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Importance of Proper Employee Classification

Importance of Proper Employee Classification

There are several employee work classifications covering everyone from full-time workers to special classes, such as temporary workers. Each person needs to be sorted into their appropriate groups to help determine their benefit eligibility.

However, there are occasions where employees can be incorrectly classified. The Department of Labor (DOL) found that up to 30% of employers have misclassified at least one worker often by accident. It can be tricky to determine each employee’s class, and the government strictly follows this issue. That’s why it’s important to know about employee classification, and how it can affect your business.

What Is Employee Classification?

The Society for Human Resource Management (SHRM) writes that proper employee classification, “make[s] sure that all legal requirements are maintained so that there is no discrimination in terms of benefit plan eligibility and payment of compensation in accordance with federal and state laws.” In general, there are seven categories that employee classes fall into:

  • Full-time
  • Part-time
  • Contract employees
  • Independent contractors
  • Temporary
  • On-call
  • Volunteer

Arguably the most crucial part of employee classifications is determining whether a worker is exempt or non-exempt. Exempt employees can receive company perks like healthcare and PTO but are not granted benefits from the Fair Labor Standards Act (FLSA). Meanwhile, non-exempt employees are eligible for both FLSA benefits and those given out by the company.

There are special rules that dictate which types of employees are considered exempt or not. In order to be considered exempt, employees must pass the following three tests:

  • The salary basis test – Exempt employees must be paid a predetermined and fixed salary that is not subject to reduction.
  • The salary level test – Exempt employees must meet the threshold for minimum weekly salary (at least $684 per week effective Jan. 1, 2020).
  • The job duties test – Exempt employees must primarily perform a list of set duties (read our post on which employees qualify as exempt for a breakdown of these duties).

How Employee Misclassification Happens

The biggest issue with misclassification is that some owners don’t know how to list someone in their manual class. An employee’s specific job duties can dictate their classification, but class codes can change based on a business’ location.

One such employee classification example stated by the Ohio Bureau of Workers’ Compensation lists the 8810 classification as the standard exception for clerical office employees. If a business owner classifies an employee under 8810, but that employee spends half his time in an office and half his time in a warehouse operating tow motors and moving boxes around, the employee should not be listed as an 8810. He should be classified as a warehouse worker. 

Another employee classification example involves misidentifying someone as an independent contractor instead of an employee. Independent contractors always maintain some level of independence, whereas employers have more control over how an employee completes projects and the economic aspects of that person’s job. For example, a freelance worker who decides their own schedule and how they complete tasks is more likely to be an independent contractor.

Improper classification can have a major impact on benefits, compensation, and other costs. This is especially true if it’s an issue of misclassifying an employee as an independent contractor or mixing up who counts as a full-time or part-time employee. Misclassification can lead to employers dodging certain expenses, including:

  • Overtime
  • Social security and Medicare taxes
  • Employee benefits (paid time off, etc.)
  • Unemployment compensation tax
  • Workers’ compensation insurance
  • Minimum wage

Whether misclassification is due to an honest mistake or an intentional effort to skirt legal requirements and costs, it’s an offense that can end up hurting a business. 

Two construction workers with full-time employee classifications.

The Costs Of Employee Misclassification

Remember the example above, where an employee was misclassified as a clerical office worker? If the BWC audits the company and discovers the misclassification, that company can expect serious financial consequences.

There isn’t a definitive figure or amount that is used for every case. Instead, penalties are based on the severity of the situation and how big of a gap there is in the classification rates. These penalties can come in multiple forms, including:

  • The collection of unpaid wages for hours worked
  • Back taxes
  • Additional penalties for failing to deduct and withhold taxes for misclassified employees
  • Punitive damages from lawsuits for unpaid wages and taxes

There are also other drawbacks to misclassification. Once a business is caught misclassifying an employee or employees, they’re known as a potential repeat offender. That offense raises a red flag for the DOL and OSHA, which can lead both organizations to target that business in the future. Similar to how steroid users are regularly tested in Major League Baseball, offending businesses can expect regular audits to ensure they remain compliant.

Partner With A PEO To Prevent Misclassification

Making sure your employees are properly classified is difficult when you’re unfamiliar with classification codes and other important identifiers. It can take a lot of time to learn all the appropriate classifications, taking you away from core business tasks. There’s always the chance that even after all that studying, you can still make a costly mistake!

That’s why many business owners turn to a Professional Employer Organization (PEO) to help them avoid misclassification issues. Contact GMS today to learn how our experts can keep your company compliant so that you can focus on growing your business.

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