Today’s Biz Ladies post comes to us from Deanna Lohnes, founder of Parlance Media. Parlance Media specializes in both human resources (HR) and social media writing, and Deanna herself has 15 years of HR experience. Today she shares with us the key to establishing payroll policies for your company. With some easy-to-understand distinctions between W-2s and 1099s and a comprehensive look at the laws regarding salaries, Deanna teaches us the many details involved in setting up a proper payroll system. Thanks, Deanna, for your helpful advice! — Stephanie
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Most entrepreneurs are fiercely independent, myself included. So many of us left our day jobs behind to start our own businesses. Most of us left corporate life with a list of things we’d never do. Just like we swear we’ll never be our mothers, as entrepreneurs we swear we’ll never be our old bosses. In our quest to do things our own way, we throw the baby out with the bathwater when we it comes to our own staff. Corporate policy develops for a reason. Creating solid policies around payroll, discipline and expectations allow you to focus on what you went into business for in the beginning. Avoid human resource headaches down the road. Develop strong policies, clear expectations and a solid understanding of the laws that regulate payroll.
One of the most contentious issues business owners have with their staff is a problem with money. The most frequent human resource questions I get are related to paying employees. I want to clear up misconceptions and maybe show the wisdom behind some of the uptight corporate rules we longed to escape.
When you have a small business, it’s tempting to 1099 your workers and be done with it. There are a number of reasons why you shouldn’t do this. Number one is that it opens you up to Department of Labor and IRS scrutiny. Recently, there has been a serious crack down on companies for misclassifying employees as contractors. In fact, the DOL just launched a five-year plan to bring compliance up to 90%. The penalties for misclassification have the potential to be higher than the employee’s total compensation.
When the courts consider your employees, there are three sets of facts they use to determine classification. Behavioral, financial and relationship facts determine whether someone should be classified as a W-2 employee or a 1099 contractor. Behavioral facts relate to how the work is accomplished. Financial facts relate to who is paying the cost of completing the job. Finally, relationship facts define the expectations the employee has about what you do for them. This chart shows these facts and the differences between 1099 contractors and W2 employees.
|Behavioral||You dictate how the employee accomplishes a task.||You are concerned primarily with the outcome.|
|The employee uses your equipment to complete the task.||The contractor is expected to use his own equipment.|
|Financial||You pay for all the expenses required to complete the job.||The contractor could potentially incur a loss doing the job for you.|
|Relationship||You provide benefits such as insurance or paid time off.||A contractor provides his own insurance and other benefits.|
One caveat: The DOL, as well as the IRS, have definite opinions about this issue. The IRS’ opinions can be found in IRS Publication 1779: Independent Contractor or Employee? The information in this chart is intended to provide an overview. Please consult a tax professional about your own particular situation.
Once you determine whether you have contractors or employees, you need to decide if they are exempt or nonexempt. The term exempt refers to the employee’s exemption from DOL overtime rules. The short version of this question is: are they hourly or salaried? Unfortunately, it’s not quite that easy. Again, the DOL has definite opinions on this issue. The fines for misclassifying exempt or nonexempt employees can be triple the amount the of unpaid overtime.
The DOL uses three factors in determining whether an employee is exempt or nonexempt: salary, salary basis and job duties. The Fair Labor and Standards Act spells out these factors in gory detail. A brief version is in this chart:
|Exempt (salary — no expectation of overtime)||Nonexempt (hourly — paid overtime)|
|Salary||Greater than $23,600 annually ($455 weekly)||Employee is paid hourly. They cannot be paid less per hour than minimum wage.|
|Salary basis||Employee can count on receiving the same amount in any week they work.||Amount earned will depend on number of hours worked.|
|Job duties||Exempt employees perform professional, executive or exempt administrative duties.||Perform all other job tasks, including manual work.|
The law is very clear on the distinction about job duties. You can’t give your janitor the title CFO and expect to get out of paying him overtime.
Executive job duties include
- Supervising two or more other employees
- Management as the primary duty of the position
- Having genuine input into the job status of other employees (such as hiring, firing, promotions or assignments)
Exempt administrative duties are a bit fuzzier. For an administrative position to be exempt, work duties must include
- Office or nonmanual work
- Work that is directly related to management or general business operations of the employer or clients
- Independent judgment and discretion
- Work of significance
Professional duties include those of nurses, doctors, lawyers and CPAs. I won’t go into detail on those positions.
If you run a small retail shop, for example, your clerks will be nonexempt W-2 employees. You will provide direct supervision. You will determine their schedules and methods for completing the tasks. You will provide the tools they need, such as the point-of-sales system.
Protect yourself by understanding the Department of Labor’s rules regarding paying your employees. Don’t ask a clerk to accept a 1099. Employees will sometimes go along with these “arrangements” for pay because they like you, or they want to be nice. Then something happens and they report the situation to get back at you.
The best way to protect yourself against those situations is to follow the DOL rules from the start. Don’t make “arrangements” with employees. Another way to protect yourself from disgruntled former employees is to have a handbook with policies on paid time off, benefits, harassment and discrimination spelled out. Many states require a written policy on harassment and discrimination.
When you have clearly defined policies, it becomes easier to terminate employees for policy violations. No one wants to be the bad guy and have to fire people. At times, it is necessary. If you have a written policy and documented instances of policy violation, it becomes easier to present the facts and end the relationship. The rules on final paychecks vary by state. Some require immediate payment; others require the employee to demand the final check. Best practice is to pay them at the time of termination.
A solid understanding of the issues regarding paying your employees will help you avoid a lot of headaches or worse, lawsuits. Avoid audits and crippling fines by correctly classifying your employees. It’s hard to resist the temptation to do the easy thing when you have so much on your plate. The risks in taking the easy way out are not worth it. Protect yourself and your business.