As a small business owner, it is critical to your business to understand what differentiates an employee from an independent contractor, as well as what positions in your business are eligible for overtime compensation. The failure to properly identify workers and remit taxes and compensation, as required under the tax and wage and hour laws, exposes the business to significant risk. The financial costs of non-compliance remitting the cumulative overtime wages due, past due taxes, fines and penalties can bankrupt a business and its owners.

Does this sound familiar to you? “I work for a company that gives me a 1099-Misc form each year. I work for them 40 hours each week, 8 to 5 each day. I work in the accounts payable department along with 2 other people, and I am supervised by the owner of the company, who tells me what to do and reviews my workgroup. I don’t receive benefits or vacation, but I do get paid for holidays. I use the computers and other equipment on site. I’ve worked in the same position and performed the same tasks for five years. I believe I am an employee of the company, but the owner says I am a contractor!”

In the above-mentioned situation, the employer is faced with what is the Internal Revenue Service (IRS) classifies as misclassification of a worker: An employee who should be receiving a W-2 is receiving a 1099-Misc form. Payroll withholding taxes are not being withheld by the company and remitted to the IRS. The company is not in compliance with tax laws.

Another related aspect of employee classification: overtime. Employers often believe that by paying a salary instead of an hourly wage, they can avoid paying overtime. Overtime eligibility is determined by whether the employee is performing a role in the organization that is exempt or non-exempt from overtime compensation. The specifics of qualifying for overtime compensation are defined by the Fair Labor Standards Act and state wage and hour laws. (Note: For-profit entities cannot use compensatory time in lieu of overtime payments except under union-negotiated agreements. Also, overtime payments that are earned by employees cannot be waived, but are obligations under law.)

Small business owners should reduce their risk of non-compliance by ensuring they always follow these guidelines:

  • Understand the IRS checklist for independent contractor/employee determination.
  • Review exempt and non-exempt classification of each job in your business to determine overtime eligibility.
  • Require employees to maintain records of all time worked.
  • Maintain a written policy on time reporting, overtime, and other payroll related policies.
  • Require pre-authorization of overtime—before it is worked.

It may not seem important whether you give a W-2 or a 1099-Misc form, as long as the same amount of taxes are being paid. The IRS doesn’t take the same view; the requirement is to properly classify your workers and remit taxes due in the correct amount and in a timely manner.

Copyright ©2009 Lea A. Strickland

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