In order to stay compliant with all the state and federal laws, you must classify your workers based on the nature of their employment. Misclassifying employees on IRS tax forms can result in penalties or even land you in legal hassles. The main difference between salaried and freelancers is the type of work they do and whether or not they are exempt from overtime
Who is an hourly worker?
Hourly workers are employees who are paid an hourly amount for their work. They d o not follow a stable working routine. They follow a schedule set by the employer and do not work past the hours. Hourly workers have different pay rates, time off, and benefits as compared to permanent employees.
The main difference between an hourly worker and a salaried professional is that the latter gets many benefits. Fixed salary, sick leave, healthcare benefits, paid time off are some of the perks of being a salaried employee. They are also exempt from overtime. An hourly employee does not receive such benefits and are paid solely for their services. Hourly employees are usually considered non-exempt employees and must be paid overtime wages after 40 hours of work in a week.
Worker classification: What is it?
In every company, workers are classified based on their hours of work and tenure of work. All workers fall under either one of these three categories:
- Full-time worker
- Hourly worker
- On-demand worker
Full-time workers have a weekly work schedule with a company for an indefinite period of time. Full-time employees are allowed to work 40 hours. If the employee crosses the duration, he is eligible for overtime compensation. Full-time workers are eligible for benefits and fixed salaries.
Hourly workers put in fewer hours than a full-time worker.
They work irregular hours, spending 30 hours or less working per week. Hourly workers are paid an hourly wage for their services, as opposed to a fixed salary.
On-demand workers are hired for a limited period of time to assist the employer. They could be hired for a few weeks or even 9 months. Unlike full-time workers, on-demand workers do not receive benefits or job security.
What are the characteristics of an hourly worker?
- Hourly workers have their own work schedules and working hours.
- Hourly workers have additional sources of income as they work with more than one business.
- Hourly workers have their own means of accomplishing tasks and different processes in place to accomplish a given task. They do not have to adhere to your business processes.
- Hourly workers are free to offer their service to other businesses while working with you.
- Hourly workers engage in a limited project for a short tenure. They do not perform additional functions in your company.
Why is it important to maintain proper hourly workers classification?
Although full-time workers and hourly workers perform critical functions in your office, there are many key distinctions between the two. For one thing, the federal and state laws state that companies who hire hourly employees must pay them overtime fees whereas they don’t need to do so for salaried employees.
Companies must withhold income taxes, withhold & pay social security and medicare taxes, and pay unemployment tax on wages paid to a full-time employee. Whereas companies do not generally have to withhold or pay any taxes on payments made to hourly workers.
If you classify full-time workers as hourly workers, you may be held liable for employment taxes for that worker. Employee misclassification causes substantial loss for the federal & state government causing them to lose out on tax and payroll revenue. If the government finds out that you have misclassified your employees, you could be held responsible for tax evasion and a penalty will be imposed.
Common mistakes to watch out for while misclassifying employees
Wage claim violation
If employers misclassify employees, they may be violating wage, tax, and employment eligibility laws. Your company will be held liable for failing to pay overtime and minimum wage under the Federal Fair Labor Standards Act (FLSA) as well as under state wage laws. But one loophole in this scenario is that the federal, state, and other government agencies all use different logic to determine misclassification, and this makes legal compliance difficult.
Negative audit report
If the government agency finds that you paid state and federal payroll taxes, social security and medicare taxes for an incorrectly classified employee, they can impose penalties. If an hourly worker was classified as an employee, you will need to pay fines for not having an I-9 form on record for him.
Penalties can also be imposed for failing to timely deposit payroll taxes and for paying back-taxes & interest on wages that weren’t withheld originally. If the IRS finds out that you’ve intentionally misclassified workers, they impose criminal and civil penalties and sanctions. Failure to make these payments can result in additional fines.
Complaint from a misclassified worker
If a worker feels that he has been misclassified, he can file a complaint with the state Department of Labor. If the claims are found to be true, you will need to provide the worker employee benefits health insurance, and overtime fees. If this issue comes into the attention of tax and labor authorities, they can impose additional penalties.
How to avoid misclassification of employees?
- Always make sure that you have a written contract for each hourly worker you work with. It should explain their classification, work hours and duties owed to your company.
- Your contact must state that hourly workers are not entitled to employee benefits.
- Provide copy B of the IRS form 1099-NEC to the hourly worker as mandated by the IRS.
- State the factors that you took into consideration to determine the worker’s classification.
- Obtain a furnished W9 form from the hourly worker which contains their personal details and Social Security number before paying them.
- Always keep a Form I-9 for each one of your employees to prove their employment eligibility.
If you are hiring hourly workers, always make sure that they understand their classification status as well as the terms of the work relationship. Your company must have a defined classification scale in place to manage hourly workers. Having a clear established classification methodology helps avoid serious penalties, compliance risks and legal entanglements on the long run.