly. It helps a lot to have your place of employment near your neighborhood.

We’re a pretty simple company with simple needs. The city of Allen and economic development board have made it easy for us to do business here.

Jennifer Slack is the CFO at TelStrat. Reach her at (972) 633-4512 or jslack@telstrat.com.

Reach the Allen Economic Development Corporation at www.allentx.com or call (972) 727-0250.

By some estimates, oil and gas wells will be pumping $30 billion into Ohio’s economy in 2015, creating 200,000 jobs. All that money and activity also promises to keep attorneys busy.

“Companies are still feeling things out. So far, there have been about 500 permits issued and there are only about 80 producing wells. But 101 permits were issued in March alone. There will be a lot more drilling this year,” says Michael Schottenstein, an associate with Kegler, Brown, Hill & Ritter.

As companies look to start drilling, property owners with leases signed when offers were lower want to renegotiate more favorable terms. And some communities continue to fight to keep hydraulic fracturing of shale rock formations, a process also known as fracking, from taking place within their borders.

Smart Business spoke with Schottenstein about current legislation and the outlook for oil and gas well production in Ohio.

What’s the status of potential fracking bans?

In a recent case in the 9th District Court of Appeals, State ex rel. Morrison v. Beck Energy, the court said Ohio Revised Code section 1509.02 gives the Ohio Department of Natural Resources, Division of Mineral Resources Management, exclusive authority over drilling permits, pre-empting local ordinances. Municipalities can regulate things like excavation and right-of-way usage and construction, but have no authority when it comes to drilling.

However, there are still municipalities discussing bans. The city of Munroe Falls has appealed to the Ohio Supreme Court and asked the court to weigh in on the issue, but the court has not said yet whether it will take the case. It’s unlikely municipalities will be able to impose outright bans.

What are some other legal developments?

The natural gas severance tax increase Gov. John Kasich proposed in his new budget is significant. Drilling companies and other industry players have been trying to stop it because they say it would discourage drilling. The industry may have won the fight for now, though. The budget plan the Ohio House Republicans recently put forward left the severance tax where it is. It’s still possible it could get passed if the Ohio Senate makes some changes, but it is unlikely.

Another development involves a line of cases dealing with lease terms and whether perpetual leases are void as being against public policy in Ohio. In Monroe County, a judge in the case of Hupp v. Beck Energy essentially said that public policy in Ohio so disfavors perpetual leases that any oil and gas lease that allows drilling companies the right to extend the lease indefinitely by paying delay rentals without an obligation to actually drill are void as against public policy.

There’s also a federal case from the Southern District of Ohio in which the decision says state law disfavors perpetual leases and will interpret them not to be perpetual when possible, but did not say they are actually void.

These are important cases because a lot of landowners are trying to find ways to get out of leases signed when companies were paying a lot less for them.

What are leases going for now?

Royalty percentages had historically been about 12.5 percent for the landowner, but we’re seeing some up to 20 percent. Reports out of eastern Ohio are that some companies are offering bonus payments of $5,000 to $10,000 an acre. Those who entered into a lease 20 years ago, got a small bonus payment and now get a royalty check for $10 a month, are trying to get a better deal.

Oil and gas leases typically provide for a period of one to five years during which companies can explore to see if there’s oil and gas on the property. Leases also usually have a clause that the lease continues as long as oil or gas is produced in paying quantities, which can be an issue if drilling was interrupted for some reason.

Are their other issues on the horizon?

One major concern is waste disposal. Fracking produces waste, called brine, and it can’t just be put it back into the water system. Because this liquid would pollute the water table, drilling and disposal has to be done right and companies must take necessary precautions. A company near Youngstown was recently indicted for dumping brine into the Mahoning River, but if companies don’t cut any corners, our water should be safe. Still, expect more litigation, legislation and regulations involving waste disposal in the future.

Michael Schottenstein is an associate at Kegler, Brown, Hill & Ritter. Reach him at (614) 462-5451 or mschottenstein@keglerbrown.com.

Join us for Eggs & ESOPs on Thursday, May 23, for a morning seminar discussing the ins and outs of ESOPs. Visit www.keglerbrown.com for more information.

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Many businesses neglect cyber and privacy issues because they simply don’t believe they are at risk or they do not fully understand the exposure.

“The majority of them think they’re safe because they have a secured firewall in place and virus protection. This is the biggest misconception out there. In reality, data thieves are simply looking for the path of least resistance. Owners of small to midsize businesses who become complacent or think they have adequate protection against cyber and privacy attacks can actually be a bigger target than large companies,” says Derek M. Hoch, president of Leverity Insurance Group.

