Surviving the IRS Employer Tax Crackdown

As budget deficits go stratospheric, the federal “tax gap” is once again a hot topic in Washington. The tax gap is money the government believes should be paid in taxes, but isn’t.  So bureaucrats are beefing up enforcement of existing rules or implementing new ones created by Congress, forming a new gauntlet of compliance requirements for small employers – especially those who use freelance or contract help.

[BizBest Update:  Also see our followup to this story on a new SBA-sponsored report that says the IRS crackdown on small business has been bogus from the beginning!]

The bulls-eye is “worker misclassification.” Basically, that’s when you pay somebody as an independent contractor – thus avoiding the need to withhold payroll taxes – rather than as an employee.  Or perhaps you are paying someone a salary when they really should be hourly and subject to overtime pay.  Either way, if you get it wrong, it could cost you dearly.

The new federal budget hands the U.S. Department of Labor (DOL) an extra $25 million to pursue misclassification miscreants.  But according to MBO partners, a leading human resources consulting firm, the extra dough for DOL is nothing compared to an estimated $8 billion boost the feds are giving IRS to modernize and expand enforcement programs.

Implications for small business are immense. “Minimum wage and overtime laws can be confusing, and not paying the proper wage to an employee can quickly turn into an expensive headache,” says Karen Harned, executive director of the NFIB Small Business Legal Center.  “DOL is hiring more agents to investigate and charge businesses with overtime and other wage violations,” says Harned.  To avoid penalties or claims from disgruntled employees, make sure your business hasn’t fallen into these common traps.

1. Letting hourly employees waive their right to overtime pay. Overtime pay is mandatory. Employees can’t opt out.  Even if an employee is instructed to only work 40 hours per week, any hours actually worked over 40 hours in a seven-day workweek are subject to overtime pay.

2. Averaging hours worked over two weeks. Even if you use a two-week pay period, the Fair Labor Standards Act (FLSA) treats each work week as a single unit.  An employee who works 42 hours in one week must be paid two hours of overtime, even if the same employee only works 20 hours the next week.

3. Giving time off instead of cash. The law is highly biased in favor of cash compensation rather than “comp time.” Neither the employer nor employee can agree to or insist on comp time in lieu of overtime pay.

4. Treating all salaried employees as exempt from overtime rules. Just because someone is salaried or carries a fancy job title doesn’t make them exempt from FLSA overtime requirements. Employers must be careful to ensure that employees are properly classified. Exempt employees must meet a certain minimum salary and fall under a certain exemption category specified by the FLSA.  You can find details of the law at the DOL website (

5. Docking the pay of an exempt employee. An exempt employee must be paid on a salary basis. This means the employee receives a predetermined amount of pay which is not subject to reduction.  Here’s the danger:  If you make improper deductions from an exempt employee’s salary, the salaried basis of payment is destroyed and the exemption is lost. Don’t jeopardize the exemption. Make sure exempt employees are paid the same each pay period, regardless of hours worked.  In other words, if an exempt employee shows up for part of a workday, you must pay him or her for the whole day.

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Filed Under: BizTaxesTroubleshooter

About the Author: Daniel Kehrer, Founder and Chief Content Officer of BizBest Media, is a senior-level leader in digital media, content development and online marketing with special expertise in startups, SMB, social media and generating traffic, engagement and leads. He holds an MBA from UCLA/Anderson and is a passionate entrepreneur (started 4 businesses), syndicated columnist, blogger, thought leader and author of 7 business and financial books.

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