Employee Classification

It’s crucial for employers to classify their workers correctly to avoid lawsuits and substantial government penalties. To do this, you must understand proper employee classification.

  • Employee v. Independent Contractor. Whether workers are correctly classified as employees or independent contractors has many legal implications. When hiring an employee, employers must pay federal and state taxes, unemployment insurance, health insurance, among other costs – all of which they can avoid by hiring a contractor. The test to determine whether a worker is an employee or contractor boils down to one central issue: control – does the employer control where, when and how the work is performed? If so, the worker is very likely an employee. Be careful as penalties for misclassifying employees as contractors can be huge.In California, state penalties alone range from $5,000 to $25,000 per violation, and on top of that, the IRS imposes a penalty of 1.5 to three percent of the employee’s wage. This is in addition to any lost wages and overtime the employer may owe.

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  • Exempt v. Non-Exempt. A common misconception, particularly among early-stage companies, is that salaried employees are not entitled to overtime pay. In fact, whether or not employees are salaried has little to do with whether they can collect overtime. To determine whether an employee is exempt from overtime pay, an employer must determine if the employee qualifies for an exemption, the most common of which are administrative, executive and professional. Under each of these exemptions, employees must have the authority or power to make independent choices – free from immediate direction or supervision – in matters of significance to the company. In other words, employees’ titles don’t affect whether they are exempt. Only their actual job responsibilities matter. Keep in mind that there is usually an income requirement for employees classified as exempt. In California, for example, in addition to meeting all of the aforementioned criteria, an employee must be paid at least two times the minimum wage ($41,600 annually) to qualify for an exemption.

It’s wise for startups to hire trusted legal counsel with experience in employment law to advise them as they scale in order to avoid major costs and penalties.

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Employee Classification

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