Attacks can be harder for small and midsize businesses to recover from. Many businesses close permanently within six months after being victimized by cybercriminals.

“That’s why it is vital to have adequate controls and the proper insurance in place,” says Hoch.

Smart Business spoke with Hoch about cyberattacks and how business owners can protect themselves.

What are the cyber and privacy issues for business owners?

Cyber and privacy liability is best described as any third party or first party hacking into your database for personally identifiable information (PII). This includes access to names, dates of birth, Social Security numbers, credit card information, emails and passwords. Ultimately, this can potentially lead to identity theft and/or cyberextortion.

In addition, businesses that operate with paper files or ‘non-electronic’ information have the same potential to be compromised by both third parties and employees.

However, the most overlooked exposure to business owners is the actual cost of a data breach when your records have been compromised. On average, a data breach can cost a company more than $200 per record when considering loss of business, ongoing forensic expenses, notification costs and credit monitoring.

What types of businesses need cyber and privacy liability coverage?

Every business owner has exposure on some level if they have third-party and/or employee information stored on a computer or in paper files.

Cyber and privacy liability is relatively new, so most business owners don’t even know that the coverage exists or is available in today’s insurance market. It is a significant exposure and should be included in your overall risk management program.

How can businesses protect themselves?

It starts with the culture of the business owner and includes training employees to use proper cyber and privacy security policies and procedures. This list of procedures should include the following at a minimum:

• Use passwords on all computers, laptops, tablets and smartphones.

• Regularly change passwords every 30 to 40 days.

• Limit employee access to data.

• Restrict authority to install software unless approved by management.

• Provide ongoing training for employees who gather, use, transmit and dispose of confidential data.

• Install and update anti-virus and anti-spyware programs on every computer. Smartphones and tablets are often overlooked, yet most salespeople out in the field are using them.

• Back up your data off-site in a secure location, not in the same facility of your day-to-day operations. If the system is hacked or temporarily shut down, you can still retrieve the information and continue to operate your business.

Isn’t cyber and privacy liability part of standard business insurance?

No, most insurance policies exclude this coverage or may offer a small amount of ancillary coverage to recover or reconstruct any lost data. Cyber and privacy exposures are not covered under any property, general liability, crime, directors and officers liability, or umbrella policies. Business owners need to purchase a true cyber and privacy liability policy including security and privacy liability, notification and forensic expenses, business interruption, and cyberextortion to complete the proper risk management of their business.

Derek M. Hoch is president of Leverity Insurance Group. Reach him at (216) 861-2727 or derek@leverity.com.

Social Media: Keep up on issues that could impact your business at www.linkedin.com/company/leverity-insurance-group-inc.

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It may not seem vital to know the value of your business until it’s time to sell. However, by then, it’s too late. There’s nothing you can do if it’s not worth what you expected.

“Typically, a closely held business is the largest asset owners have, perhaps 60 to 80 percent of their net worth.

Unfortunately, many just guess at the value and guess wrong. Then their retirement is significantly different than what they expected,” says Tim McDaniel, CPA/ABV, ASA, CBA, a principal with Rea & Associates.

Smart Business spoke with McDaniel about determining the value of a business and steps owners can take to help it grow.

How is the value of a business determined?

There are a few different approaches an evaluator will use to value a business, but in most cases, the most effective way is an income approach. In this approach, the valuator uses the mindset of an investor to project the company’s future cash flow and determine how much risk is associated with it.

All valuations are really a forecast. Historical trends are reviewed to predict future cash flows, but the valuator will also interview management to understand what the company’s future looks like.

Should owners always know what the business is worth?

People will spend a lot of time with an investment manager trying to grow a stock portfolio that may be only 10 to 20 percent of their net worth and ignore their largest asset, their business. In order to treat the business as an investment, the first step is to know the value.

Next, set goals — how much should the value grow annually and where do you want it to be when you exit — and implement a plan to reach them. There are three major factors that impact the value of a business:

  • Increase expected future cash flow.
  • Decrease risks associated with your business.
  • Increase the future growth rate.

Develop a plan addressing how to positively impact these three areas. Too often business owners don’t develop a plan — they work in their business, not on their business. Between keeping customers happy, ensuring employees are doing their jobs and maintaining quality control, it’s easy to get caught up in the day to day.

