How To Correctly Classify Your Employees
You've designated specific job roles and responsibilities, but have you taken the time to classify your employees?
If you're a business owner or human resource manager, this is one step you can't afford to miss. Classifying your employees can help you meet stringent federal, state, and local requirements used to determine benefit plan eligibility and compensation payments.
Yet, it's no secret that classifying works can be confusing, challenging, and time-consuming to implement. That's why we're here.
Today, we're taking a closer look at how to classify your employees, what each classification means, and how our comprehensive solution can alleviate the exhausting burden of doing all the legwork yourself.
Ready to learn more? Let's get started.
Introduction to Classifying Employees
Put simply; an employee is anyone who works for your business. However, it's likely that not everyone is the same type of employee. On any given workforce, you could have several different classifications, including:
- Full-time employees
- Part-time employees
- Temporary and seasonal employees
- Independent contractors
- Statutory employees and non-employees
From this list alone, it's easy to see that employee classification isn't a one-size-fits-all job. That's why it's important to understand the terms used to define these categories. Especially as your small business grows, you might find yourself taking on a wider range of employee types, and knowing which classification they fit into is vital.
Failing to label an employee the right way can result in hefty fines enacted by the IRS. This is because confusing their classification types could mean not paying the proper taxes or failing to distribute the proper level of benefits.
Next, let's take a look at how the specifics of each surrounding to make sure your organization follows the correct layout.
The U.S. Department of Labor (DOL) doesn't define full-time or part-time employment, nor does the Fair Labor Standards Act (FLSA). However, under the Affordable Care Act (ACA), the IRS does set standards around this classification, identifying a full-time employee as someone who is, for a calendar month:
- Employed, on average, at least 30 hours of service per week or 130 hours per month
Also known as common-law employees, most businesses recognize full-time employees as those who work between 35 hours and 40 hours per week. In some cases, employers might choose to classify someone as full-time if they work only 30 hours per week.
In the event that a full-time employee is required to work more than 40 hours per week, the FLSA requires that employers provide them with overtime pay. While salaried employees will normally receive a flat pay rate regardless of their hours worked during the week, check with your local regulations to understand overtime payment terms.
The IRS requires that you pay the following for full-time employees:
- Social Security
- Federal unemployment tax (FUTA)
Each employee's W-4 form will reveal how much Social Security, income tax, and Medicare you'll withhold from their pay, along with how much to give to the government. You'll take FUTA out of your own funds.
If you inadvertently misclassify a worker as part-time when the ACA identifies him or her as a full-time worker, the result could be disproportionate benefits distribution. This could result in expensive penalties and fees.
Part-time employees are also considered common-law employees and work for your company on a continuous basis.
The only difference between these workers and full-time employees is that the number of hours they work per week falls short of what your organization considers a full-time workweek.
Like full-time employees, you can pay part-time workers on a salaried or per-hour basis. In most cases, you'll stick to the same rate of pay for both classifications, but pay part-time employees on a prorated basis. This means that a part-time employee working three hours a week will earn 60% of what you'd pay a full-time employee with the same workload.
You'll have to pay the same types of taxes for part-time employees as you do for full-time ones. Benefits, though, will differ.
Many companies choose to extend a portion of their benefits to part-time employees, though on a limited basis. For instance, you might withhold fringe benefits, including sick days, paid time off, or tuition reimbursement, from your part-time workforce.
When it comes to health insurance and retirement plans, you are not required to extend these benefits to your entire part-time workforce. However, both the IRS and Employee Retirement Income Security Act (ERISA) explain that some part-time employees who work more than 1,000 hours per year may be eligible to participate.
Another exception applies if your company offers pension plans, and a part-time employee works at least 1,000 hours during the year. According to federal law, these employees must have access to the same pension plan as your full-time employees.
Temporary and Seasonal Employees
Does your company experience a surge in sales activity during a certain time of the year? If so, you might rely on temporary and seasonal employees to help shoulder the workload.
For example, retailers might need extra help during the holiday season, while business owners in vacation destinations may require it during the tourist season.
In most cases, it's in your best interest to let a staffing agency hire these employees for you rather than tackle the task yourself.
If you hire temporary employees yourself and pay them on a salary or hourly basis, you'll be required to withhold taxes from them. However, if these workers are technically employed with a staffing agency instead, the agency can take care of those details for you.
In terms of benefits, you're required to extend Social Security and unemployment benefits to temporary employees, but you do not have to provide benefits beyond that.
