Apr 03, 2023

How To Classify Your Workers

In order to pay your workers properly while remaining in compliance with both IRS- and state-mandated requirements, you must correctly classify the people who work for you. Incorrect classifications can be detrimental to your business operations. But how do you know whether you're classifying your workers correctly? Read on to understand the differences between exempt and nonexempt employees as well as various other worker classification terminology.

When you hire someone to work for you, the worker will likely be considered either an employee or an independent contractor. Usually, you will decide whether you want to onboard an employee or simply hire a contractor prior to advertising for the available position. That way, whoever comes across your job post will know whether they can expect employment or a contract job prior to applying for the position.

Properly classifying your workers is important because misclassification of those who work for you can lead to very impactful tax penalties. Thankfully, these are avoidable as long as you are in compliance with the rules and regulations. Furthermore, you absolutely must comply with requirements regarding tax contributions and how much you withhold in the context of employees, not contractors.

As you seek to accurately classify your workers, you will likely come across the terms exempt and nonexempt, but what do these words mean? And where do they fit into the conversation? Let's explore the answers to these questions and more.

Exempt vs. nonexempt

Exempt employees are not required to be paid overtime. However, that said, you might decide to offer some form of compensation to exempt employees who work extra hours, which should be well defined within the employee's benefits package.

On the other hand, nonexempt employees will either receive a predetermined hourly wage or earn an annual salary. From there, nonexempt employees will be entitled to a minimum wage, namely if they earn an hourly wage, as well as overtime pay in situations where they work more than 40 hours per week as determined by the Fair Labor Standards Act. The FLSA is a federal law that not only determines the federal minimum wage but also the requirements for overtime pay and standards.

Information from the FLSA and Department of Labor regarding classification of employees

In the words of the FLSA, all employers are required to pay their nonexempt employees time and a half for every hour the employees work beyond 40 hours per week. Time and a half is calculated based on the employee's regular pay rate. For instance, if you earn an hourly wage of $15 per hour, then your overtime pay would be $22.50, which is calculated by dividing 15 by two and adding that value to $15.

If you have nonexempt employees who are not paid hourly, then the employee's hourly rate can still be determined by taking the amount of money your employee earned and dividing it by the total number of hours the employee worked. However, do not include vacation time, official holidays or sick days when you are calculating the employee's pay.

The DOL has official guidelines regarding who is and is not eligible to receive overtime pay. There are certain situations where employees can be considered exempt.

These include whether your employees are paid an annual salary, whether they earn $684 per week at a minimum, whether they earn at least $35,568 per year and whether they perform the job duties of someone who works in an administrative or executive role. Also, employees who are highly compensated, meaning they earn approximately $107,432 or more per year, are not eligible for overtime in the way that other employees are.

The amount of money an employee earns, whether on an annual or hourly basis, is not the only determining factor when it comes to whether an individual is considered exempt versus nonexempt. Even so, their pay rate can play a role in the context of workplace policies.

If your workers fail to meet the requirements of the FLSA duties test, earn no more than $684 weekly, make less than $35,568 annually or claim specific deductions in regard to their take-home pay, then those employees might be eligible for overtime pay. That said, certain industries, such as agricultural businesses, movie theaters and railroad companies, hire hourly workers who are not entitled to overtime pay.

All your employees, whether they work full or part time, must fill out an IRS-backed Form W-4 and then give it to you as their employer prior to working for you. Independent contractors, on the other hand, must fill out a different form, the W-9.

Now, if you are not sure how to classify any of your workers, take the time to fill out Form SS-8, which is the Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding. Once you fill it out, send it to the IRS for processing.

You might find it easier to pay your employees on a salaried basis because it ensures that the payroll process is simplified altogether while keeping things consistent. This is because salaried employees receive the same amount of money on a monthly basis no matter how many hours they work per week or month.

In order for an employee to be salaried, they must uphold the duties of their position while also adhering to the requirements set forth by the DOL. At the same time, paying employees an hourly wage instead of a salary can make more sense in certain situations, as hourly workers provide managers with greater flexibility when they sit down to make the schedules every week.

This can be significantly beneficial for job roles that do not necessarily come with the need for consistent schedules. Failing to properly identify exempt employees and classify them differently than your nonexempt employees can affect your business in drastic ways, as can the act of misclassifying workers, even if you do so by accident.

The misclassification of your workers can result in any of the following:

• Enforcement of proper classification and disciplinary action.
• Costly fines and business-related penalties.
• Lawsuits from employees who worked overtime that went unpaid.
• Responsibility of the costs for remedying the misclassification.

While misclassification is never acceptable, especially when it is intentional, there are instances in which reclassification is necessary. For example, a nonexempt employee might need to be reclassified as an exempt employee or vice versa.

Similarly, you might initially hire someone as a contractor, but as time goes on there might be a conversation about onboarding the contract worker as a long-term employee. Likewise, an exempt employee who is reclassified as a nonexempt employee might perceive the exempt-to-nonexempt transition as a demotion in terms of prestige.

Regardless of the specifics, make sure you explain the law to your employees, especially those who might feel slighted by changes in classification or employment status. Try to stress that the reclassification is in no way indicative of the employee's performance or any work-related issues so that your employees do not take the change as a personal attack.

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