February 26 Tip of the Week

“Misclassification: An Expensive Mistake”

One of the most important things that an employer can do is to classify their employees correctly.  An incorrectly classified employee can lead to huge damages if the employee or an enforcement agency learns of the misclassification.  There are two primary areas of misclassification – the first is whether an individual is an employee or an independent contractor.  This type of misclassification involves the way that employment taxes are paid (or not paid) and involves the IRS and other agencies.  The second area of classification involves how the employee is paid – are they are an exempt employee who, based on their duties and responsibilities, is not eligible for overtime?  Or are they a non-exempt employee who is eligible for overtime pay and is paid based on the number of hours worked?  These classification issues are becoming increasing important as they are a new area of focus for the United States Department of Labor. 

With respect to employee or independent contractor decisions, there are a number of violations that can be found if an employee is misclassified an independent contractor.  The first violation is the lack of I-9 form; employers are not required to complete an I-9 form regarding an independent contractor’s ability to work legally in the United States.  If the independent contractor is really an employee, the employer will be subject to penalties under immigration law.  These penalties can include civil fines, criminal penalties, and debarment from federal contracts.  One of the most expensive costs of improper classification of independent contractors is under the wage and hour laws.  Independent contractors are not subject to the Fair Labor Standards Act and are not required to be paid minimum wage or overtime.  If an individual is improperly classified as an independent contractor, the employer may be on the hook for unpaid wages, unpaid overtime, and other massive penalties including liquidated damages and attorneys’ fees that are incurred in defending against the misclassification claim.  An employer who improperly classifies an employee as independent contractor may also be in violation of the workers’ compensation and unemployment compensation laws, and may be subject to penalties for failing to pay state and federal payroll taxes on behalf of the misclassified independent contractor.  Other issues can arise under other statutes that apply to employees and not to independent contractors, including those that involve employee benefit eligibility and FMLA leave.  Given the breadth of the impact of a misclassification of an independent contractor, employers should always err on the side of finding an individual to be an employee if there is any question as to the appropriate classification. 

With respect to exempt and non-exempt employee issues, it is important to focus on the duties and responsibilities of the job that the individual employee is performing.  The amount of payment and the method of payment (such as hourly or salaried) do not dictate whether an employee is exempt or non-exempt, rather it is the actual duties performed by the employee in the course of their employment that dictates whether they are exempt or non-exempt.  The amount of pay earned by the employee is also important – once the employee is determined be performing the duties that make them eligible for an exemption (administrative, executive, or professional), they must also earn a certain amount of salary.  That number is currently set at $684 weekly or $35,568 annually by the federal Fair Labor Standards Act, but may be higher in states with their own minimum salary amounts.  Recently, the DOL proposed an increase to this minimum exempt salary amount; that increase would require exempt employees to earn $1,059 per week or $55,068 per year to be properly classified as exempt.  While this rule is only proposed at the current time, it is likely to be implemented by the middle of 2024. 

In preparation for the implementation of this new salary amount, employers should conduct their own internal audits of employees who fall within the new and old salary range to determine whether the duties performed by these employees meet the duties requirements of the exemption.  If they do, then employers need to determine whether they want to continue to treat them as exempt and raise their salary to the new minimum when it goes into effect or whether they want to reclassify them as nonexempt and pay them an hourly rate of pay and overtime when warranted.  The fact that an employee can be classified as exempt does not meant that they have to be paid as an exempt employee.  An employer can choose to pay all its employees on an hourly basis and pay overtime for all work hours over 40 in a week.  The decision of how to pay employees is largely a business decision that is dictated by the facts and circumstances of each position involved.  If the position meets the duties test and requires additional hours over 40 in a week on a regular basis, then that position should be classified as exempt because it will cost the employer less to get the work that they need out of the position.  If the position meets the duties test, but does not require any overtime and they can pay an hourly rate that is less the new exempt requirement, then it may be better to pay the employee as a  nonexempt employee from a financial standpoint. 

As this new salary threshold looms on the horizon, employers need to sharpen their pencils and do the analysis, including the math.  Does the position include job duties and responsibilities that meet the requirements for any of the three exemptions?  If so, does the position require the incumbent to work more than 40 hours in a week on a regular basis?  If the answer to those questions is yes, then it is appropriate to classify the position as exempt.  If the answer to the first question is no, then the position has to be classified as nonexempt.  If the answer to the first question is yes and the answer to the second question is no, then you need to do the math and determine whether it is more beneficial from a financial perspective to pay that employee as a nonexempt employee.  myHRcounsel can assist you in this exercise and we encourage you to begin this analysis as soon as possible so that you can take a proactive approach to the proposed change in the salary threshold.