If you are a business owner or manager, you may have had this great idea at one time: “I can save my company lots of money if I hire ‘contract labor’ instead of employees to do this job.”

The hope of every business person is that hiring a contract laborer will allow the company to avoid the headaches that accompany being an employer.

Employer anticipate a savings by not paying the employer’s portion of federal payroll taxes, worker’s compensation premiums, retirement and health benefits, as well the cost savings of avoiding state and federal unemployment taxes. Also, refusing to put another employee on the payroll is believed to help prevent the liability for discrimination and overtime wages.

Unfortunately, if you decide to take a bite of this poisonous fruit that the serpent is offering and hire a contract laborer, you could face regrets and costs much greater than anything you incur by accepting the responsibilities of being an employer.

You can’t just choose to classify a worker as a contract laborer when he is performing work for you. Chances are very high that all of the people who perform work for your business are actually your employees, whether you call them that or not and even if they agree to the arrangement. The IRS and the Department of Labor will see this as the tax dodge that it really is.

There is someone called an “independent contractor”, but he performs work for your company as well as others. You exercise no control over where, when and how the specific job for which you hired him gets done. This could be your lawyer, your accountant, your plumber, or other workers who are usually self-employed or employed by another company and are not economically dependent on you.

But if you dictate the manner and means by which work is done for you, provide training, supervise the worker, set the hours, provide the tools and equipment or make a profit off of the labors of the worker, he is an employee and cannot be classified as contract labor.

If you misclassify an employee as an independent contractor, there are already significant penalties, and those may soon increase.

A bill was filed in both houses of the United States Congress on April 22, 2010, aimed at insuring that workers are classified as employees, making them eligible for the legal protections and tax benefits provided to employees by law.

If passed, the Employee Misclassification Act will require employers to keep records of every worker classified as an independent contractor along with the analysis of the reasons that the worker was classified that way.

If you are wrong in that analysis, the Act will also increase the penalties for employers who misclassify their workers, including double damages for any violation.

Even if this new legislation doesn’t pass, regulators in President Obama’s executive branch are already on the lookout for companies who misclassify workers as contractors rather than employees.

The United States Department of Labor has increased its resources, investigators and emphasis on enforcement against employers who misclassify workers as contractors. The DOL estimated in 2000 that 30% of companies are guilty of this error.

The DOL’s 2011 proposed budget adds $25 million and 100 investigators just to focus on the “Misclassification Initiative”.

In addition, the IRS announced in February that it will audit 6000 businesses at random over the next three years to determine if any of them have misclassified employees as contractors. So you could get investigated by two federal agencies who have the power to impose significant penalties on your company.

Industries that often have problems with misclassifying their employees include the home health industry, construction, trucking, shipping and delivery, security, spas, technology and media companies. Even a group of strippers sued their club owner in 2009 for making them “pay for the pole” and earn only tips, when the women claimed they were regular employees who were due hourly wages and overtime.

So as a responsible business owner or manager, what can you do to avoid being one of those companies that faces federal enforcement of the regulations prohibiting you from classifying an employee as an independent contractor?

• Assume that everyone who works for you is an employee. Don’t classify someone as contract labor unless you have a legal opinion specifically addressing whether that person really is an independent contractor.
• If any worker actually is an independent contractor, you need a written agreement spelling out the terms of service with that worker.
• Keep careful records of your classification of all workers and how you compensated them for each day’s work.
• Annually review the duties of anyone who works for you and make sure that your initial classification of that worker, whether employee or contractor, still applies.

In the human resources and employment law trade journals that I regularly read, the headlines proclaim repeatedly that employers are paying their employees incorrectly and getting in legal hot water because of those mistakes. The penalties range from the expensive for any small business owner to the absurd for Wal-Mart.

At the lower end of the spectrum is the nearly $90,000 that a Houston landscaping company paid in February to settle an audit by the Department of Labor for misclassifying office staff and others as exempt from overtime and minimum wage laws. The company also got in trouble because they apparently weren’t paying workers for the time spent loading and unloading materials and tools at the start and end of each workday. These activities generated overtime hours for the workers, but they weren’t paid overtime. In addition, the DOL found recordkeeping problems.

At the high end of the scale, this month Wal-Mart agreed to pay as much as $86 million for a wage and hour class-action suit in California involving about 232,000 former and current employees who weren’t paid correctly for overtime and vacations. This is separate from a 2008 agreement that Wal-Mart made to settle 63 other wage-related suits for $640 million.

Whether you are a large or small employer, you must pay your employees correctly to avoid costly litigation by the Department of Labor, or worse, the employees and their attorneys looking for double damages and attorneys fees.

I have written other blog entries on paying overtime correctly (click here and here), keeping proper compensation records (click here), the new enforcement efforts by the DOL (click here) and the pitfalls of compensation mistakes (click here). I don’t want to sound like a broken record, but I constantly find companies who still don’t take wage and hour issues seriously and who haven’t conducted an audit to determine if they are paying their employees correctly (when in doubt, pay hourly and overtime). Please invest the time and effort to correct these issues now so that your company will not face costly overtime litigation.

