The 2 Biggest FLSA Threats to Startups and Tech Companies

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Editor’s Note: This article provides a general overview of certain tax and legal issues. Please consult your own tax and legal advisers about your specific situation. 

The Fair Labor Standards Act has been in the news a lot recently, and while the December 1 deadline for the new overtime rule has been postponed (which would have boosted the overtime threshold from $23,660 to $47,467), that doesn’t mean business owners have a get-out-of-jail-free card when it comes to labor laws.

Experts estimate that 8 million employees are currently considered misclassified. No matter what the overtime threshold, employee misclassification is still one of the deadliest sins of the FLSA — especially in the tech industry.

Not only can employee misclassification result in a hefty lawsuit — costing you tens of thousands of dollars in fines and employee back wages — but most business owners don’t even realize their employees are classified incorrectly.

Unfortunately, ignorance of the law is not a valid defense. FLSA wage and hour lawsuits are already on the rise and misclassification is an ever present threat.

Employment experts recommend conducting a classification audit as soon as possible and checking with your legal counsel to ensure your employee classifications are on point. But, a word of warning: Don’t make the mistake of assuming that an employee making more than $23,660 (or even $47,467) per year is automatically exempt from overtime pay.

An employee’s classification isn’t dependent on their compensation alone. Remember, to qualify for the exemption, an employee must be (1) paid on a salary basis, (2) that salary must meet a certain threshold level (currently holding at $23,660), and (3) they must be engaged in the performance of “white collar” job duties and responsibilities. This three-part exemption test makes it possible for an employee to be paid above the overtime threshold but still eligible for overtime pay.

Sound complex? That’s because it is. Unfortunately, these complex classification rules become even more complex when applied to SaaS companies and startups in the tech industry. And, when it comes to employee classification, the overtime threshold isn’t even the biggest threat.

So, what is?

Highly Compensated Non-exempt Employees

The tech industry is one of the few industries with highly compensated employees (making well above the overtime threshold) who can still earn overtime pay.

How is it possible? Employment attorney Maria O. Hart has the answer:

“Computer professions are tricky. There is computer-related clerical work and there is creative, development work. One is exempt, the other is not. Software developers are often exempt — they are creating software. Entry level IT specialists, on the other hand, often aren’t — they maintain what has been installed on a computer and they install software someone else has created.”

A fact sheet provided by the DOL has more insight: “Section 13(a)(1) and Section 13(a)(17) of the FLSA provide an exemption from both minimum wage and overtime pay for computer systems analysts, computer programmers, software engineers, and other similarly skilled workers in the computer field who meet certain tests regarding their job duties and who are paid at least $455 per week on a salary basis or paid on an hourly basis, at a rate not less than $27.63 an hour.”

In layman’s terms, systems analysts, computer programmers, and software engineers making more than $23,660 per year on a salary basis are most likely not eligible for overtime pay.

However, “The computer employee exemption does not include employees engaged in the manufacture or repair of computer hardware and related equipment.” In other words, an IT specialist could earn above the overtime threshold and still be eligible for overtime pay regardless of whether they’re paid hourly or on a salary basis because they fail to meet the job duties prong of the exemption test.

But there may be some limits. The FLSA provides for a “highly compensated employee” caveat. In essence, “If the employee is paid hourly,” says Hart, “and makes over the current upper threshold of $100,000, the employee is then treated as if they are exempt.”

It seems simple enough, but remember, the exemption from overtime pay applies only to employees who meet all three tests: the salary basis, salary level, and job duties. So don’t make the mistake of assuming that an employee’s job title or salary level alone can determine their correct classification. “Job titles do not determine exempt status,” nor salary level alone. Rather, these two elements coupled with an employee’s specific job duties and compensation must meet all the requirements of the Department’s regulations.”

When in doubt, check with your employment counsel to determine the correct course of action.

Independent Contractors vs. Employees

In 2015, home-cleaning startup Homejoy shut down after just five years of business. Why? Homejoy CEO Adora Cheung listed a few reasons, but ultimately blamed employee misclassification. The startup was facing four pending lawsuits at the time from independent contractors who claimed they were really employees.

Unfortunately, theirs wasn’t an isolated incident. Most notably, transportation startups Uber and Lyft have both faced massive lawsuits from drivers who believed they were misclassified as independent contractors. Early this year, Uber agreed to pay up to $100 million to settle class-action lawsuits in California and Massachusetts – but they were hit with two additional lawsuits two weeks later. And the hits keep coming.

These companies, like many others, face tight financial margins and rely heavily on independent contractors to save money. According to a 2010 New York Times article, “Companies that pass off employees as independent contractors avoid paying Social Security, Medicare and unemployment insurance taxes for those workers.” And attorney general Richard Cordray adds, “Misclassifying can mean a 20 or 30 percent cost difference per worker.”

With that in mind, it may come as no surprise that a federal study determined that more than 3.4 million employees are currently misclassified as independent contractors – and the Department of Labor estimates that nearly 30 percent of American companies misclassify their employees.

Are you one of them?

Many employers deny misclassifying their employees on purpose – they say the difference between an employee and an independent contractor is unclear. But, as always, ignorance is not an excuse that will hold up in court.

There are quite a few factors to help you determine whether or not a worker is an independent contractor or an employee, but it all comes down to this: Is your worker in business for themselves? Do they regularly perform services of the same nature for other customers outside of your company? If not, they should probably be classified as an employee.

As always, check with your legal counsel before making any major (or even minor) decisions regarding employee classification.

Learn more about what attorneys say are the most common types of FLSA violations in TSheets’ 7 Deadly Sins of FLSA Compliance.