Finding and keeping good employees is one of the most difficult aspects of running a successful business. When my business clients discuss their biggest challenges and frustrations, employment-related issues and employment law issues are almost always at the top of their list.
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One of the most interesting things about employment law is that it is constantly evolving, largely depending on which political party controls the federal and state government agencies that set and enforce employment policies. This can be really frustrating, however, for employers who don’t have time to keep up with every new legal development.
A good portion of my workday is spent discussing employment-related legal issues with small and mid-size business owners. The purpose of this article is to summarize two of the more common employment law issues that Arizona business owners deal with.
1. Worker classification: W-2 v. 1099
To paraphrase a famous line from Hamlet: “to 1099, or not to 1099, that is the question.” One of the threshold decisions that every business faces when hiring a worker is whether to classify that worker as an employee (W-2) or as an independent contractor (1099-MISC). This is a very important decision, and if made incorrectly, can have severe consequences down the road.
Over the past decade, state and federal government agencies have strongly focused on rooting out worker misclassification issues. That is because an employee’s paycheck is typically subject to more state and federal withholdings than independent contractors, and employees are entitled to certain benefits and protections that independent contractors are not, including (a) unemployment benefits if their employment is terminated, (b) worker’s compensation benefits if they are injured on the job, and (c) protections under wage-and-hour laws, including guaranteed minimum and overtime wages.
Here are some real-life instances where a company was alleged to have misclassified its employees as independent contractors:
- An independent contractor filed for unemployment benefits with the Arizona Department of Economic Security after her contract was terminated by the company. The Department determined that the worker had been misclassified as an independent contractor and awarded her unemployment benefits. The company was then assessed back taxes, fines, and penalties.
- An independent contractor was injured on the job and applied for workers’ compensation benefits with the Industrial Commission of Arizona. The Commission paid the $250,000.00+ claim and then sought reimbursement directly from the company after determining that the worker should have been classified as an employee.
- A business was sued because its independent contractor caused a serious motor vehicle accident, badly injuring a pedestrian. The employer’s CGL policy initially denied coverage because the vehicle was driven by an independent contractor, leaving the company to defend the claim out of its pocket while disputing coverage with its insurance carrier.
- Workers filed a lawsuit against a business alleging that they had worked hundreds of overtime hours for which they had not been paid because they had been misclassified as independent contractors.
- A business was subjected to multi-year audits from various state and federal agencies and was ultimately assessed hundreds of thousands of dollars in back-wages, taxes, penalties, fines, etc.
With such significant consequences for misclassifying a worker, one would think that the law would be very clear when it comes to determining whether a worker is an employee or independent contractor. I’ve got bad news for you. It’s not. Nearly every government agency applies its own multi-factor test when determining whether a worker has been properly classified. Some tests contain up to 20 different factors, with no one factor being dispositive.
I’ve seen instances where one government agency has determined that an independent contractor was properly classified while another government agency came to the exact opposite conclusion. So frustrating.
There isn’t enough space to outline and discuss every factor of every test applied by every government agency. Most tests, however, focus on (a) the company’s “right to control” the work that is being performed, and (b) whether the work performed is an integral part of the company’s business.
Business owners should consult with a knowledgeable employment law attorney before classifying any worker as an independent contractor, even if the worker agrees to it. The consequences of misclassification—although not quite Shakespearian tragedy levels—can be significant and costly.
2. Salaried employees and overtime wages
Many employers mistakenly believe that salaried employees are not entitled to overtime wages simply because they are paid a salary. Unfortunately, the analysis is more complicated than that.
Here is a quick refresher and update on a recent change in the law. The Fair Labor Standards Act (FLSA) provides that all employees are entitled to overtime wages unless they are exempt. An employee is considered exempt if (a) they are classified as an executive, administrative, or professional, and (b) they are paid on a salary basis at a rate not less than $844 per week ($43,888 annualized).
To qualify for the executive employee exemption, the employee’s primary duty must be managing the enterprise, regularly directing the work of at least two full-time employees, and they have discretion over personnel decisions in the workplace.
To qualify for the administrative employee exemption, the employee’s primary duty must be performance of office or non-manual work related to the management or general business operations and they must have discretion when it comes to matters of significance.
To qualify for the professional employee exemption, the employee’s primary duty must be performance of work requiring advanced knowledge in field of science or learning which is typically acquired through specialized intellectual instruction.
In addition, to be exempt from overtime wages, any employee falling into one of these three categories must be paid on a salary basis at a rate not less than $844 per week ($43,888/year). This salary threshold has recently been increased from the previous threshold of $684 per week ($35,568/year). This increase in the salary threshold is estimated to affect millions of workers.
Arizona businesses should review their payroll records and ask the following two questions about their exempt employees: (1) does the employee’s job duties fit within the executive, administrative, or professional classifications? and (2) does the exempt employee’s annual salary exceed $43,888/year?
In conclusion, classifying a worker as an independent contractor is a crucial decision that should only be made after careful analysis. The same consideration is required when determining whether an employee is exempt from overtime wages. Getting those decisions wrong can set business owners on a path that can lead to significant financial liability.
Employers who have specific questions about worker classification, overtime wages, or any employment law topics should consult with an employment law attorney.
Author: Lindsay Leavitt is a shareholder at Gallagher & Kennedy, where he represents and advises companies of all sizes in employment and business litigation matters.