If you have employees who you believe are exempt from being paid overtime or the minimum wage (and who doesn’t?), your company is vulnerable to being accused of “wage theft” by the Department of Labor and being faced with repayment of wages, liquidated (double) damages, interest, penalties and attorneys’ fees. “Wage theft” is the new inflammatory term, coined by an activist named Kim Bobo, author of Wage Theft in America, to describe any failure to pay workers in strict compliance with federal and state law.

Bobo’s thesis is that the DOL has not been properly funded in many years and has focused on helping employers comply with the laws rather than targeting those same employers for vigorous enforcement efforts and collection of the wages which have been “stolen” from low-income workers. She advocates greatly increasing the number of investigators employed by the DOL, which my earlier posts (click here and here) have said is exactly the plan that the Obama administration is following.

The areas in which an employer is most vulnerable to being investigated and prosecuted for wage theft are:

1. MInimum wage payment.
2. Misclassification of workers as “contract labor”.
3. Overtime pay.

The employers in the Texas Panhandle who come to me with compensation questions are not committing wage theft. They are generally confused, or are using common sense instead of knowledge of the law, or are doing what they’ve always done in times when the government wasn’t so rabid about enforcement. They often don’t know they have done anything wrong until a disgruntled former employee complains to the DOL and an investigator comes to audit the business. Now with the present enforcement efforts, the employer is too late to correct the problems and is faced with significant costs and penalties.

So how can you make changes now to avoid an accusation of wage theft and an investigation of your pay practices?

The easiest way to avoid being investigated for the minimum wage violations is to make sure every worker is earning at least $7.25 during each pay period for every hour he spends at work, even if he is paid on commission and hasn’t really produced any sales, even if he is an agricultural worker and it is harvest time so he is working 18 hour days but barely works at all in the winter, and/or even if he is not at work, but is still on call or answering work calls on his cell phone during his personal time.

To avoid liability for misclassifying an employee as contract labor, make sure every person who performs any work for you is on the payroll and all taxes are being withheld from each paycheck. Don’t ever buy into the myth that you can choose to make a worker into a contract laborer. Anyone who performs work for you is probably an employee other than the self-employed plumber who shows up once per year to fix your sink or the lawyer who drafts your personnel policies and reviews them annually.

To avoid overtime liability, you may want to forget about the “administrative exemption” to the Fair Labor Standards Act. This is a catch-all white collar exemption that many businesses use to classify these types of employees: tax; finance; accounting; budgeting; auditing; insurance; quality control; purchasing; procurement; advertising; marketing; research; safety and health; personnel management; human resources; employee benefits; labor relations; public relations; government relations; computer network, internet and database administration; legal and regulatory compliance; and similar activities.

The problem is that just having one of these job titles is not enough. The exempt administrative employee must also have significant independent discretion and judgment, a requirement that the DOL is interpreting more and more narrowly. Now, even employees who work without much supervision will not be considered exempt if the employer has provided specific instructions on how he wants the job performed. Therefore, an administrative employee who you have always considered to be exempt in the past may not pass the DOL’s scrutiny now.

A careful employer will now get a legal opinion on each employee that he wants to exempt from the overtime and minimum wage laws. As extra protection, even if you believe that your employees are clearly exempt, have every single employee clock in and out every day so that inflated claims can never be made on the hours that a particular employee worked if your exemption determination is questioned in the future.

As if you didn’t have enough to worry about as an employer this year (health care reform, COBRA subsidies, the broad amendments to the Americans with Disabilities Act, and, oh yes, the economy), here is one more thing to keep you up nights.

Have you issued a cell phone to some of your employees? Do you expect those employees to take calls on it while they are away from work? What about smartphones that access email? Are your employees checking their work email account at all hours of the day? If so, you may have overtime problems.

Your exempt white-collar employees can answer the phone or check emails at any time and their salaries will cover that time. But if you expect or allow non-exempt employees, such as sales associates, service technicians, and administrative assistants to answer their phones or check their work email after hours, you have to pay them for that time “worked”.

Plaintiffs’ employment lawyers are salivating over the class action possibilities that off-the-clock smartphone use present. The Fair Labor Standards Act, which regulates overtime and minimum wage, allows employees when suing for overtime violations to collect double damages and attorneys fees. Multiply even occasional after-hours smartphone use by thousands of nonexempt employees and you can see the appeal to plaintiffs’ lawyers of these kinds of suits.

What can you as an employer do to avoid facing such a suit yourself?