Keep in mind that if a worker's temporary employment goes well and you wind up bringing them on board on a part-time or full-time basis, their privileges and benefit eligibility will change. Thus, it's important to reclassify them correctly once you make this decision.
Independent contractors are people who work for themselves but provide a service for your company. Often working as freelancers, they're responsible for handling their own taxes. And, as they don't technically work strictly for your company, you don't have to include them on your benefit plans.
While these perks might sound advantageous from an employer's standpoint, resist the urge to classify common-law employees as independent contractors just to save money. If the IRS finds that you did not submit a W-2 form for an employee who should have received one, it will subject your company to pay strict penalties, including:
- Back tax that equal up to 41.5% of the independent contractors' wages (up to three years)
- A criminal conviction of up to a year in jail
- Fines as high as $500,000
Independent Contractors versus Employees
To avoid accidentally misclassifying your workforce, how can you discern the difference between an independent contractor and an employee?
While the IRS gives a thorough explanation, the basic logic lies in understanding three principles, including:
- Behavioral control
- Financial control
- Worker/business relationship
First, as the employer, do you maintain the right to direct and control the work that the worker performs? Second, are you in a position to control the financial aspects of that person's job?
Finally, what kind of relationship have you established? Did you sign an official contract outlining work terms, and is this worker a critical part of your ongoing business endeavors? Do you extend benefits to this individual?
If the answer to all of the above questions is "no," then you're likely working with an independent contractor. If there is any confusion, be sure to clarify it before moving forward.
Statutory Employees and Non-Employees
Both statutory employees and non-employees are certain kinds of independent contractors.
Statutory employees are special kinds of workers whose wages are not subject to federal income tax withholding. However, they are subject to Social Security and Medicare (FICA) and unemployment taxes (FUTA). Technically, these workers are independent contractors, but special statutes mean they can avoid paying federal income tax.
The IRS identifies four categories of statutory employees, including:
- Certain food and beverage distribution drivers or laundry/dry cleaning drivers
- Full-time life insurance sales agents who work for one primary company
- Home-based workers who work on materials or goods that you supply and that must be returned to you
- Certain full-time traveling or city salespeople
On the other hand, statutory non-employees aren't subject to the same statutes. That means they're not subject to federal income withholding tax, nor do they qualify for FICA or FUTA taxes. In most cases, employers can treat them as independent contractors for tax purposes.
The IRS recognizes three categories of statutory non-employees, including:
- Licensed real estate agents
- Direct sellers
- Certain companion sitters
Looking for short-term talent to help fill a gap within your team? Interns can be an excellent resource, and many end up turning into full-time employees when their internship is over.
In most cases, employers will treat interns as temporary employees, and the position can be either paid or unpaid.
Are you considering hiring an unpaid intern to join your workforce? The U.S. Department of Labor has created a six-factor test to help lay the groundwork for how this partnership should work. The full language of the test is available here, but the high points are as follows
The internship should be similar to a training program that you would deliver in an educational environment.
The internship should benefit the intern.
The intern should not displace your existing employees but work with them to their benefit.
Trainers might not derive an immediate advantage from his or her activities, and at times, they might impede their own.
The intern is not guaranteed a job at the end of the internship.
The intern is not entitled to receive wages during the internship.
Under the FLSA, only non-profit organizations and those in the public service sector can accept the help of volunteers who donate their time without the expectation of compensation.
This is because the FLSA recognizes that workers may volunteer their time freely for charitable and public purposes, such as for a non-profit organization, although they are not covered by the FLSA during this time. However, these individuals cannot volunteer in commercial activities, such as in a gift shop or donation center, that the non-profit operates.
Conversely, you cannot expect your full-time, commercial workers to stay late and work on a big project on a "volunteer basis." They're entitled to the same treatment, pay, and benefits as always. In other words, you can't allow them to perform their normal, for-profit duties without providing appropriate compensation in return.
Classify Your Employees Right the First Time
Learning how to classify your employees the right way can feel like a chore, but it's one you can't put off. When you accomplish it, your business will run smoother, you'll be protected from significant consequences, and your team members will better understand their place at your organization.
It's especially important to understand the difference between a full-time employee and a part-time one, as well as what distinguishes an independent contractor from a common-law employee.
The only problem? Abiding by federal and state standards can be a challenge in itself, not to mention the legalities to follow with local requirements. We understand the nuances can be confusing, and we're out to make this process as simple as possible.
At Worklogic HR, we provide packages that can help you work through this red tape, understand the legal jargon, and take a right next steps for your company. Contact us today for a free HR consult and never worry if you're getting it right again.