January 13, 2021

3 Expensive Payroll Error Laws You Need to Follow

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Tags: HR

This post has been updated for 2020.

Disclaimer: We’re not legal experts and every case is different, so make sure you check with your legal counsel or tax expert before making an important decision. TechnologyAdvice does not offer legal or tax counsel.

Ask any business owner to state their worst fear in one word, and they’ll likely say, “lawsuit.” Lawsuits are scary. For businesses in particular, they can be terribly expensive, and that’s not even taking into account the risk of attracting negative press or the personal toll stress has.

With a growing number of wage and hour litigations, it’s crucial that you perform due diligence in regards to payroll. Here are three payroll error laws you should be sure to abide by when doing business in the U.S. Warning: Legal talk ahead.

Payroll software can help you avoid these costly mistakes and keep your books organized and accurate. To find the best payroll software for your business, try our Product Selection Tool. Answer a few questions and you’ll get an unbiased list of vendors customized to your needs.

Table of contents

  1. Paying overtime
  2. Paying employees by the hour
  3. Misclassifying employees as independent contractors

1. Paying overtime

In 2019, the top ten wage and hour lawsuits alone cost the employers nearly $500 million in settlements. Most were class-action lawsuits, meaning that it wasn’t just one person missing overtime pay, but many.

A simple payroll calculation that might have normally added a little extra to employees’ paychecks and done very little to the organization’s bottom line ended up costing the company millions of dollars in legal fees and generating negative press. Ouch.

According to the United States Department of Labor, “Unless exempt, employees covered by the [Fair Labor Standards] Act must receive overtime pay for hours worked over 40 in a workweek at a rate not less than time and one-half their regular rates of pay.”

  • Translation: If you employ someone who has worked more than 40 hours in a workweek, you’re obligated by law to pay them time and a half for all time worked over that threshold.
  • There are some exemptions to this law, but it’s probably a good idea to play it safe in most cases and pay employees overtime when they’ve worked over 40 hours in a workweek.
  • Keep in mind that many states have their own overtime laws, and many of them default to the law that gives the employee higher compensation.

For determining when employees are exempt from overtime pay, the non-profit organization Workplace Fairness has a good online resource that you can check out here.

  • Pro tip: This is a lengthy resource, so for faster answers, search the phrase “Exempt from FLSA overtime coverage” in your browser window.

How time tracking software can help

Time tracking software logs employee clock in and clock out times to create a record of the time they worked each week. Rather than payroll employees having to spend hours collecting and organizing timesheets, the software automatically adds all the time together to ensure accurate pay stubs. This way, you’ll be able to see exactly which employees worked more than 40 hours in their workweek and pay them accordingly. Time tracking software works through geofencing, computer or mobile device logging, GPS tracking, or an on-premise time clock.

Top time tracking software:

Also read: The Best Time Management Systems to Boost Productivity

2. Paying employees by the hour

Unless they’re salaried, most employees will be paid by the hour. Depending on their coverage status under the Fair Labor Standards Act (FLSA), most employees should be paid the current federal minimum wage of $7.25 per hour, but this can vary by state, county, and even city.

For example, in Washington State, the state minimum wage is $13.50 per hour, taking precedence over the U.S. federal minimum wage of $7.25 per hour. That all changes if you’re in Seattle, where the city’s Office of Labor Standards’ Minimum Wage Ordinance requires an employee working within Seattle city limits who doesn’t receive tips to be paid $15 per hour by employers with 500 or fewer employees who don’t pay towards the employee’s medical benefits. Confused yet?

Human error can cost you big time

Imagine having employees in other cities and counties in addition to Seattle, all with their own nuanced minimum wage laws. You can quickly learn the ins and outs of your city’s minimum wage ordinances if you’re only located there, but what if you have minimum wage employees in Los Angeles, Minneapolis, St. Louis, or Washington, D.C.?

Thankfully for employers, most places in the U.S. simply require you to at least pay the federal minimum wage of $7.25 per hour, but even some people get tripped up on this one. Believe it or not, it’s a common mistake for employers to pay their employees based on employees’ schedules, not hours worked.

Most instances of this happening are likely innocent mistakes as opposed to regulatory ignorance or foul play, so it’s important to pay careful attention when running payroll.

Yes, Sam might typically work the 8-12 shift on Saturdays, but if she clocks out at, say, 12:30 p.m. on a particularly busy Saturday, you will need to compensate her for 4.5 hours worked instead of her scheduled 4 hours.

It’s a simple distinction (and one that might seem too small to mention), but it also manages to slip the mind when calculating payroll at the end of a long workday for multiple employees with different schedules. Watch out for careless errors like this—they could end up costing you later.

Use payroll software to avoid human error

Most payroll software either includes a time tracking system or will integrate with the one you’re currently using and automatically pull reports and pay according to actual time worked. This greatly reduces the chances for human error and ensures your employees are paid promptly and correctly. These systems also offer employee self-service portals, so they can put in their own time if you don’t use time tracking software.

Top payroll software:

Also read: 8 Reasons Accounting Software Isn’t Just for Big Business

3. Misclassifying employees as independent contractors

With the rise of the gig economy has come an interesting debate over who is and isn’t considered an independent contractor.

Rideshare titan Uber has famously been locked in a legal battle with New York and California over whether or not its drivers should be legally classified as employees or independent contractors. Naturally, Uber contends that its drivers should be considered contractors in the eyes of the law, but New York and California don’t see eye-to-eye with the company on this. The federal government has also started to weigh in, further complicating the issue.

The outcome of this argument will have huge implications for other companies in the gig economy, but if you find yourself in a more traditional industry, chances are it’s much easier to determine if you should document someone as an employee or a contractor.

The IRS provides general guidelines based on three different categories for helping employers who seek service providers to determine whether they should hire the service provider as an employee or as an independent contractor:

  1. Behavioral. Will the company guide the service provider’s behavior? This applies to both scope of behavior allowed and specific methods used to produce the desired outcome. Employers have much more say over the behavior of employees than they do with independent contractors.
  2. Financial. Who leads the conversation in terms of money? In other words, an employee usually accepts a set wage from an employer whereas an independent contractor typically sets a price for their services.
  3. Type of Relationship. Does the employer contribute toward this person’s health benefits? Do they offer them paid time off? Do they need the services for a set amount of time, or do they envision more of an indefinite, long-term need? An employee will receive health benefits through an employer, receive paid time off, and usually fulfill an ongoing need. An independent contractor will—as the name implies—be on their own for benefits and PTO and will typically be hired for a specific project with a definite beginning and end.

While the IRS is quick to note that there’s no hard and fast rule that determines what constitutes categorizing someone as an employee or an independent contractor, most employers stick to this diagnostic question as a general rule of thumb: “Will I need to direct how this person produces the outcome I’m paying them for?” If so, chances are they’re an employee.

This is by no means a definitive guide to deciding whether or not to hire someone as an employee or an independent contractor (we could easily write a separate, lengthy blog post on this subject alone). And if you’re really unsure, it’s probably best to consult a professional such as an accountant or a lawyer.

Either way, this is one area you don’t want to skimp on. As Uber is learning the hard way, the line between employee and independent contractor can be a bit of a razor’s edge that, when ridden too closely, can result in a costly and time-consuming legal battle.

Thankfully, many payroll software solutions such as Quickbooks Payroll, Sage, and Workday will help you manage overtime pay, minimum wage and time-tracking compliance, and employment status.

You have many options when it comes to payroll solutions, so check out our Product Selection Tool for guidance on finding the right fit for your business needs.