United States: Payroll Management: Three Critical Issues Require Your Attention

The economy has finally regained strength, and many law firms are expanding and hiring new employees. While this is generally positive news, hiring support staff, associates and partners can make payroll management (which can already be a challenge for many firms) more difficult. If your firm is adding people to the payroll or even outsourcing more work to independent contractors, make sure the following three critical issues receive close attention.

1. Employee Misclassification

Employee misclassification is a hot topic right now. In July 2015, the U.S. Department of Labor (DOL) issued guidance on the appropriate standard for determining whether an employee is misclassified as an independent contractor under the federal Fair Labor Standards Act (FLSA). In recent years, the DOL has entered agreements with many state agencies to cooperate in pursuing enforcement against misclassification of employees as contractors.

In narrowing the definition of "Independent Contractor," the DOL deemphasized the degree to which a business controls an individual's work, focusing instead on the economic realities test, which looks at whether the worker is economically dependent on the employer or is in business for him or herself.

The DOL now looks to six factors in determining if an employer can classify a worker as an independent contractor:

  1. The extent to which the work performed is an integral part of the employer's business;
  2. The worker's opportunity for profit or loss depending on his or managerial skill;
  3. The extent of the relative investments of the employer and the worker;
  4. Whether the work performed requires special skills and initiative;
  5. The permanency of the relationship; and
  6. The degree of control exercised or retained by the employer.

According to the DOL "in undertaking this analysis, each factor is examined and analyzed in relation to one another, and no single factor is determinative ... The factors should not be applied as a checklist, but rather the outcome must be determined by a qualitative rather than a quantitative analysis."

Warning: Even though a worker may meet the DOL's test to be classified as an independent contractor, each state can set its own guidelines and determine that a worker is an "employee" for state unemployment compensation purposes.

Delayed Enforcement of the New Overtime Rules

One new rule law firms will not have to address, at least for now, is the increased salary cutoff for employees to determine who is exempt from overtime pay. In late November 2016, the U.S. District Court granted a preliminary nationwide injunction which delayed enforcement of the changes scheduled to go into effect on December 1, 2016.  While employers will not need to comply currently with the new overtime regulations, they should remain prepared to do so in the event the decision is modified or overturned.  Stay tuned.

2. Recordkeeping

There is often confusion among employers concerning the legal requirements for recordkeeping and retention of employee files and other employment-related records. The DOL requires every employer covered by the FLSA to keep records for each nonexempt worker (again, individual state requirements may vary). The law does not specify the form of records, but they must include certain identifying information about the employee and data about the hours worked and wages earned. The law also requires this information to be accurate.

Payroll records should be retained for at least three years. Records that are used for wage computations should be retained for two years. The latter includes:

  • Time cards;
  • Wage rate tables;
  • Work and time schedules; and
  • Records of additions to, or deductions from, wages.

You may keep the records in your firm's office or a central records office.

3. FICA Increase for 2017

Every employer must withhold Social Security, Medicare and income taxes from its employees' pay.

For 2017, the Social Security wage base increased by more than 7%, to $127,200. The tax rate is unchanged at 6.2%.

The Medicare tax rate remains at 1.45% with no wage base limit.

Your firm also must withhold an additional 0.9% Medicare tax from employees whose wages are in excess of $200,000 ($250,000 for joint returns, $125,000 for married filing separately returns) per calendar year. Withholding of this additional tax must begin in the pay period in which you pay wages exceeding $200,000, and you must continue to withhold it until the end of the year. Only employees are subject to the additional Medicare tax, not employers.

If your firm is a partnership or an LLC taxed as a partnership, your partners will be subject to the increased Social Security wage base in determining their 2017 self–employment tax.

Ongoing Challenges

Laws and regulations affecting payroll taxes and other employee compensation issues are often in flux. So, never assume you can put payroll management on autopilot. Your financial advisor can help ensure your firm complies with all of the relevant requirements.

Sidebar: What about PEOs?

Some law firms avoid payroll hassles by shifting payroll management to a professional employer organization (PEO). Among other advantages, PEOs enable firms to outsource payroll responsibilities — as well as human resources, employee benefits and workers' compensation — so they can focus on their core competencies. And, because PEOs represent multiple employers, firms enjoy greater financial leverage when negotiating services and benefits.

However, employers do not give up control of their employees. PEOs generally agree to function as co-employers, but your firm would retain control and daily supervision of its staff.

Congress recently created a new entity called a "certified professional employer organization" (CPEO). CPEOs will be solely liable for payroll taxes and penalties, an attractive feature for all employers. The IRS began accepting applications for certification on July 1, 2016.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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