It’s rare when an owner treats the business as an investment and has an annual or biannual valuation. One owner recently thought his business was worth five times its actual value because his CPA told him the value was one times gross revenue, which is completely erroneous. That may be how a CPA firm is valued, but there’s a lot more involved in valuations than a simple multiplier, and it takes years to develop the necessary skills. The unfortunate part is that some people have been living with the assumption that they will retire as millionaires, but come to find they might not be able to retire.

What are the best ways to exit a business?

Exit strategy depends on the individual. If you want the highest dollar amount, sell to a synergistic buyer — a bigger company in the same industry. The downside is that some of your long-term employees might lose their jobs. Another way is to sell to a financial buyer or employee stock ownership plan where the business may continue to run in a similar fashion. Many owners prefer to keep businesses in the family and give stock to children. If that’s the case, make sure your retirement is funded and you gift stock when the value is down. Another strategy that’s gaining popularity is retaining the business and hiring a professional management team to run it so you can significantly reduce your role.

It’s important to develop exit plans early. If you want to retain the business, it takes time to develop a good management team. If you want to sell, you want to sell when cash flows are highest. If you want to gift it to your children, they have to be ready. No matter which way you proceed, it’s a long process.

Tim McDaniel, CPA/ABV, ASA, CBA, is a Principal at Rea & Associates. Reach him at (614) 889-8725 or tim.mcdaniel@reacpa.com.

More on this subject can be found in Tim’s new book, “Know and Grow the Value of Your Business: An Owner’s Guide to Retiring Rich.” Learn more here.

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You don’t have to be pirating software to get in trouble during a compliance audit.

“Where companies get ensnared is in the deployment phase. It’s not that they are trying to get away without paying, they get caught up in the terms of conditions found in the fine print of licensing agreements,” says Heather Barnes, an intellectual property attorney with Brouse McDowell.

Smart Business spoke with Barnes about what businesses can do to make the software audit process go smoothly.

What prompts an audit?

Software companies include the right to request audits as part of the terms and conditions of the software license agreement. The fine print contains the right for the software company to audit your computers and systems. Sometimes audits are performed because that organization received a tip from a discharged employee. There also are companies that conduct audits as a regular course of business, either itself or through a third party, such as The Software Alliance. Because of the economy, software revenues have decreased, so software owners are replacing lost revenue by ramping up enforcement with compliance audits.

Once you’re notified about an audit, what should you do?

If you are an organization with in-house counsel, contact them immediately. Smaller companies should retain outside counsel, because attorneys can make a big difference in the final outcome.

The first thing an attorney will do is assist with the parameters for the audit — how and when it will occur, as well as the scope. If there is a noncompliance issue, legal counsel can draft a settlement agreement; they may even negotiate the settlement to a more reasonable number. Even if there are no compliance issues, you still want a document drafted that acknowledges how the audit was conducted and what was found, as well as a release of any claims the software company could have brought.

What problems can occur if you proceed without legal counsel?

Much is dependent on the particular company, but the audited company wants to prevent the software owner from having free reign of its systems, and that is a role legal counsel can help control. For example, legal counsel can assist in defining the scope of the audit by determining which computers are included in the audit. Do you include every computer? Just computers in use? What about the computers that are older and sitting in a warehouse? A software company could attempt to include any computer you own, even those that are obsolete and unused.

Another potential issue is how the audit concludes. You might come to an agreement at the conclusion of the audit and think a settlement is in place. Without legal counsel involved, a company could find itself with no settlement agreement or other document detailing what occurred and the responsibilities of each side going forward.

What are typical noncompliance issues and how much do they cost to fix?

Terms and conditions of the software license agreement vary by company. Many companies allow you to use older versions of software when you obtain a license for their latest product, but some do not. However, many people think that it’s an industry standard that you can deploy older versions.

Another problem is maintenance of business records proving owned licenses for software. You need to have documentation and keep those records current and accessible. That can be complicated when the software was purchased from multiple third-party vendors and for software that is old. Companies should conduct internal audits to ensure they are in compliance with what their records reflect, which could help mitigate exposure when an audit occurs.

Normally, if you are out of compliance, you’ll be charged the licensing fee you should have paid. If it is $200, $300 or $500 per license, multiply that by the number of computers out of compliance and it can get expensive quickly.

Further, if you’re found to be noncompliant, develop internal procedures to ensure compliance in the future. If you are audited once and are found to have compliance issues, it is just a matter of time before the software owner is back to check again.

Heather Barnes is an intellectual property attorney at Brouse McDowell. Reach her at (330) 535-5711 or hmb@brouse.com. Learn more about Heather Barnes.

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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 jforbes@skodaminotti.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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