Worker Misclassification and Its Consequences
Exempt versus non-exempt? Employee or contractor? You understand employment designations and terminology — or do you? Many common employment-related terms are misinterpreted, When this misinterpretation is made by employers, stiff penalties are frequently the unfortunate result. Making mistakes with exempt versus non-exempt employees – or by classifying employees as independent contractors – can be particularly costly for employers.
Exempt versus Non-Exempt
The Fair Labor Standards Act (FLSA) dictates that employees must receive a federally-mandated minimum wage. The FLSA also states that employees are entitled to overtime pay at time and one half of their regular pay per hour for each hour worked over 40 during a workweek.
However, Section 13 (a) (1) of the FLSA names exemptions to minimum wage and overtime requirements for bona fide executive, administrative, professional and outside sales employees. Certain computer employees are also exempted from minimum wage and overtime requirements under Section 13 (a) (1) and Section 13 (a) (17) of the FLSA. Exempt employees receive a salary rather than hourly wages. With specific exceptions, they receive their full salary whether they work a full 40-hour week or not. Non-exempt workers receive hourly wages plus overtime for each hour worked over 40 during a workweek.
The FLSA dictates that exempt “creative professionals” and “learned professionals” must be engaged in non-manual labor AND paid a weekly salary of at least $455. However, Physicians, teachers and similar “learned” or “creative” professionals who receive hourly wages are also considered exempt.
Exempt computer employees must receive a weekly salary of at least $455 or an hourly wage of at least $27.63. Examples of exempt computer related positions include systems analyst, computer programmer and software engineer. Outside sales people must be engaged in obtaining orders or services for which they are paid by clients or customers AND regularly and routinely perform their duties away from their employer’s place of business to be exempt from FLSA required minimum wages and overtime.
Some unscrupulous employers attempt to skirt FLSA overtime pay requirements by paying otherwise non-exempt employees by salary versus hourly wages, or by giving them “executive” titles without the corresponding job duties and compensation. However, workers are not exempt from receiving overtime pay simply because they hold a specific job title or draw a salary rather than hourly wages. Employers who are caught Violating FLSA requirements by misclassifying non-exempt employees as exempt may be subject to hefty fines and penalties, in addition to required payment of back-wages for overtime pay.
Employee versus Independent Contractor
The FLSA provides guarantees and rights for employees such as paid holidays, unemployment compensation and payment of half of required Medicare and Social Security benefits. Full-time workers generally receive more rights than part-time workers. However, independent contractors receive none of these benefits. As a result, dishonest employers often label workers as independent contractors to avoid paying benefits for which they would otherwise be responsible.
However, the FLSA lists six criteria that determine whether a worker is truly an independent contractor or should be considered an employee.
- Whether a worker’s duties are integral to the business – if so, the worker is more likely to be an employee
- Whether workers are subject to both profit and loss – if so, the worker is more likely a contractor.
- Whether workers must invest in AND bear the loss for their own tools or equipment – if so, the workers is more likely to be a contractor
- Whether workers are engaged in regular competition with others for assignments – if so, the worker is more likely to be a contractor
- Whether workers are permanently employed – if so ,the worker is more likely to be an employee
- Whether work hours, pay and work location are dictated by employers – if so, the worker is more likely to be an employee
Employees who believe they have been misclassified may file Form SS-8: Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding and Form 8819: Uncollected Social Security and Medicare Tax on Wages. If the IRS determines that particular workers have indeed been misclassified, employers can receive a nasty surprise in the form of a demand to repay Social Security and Medicare taxes – along with substantial penalties.
Employers who wish to obtain partial relief from the financial consequences of misclassifying employees as contractors may file Form 8952: Application for Voluntary Classification Settlement Program (VCSP) and enter an agreement to classify workers as employees going forward, including paying employment related taxes. In exchange, employers are liable for only 10 percent of the employment tax they would have been required to pay, plus interest and penalties are waived and the IRS agrees to forego employment tax audits for previous years regarding reclassified workers.
Disclaimer: This article provides a general description and overview of employee misclassification and its possible legal and financial consequences. It is not intended to provide legal advice. Please consult with an attorney in your jurisdiction who specializes in employment-related matters with specific questions regarding classification of your company’s workers.
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