1. Have a very clear idea of which of your employees meet the FLSA exemptions and which ones don’t.
2. Don’t issue phones to or expect after-hours attention from your non-exempt employees.
3. Have an off-the-clock policy that explains that if nonexempt employees do consult their work email or take work-related calls after hours, that they must report that time to the timekeeping system so they can be paid for that time.
4. Explain what types of calls and issues are emergency issues that can be handled after hours. Limit in writing the employees’ need to take any other type of call or email while not on the job.
5. If you want your nonexempt employees to be reachable after work, then expect to pay overtime for that privilege and don’t make your employees reluctant to report that time worked.

This is just a reminder to all employers that the minimum wage rate will increase next week. Any time worked by your employees after 12:01 a.m. on July 24, 2009 must be paid at a minimum rate of $7.25 per hour.

This is the last increase from a federal law which began raising the minimum wage in $.70 increments from $5.15 per hour, which was the minimum rate prior to July 24, 2007.

If you have any belief that your employees are not entitled to minimum wage, or any questions about applying minimum wage laws, call an employment lawyer immediately. The consequences of failing to pay minimum wage properly can be very costly for a business.

I frequently work with clients who are being investigated by the Department of Labor for violations of the Fair Labor Standards Act, the federal law that regulates the payment of the minimum wage and overtime compensation. I was recently reminded by a client that the FLSA requires many things that may be legal but certainly aren’t fair. This may be one of the reasons that the FLSA is so often violated: it sometimes makes no rational sense.

For example, the FLSA requires most bonuses to be included in an employee’s regular rate of pay for purposes of calculating overtime pay. So if you give your employees a performance bonus, an attendance incentive, a monetary gift every Christmas or almost any other kind of bonus, you will be required to pay those employees more in overtime pay because the bonus will increase their rate of pay in the pay period in which you provide the bonus. What this often means to an employer is that the regulations act as a disincentive to use bonuses to increase productivity or performance. This makes no sense from a business perspective, but it makes sense to the Department of Labor, which is charged with enforcing the FLSA.

These types of paradoxes of the FLSA mean that many employers violate the FLSA without knowing it and without any malice simply because the rational business brain cannot imagine that this law is as illogical as it really is. Here are some of the pitfalls that businesspersons often fall into with the FLSA:

1. Failure to keep daily time records for “exempt” employees. If you are paying an employee a set salary regardless of how many hours they work, you may believe that requiring that employee to keep a time sheet is unnecessary. However, salaried employees are not automatically exempt employees. They may still be due overtime or minimum wage and once it is determined that they are due those wages, the number of hours actually worked becomes a huge issue. It is the employer’s responsibility to keep accurate track of the hours the employees work and if the employer fails to do this, any number of hours worked that an employee makes up may be enforced by the DOL.
2. Believing that many employees are exempt from overtime or minimum wage laws. I use a very generalized, unscientific rule of thumb in many types of small businesses (less than 50 employees). If more than 10% of your employees are considered exempt, you have a problem. It doesn’t take that many executives, administrators, or professionals to run a company and classifying a lot of your employees as exempt means that you have waived a red flag in front of the DOL. Obviously, every business is different and the only way to be sure if you have classified your employees correctly is to have a knowledgeable HR person or employment lawyer review every job description as well as the duties actually performed by your workers.
3. Meal break deductions. Many employers get tripped up by this one. In general, you have to pay your employees if their lunch break is less than 30 minutes long. You also have to pay them if they are not completely relieved of all duties during the break and free to leave their work area. If you assistant stays at her desk, eats her sack lunch and still answers your phone, you have to pay her for that “break”, even if she spends most of it reading a romance novel.
4. Deducting items from an employee’s pay that take the employee below minimum wage for that pay period. Required uniform expenses, deductions to cover damaged or lost tools, deductions for poor performance, such as chargebacks for dissatisfied customers who return items, are all types of deductions that become illegal if they take the employee’s pay below minimum wage before taxes and other legal deductions are subtracted.
5. Docking or withholding wages for hours actually worked. Anytime you determine as an employer that you are going to withhold an employees’ earned wages, STOP. You are making a mistake. For example, some employers refuse to pay an employee who routinely fails to clock in or out. This is illegal. You still have to pay the employee for the hours you reasonably think he worked that day. Then you can discipline him by written warning, suspension, or even termination for failing to follow the company rule about clocking in and out. But you cannot use his pay as a club with which to beat him. Same rule applies to an employee who works “unauthorized overtime”. Whether it was authorized or not, you still owe her pay for the hours she actually worked and time and one-half for the overtime hours. You may discipline her for failing to get authorization, but you can’t withhold the pay actually due to her.

Many employers don’t understand what the big deal is about violating some little FLSA rules and therefore pay little attention to the overtime and minimum wage requirements. But the regulations of this act allow the employer to be sued for twice the amount owed, going two years back, and automatically awards attorneys’ fees to the employee if he/she wins. In addition, not just one employee will sue. The court will probably allow the employee’s attorney to contact all of your former employees during the last two years to get them to consent to be part of the suit against you also. These rules can turn an otherwise minor violation into a very expensive mistake.