Employee Classification: How to Properly Classify and Avoid Misclassification penalities

September 27, 2018

Employee classification is hard to determine sometimes. Learn the differences between classifications to avoid those scary misclassification penalties!

Employee classification cover photo

You have the resume in front of you—you have identified the perfect candidate. Based on how the interview is going, it is evident that this person pays attention to detail, understands your company, and has experience in your industry. The candidate is poised and relaxed as you ask questions; the answers are thoughtful, yet sincere. You are ready to make your move.

Not so fast. You realize there is something you need to check on before you extend that offer. The details of classifying this position are not clarified with your human resources department. You realize you aren’t 100% certain about the employee classification.

While you think this a salary position, you want to ensure that’s correct. Considering salaried positions are not eligible for overtime (and you know there could be plenty of late workdays involved), you’re unsure where they fall. After all, if this candidate is the best fit, you want to be intentional about holding up your end.

What is employee classification?

Understanding employee classification is as simple as your viewpoint on their position, combined with the tasks they perform.  This viewpoint is the essence of the employee’s job.Employee Classification image 4

To protect employee rights, the United States Department of Labor (USDOL) enforced the Fair Labor Standards Act (FLSA).  The FLSA ensures that employees receive proper pay.

One such item under the FLSA is employee classification.  Employees are classified as either contract workers (also referred to as 1099s) or employees (also referred to as W-2s). Employees are either classified as exempt or non-exempt, based on payment methods.

Contract workers

Contract workers, while on assignment for a company for short-term or long-term projects, are not actually employees of the company.  How would you be able to decide if a worker should be a contract worker or an employee?

Ask yourself this:  Do I tell this person what I want done, when I want it done, and how I want it done, and do I give this person the tools to get everything done?  Or: Do I tell this person what I want done, and he/she will work at his/her own pace to complete the task, and he/she will complete the task how he/she sees fit, and using his/her own tools?

Employee Classification image 2If you, as the employer, are directing the task and providing the tools, then that worker would likely be an employee of the company.  If you are assigning a task and then waiting on its completion, with little involvement otherwise, then you likely have hired a contract worker.  Companies are not required to withhold income taxes from contract workers’ pay, they do not pay taxes on contract workers’ behalf, and contract workers are subject to self-employment taxes.

Related:  Get a Head Start on Taxes

Exempt employees

Exempt employees are workers who receive an annual salary.  This type of worker is not eligible to receive overtime pay after working more than 40 hours in a workweek. The worker is excluded from minimum wage, and is not covered by other rights and protections for employees.

So, what is the benefit of being an exempt employee?  First of all, the salary range may be higher for exempt employees.  According to the FLSA, an exempt employee must be paid an annual salary of at least $23,600.  While this might not sound like a lot of money, that is simply the starting point. Many exempt employees receive higher salaries than the minimum.

The second benefit of being an exempt employee is the flexibility of the schedule.  For example, while there may be certain meetings that an exempt employee is required to attend, the employee might be able to attend the meeting from a remote location, as salary employees often have the tools they need to perform their job outside of the office.

Also, keep in mind that exempt employees do not punch a time clock, so some days they may work more than 8 hours, and some days they might work fewer than 8 hours, and they can have a more relaxed outlook on when they have to be in the office.

Non-exempt employees

While the flexible schedule of an exempt employee might sound enticing, there are also benefits to being a non-exempt employee.

Non-exempt employees must receive at least time-and-a-half (or 1.5 times their hourly rate) when they exceed 40 hours in a workweek. An employee receiving an hourly wage receives pay for any hours they work outside of their regular 40 hours—and at a higher rate.

Penalties for misclassification

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The DOL deters employers from misclassifying employees by imposing penalties on companies which improperly pay their employees.

If a company classifies a worker as a contract worker instead of an employee, or classifies a non-exempt employee as an exempt employee, the employer may be subject to back taxes up to three years.  The possibility of criminal charges may also apply, if they determine the misclassification was intentional. So we are not just blowing smoke, employee classification is serious business!

Related:  Keeping it Human: Understanding the Importance of Human Resources

Intermittent audits

Despite one’s best efforts, humans run companies and humans occasionally make mistakes.  One of the best ways to stay on top of misclassifications is to perform intermittent audits on employee roles.

Basically, the audit would entail reviewing the lists of contract workers, exempt employees, and non-exempt employees, and then performing a duties test to make sure the worker meets the requirements of the job performed, based on classification.

Any employees not meeting the requirements would need their classification reconsidered, adjusted, and may receive any back payment deemed appropriate, in order to be in compliance with FLSA regulations.

Get it right the first time

So, after a discussion with your HR department and review of the duties, you determined for certain that your new candidate is a non-exempt employee.  In this role, the employee will receive a regular rate of pay to work 40 hours in a given workweek, and will receive overtime pay, should the week require more than 40 hours.  Go ahead and extend that offer!  After all, you don’t want to let the good ones get away.

While we are on the topic of employee classification, for future reference, below is a chart that will help you determine what kind of worker you are hiring for the job.

employee classification blog 

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