This is part of a series of the Top 10 Bookkeeping Mistakes Small Businesses make. To read the others, click here.
Whether you have employees or not, misclassifying them is a classic bookkeeping mistake. That may sound strange, but you need to think about your employees not the way you, or even they, do – but the way the IRS does.
There are at least two ways you can misclassify employees:
1. Your employees are actually independent contractors.
This is a huge issue that the IRS and the Department of Labor are really cracking down on. Most business owners don’t realize that this is an issue with a number of federal, state and even local governments.
This mistake can impact your obligation as an employer regarding withholding taxes and paying payroll taxes. It also impacts worker’s compensation and unemployment tax. And because you’re the employer, you hold the primary burden of responsibility to get this right. The IRS has spent some time and effort to help small business employers get a better handle on what constitutes an employee versus an independent contractor. Their Publication 1779 covers three main categories:
Behavioral Control – Do you as the employer have a right to direct their work (ie, behavior)? Do you give extensive instructions?
Financial Control – Are you the employer making significant investments to get the job done, or is the employee? Do you reimburse for business expenses?
Relationship of the Parties – This includes giving benefits and written contracts.
The IRS publication above was written for the employee, so they can think about whether they’re actually an employee or rather an independent contractor, but there’s also a detailed publication for you the employer.
2. Your employees are exempt from minimum wage or overtime (wage and hour laws).
The Fair Labor Standards Act (FLSA) provides guidelines about exempt and non-exempt employees in terms of paying minimum wage and overtime.
If you as the employer are paying a salary, rather than an hourly wage, the job itself may be exempt. Usually the types of work that fall within this category are executive, administrative, and professional positions. Just because someone is salaried does not automatically mean they are exempt – there’s also a matter of the types of duties that the employee performs.
There are three ‘tests’ you can use to determine exemption:
Salary Level – There are salary levels that determine exemption, but if someone is paid over $100,000, they’re almost certainly exempt.
Salary Basis – Is there a “guaranteed minimum” amount of money that will be paid during a week in which work of any kind is performed? Read more here.
Duties – It’s not about the job title, or job description – it’s about the work that the employee does (or doesn’t do). The categories include, as noted above, the executive, professional, and administrative types of duties.
Are you misclassifying employees?
Here are a few things you can do as you review your existing employees:
– Make job descriptions clear. Review them in light of the duties that are actually performed, so that they match.
– Review your payroll procedures in light of this information and make sure your hiring practices are clear.
– Attend webinars or seminars that provide further, up-to-date help on these issues
– Talk to us, a lawyer, or an expert in employee law. Pay a fee if you need to – it will save you in the end!
It’s possible that you are already making this bookkeeping mistake of misclassifying employees – but you can fix it now!