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Top Employment Risks: Startups And Employee Classifications

Posted by Early Growth

February 19, 2015    |     4-minute read (683 words)

Sometimes I get the feeling that many startup founders view complying with employment law as a necessary evil; something that constrains them from running their businesses as they see fit.

So they play fast and loose with regulations: ignoring them until they’ve made some inroads with their business model and started to get traction. Then they start thinking about formalizing things. Or worse, one day they look up and realize there’s a mess to clean up and they’re on the other side of a legal complaint.

On our Protect Your Startup: Top Employment Risks webinar, Karen Reinhold, Shareholder at Hopkins & Carley and Glenn McCrae, Chief Strategy Officer for EGFS, discussed a number of mistakes that could come back to bite you if you don’t set things up properly from the beginning.

Employment Risk 1: Independent Contractors

Determining whether someone is an independent contractor or an employee boils down to whether or not you control the “manner and means” of their work. If you do, they are an employee, not a contractor. Within California, classification is subject to Employee Development Department audits; and there are fines plus retroactive tax liabilities for misclassifying employees as contractors.

Another item to stay on top of is your tax compliance. You’re required to issue 1099s for all your independent contractors. The tax deadlines are as follows:

  • 1/31 — all 1099s must be postmarked
  • 2/28 — 1099s must be filed with the IRS

Employment Risk 2: Exempt Versus Non-exempt Employees

Incorrectly classifying employees within these categories is one of the biggest litigation risks employers face. The classification is defined by law: not one employers can choose as they see fit. It is subject to two tests. The employee 1) is paid on a salary basis and 2) performs a category of work classified as exempt under state and federal law.

There are several categories of exemptions including:
  • Professionals (i.e., lawyers, doctors)
  • Executives (have supervisory responsibilities)
  • Administrative (must be in charge of core issues for the company)
Employers have statutory tests to meet for each of these categories. For example, most programmers are exempt: as long as they make a minimum amount in wages; employees doing outside sales must be away from the office at least 50% of the time and make a certain amount of money from commissions; and inside sales staff must be paid in a mix of salary and commission.

Employment Risk 3: Interns

As tempting as it may be to farm out your low-level administrative work to an unpaid “intern,” be careful here! Interns can’t be there solely to benefit your company. By law, they must gain value for themselves and cannot be used in lieu of hiring an employee. The Department of Labor’s standards set a high bar and ignoring them could bring heavy fines.

And don’t think your startup’s small size will shield you from regulatory scrutiny. It only takes one disgruntled employee filing a complaint to trigger an investigation that could lead to fines and retroactive penalties.

Of course these aren’t the only areas of concern. Take a look at our earlier post on employment law risks for a look into the other main risks startups face. Lastly, when it comes to these high stakes areas, be forward-thinking and put systems in place to help you mitigate the risks.

How do you manage startup employment risks? Tell us in the comments section below or contact us at Early Growth Financial Services for a free 30-minute financial consultation.

David Ehrenberg is the founder and CEO of Early Growth Financial Services, an outsourced financial services firm that provides early-stage companies with accounting, finance, tax, valuation, and corporate governance services and support. He’s a financial expert and startup mentor, whose passion is helping businesses focus on what they do best. Follow David @EarlyGrowthFS.

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