As your small business grows, you’ll be able to bring on employees to help you meet your goals. While many small businesses start off by having hourly employees, in time, you may be able to bring on a salaried employee as well. Learn the differences between an hourly employee and a salaried employee so you can figure out the best course of action for your business.
What Is a Salaried Employee?
The way employees are categorized comes down to how they are paid. An employee’s status, whether hourly or salaried, is also related to state and federal labor laws. It’s important to understand the difference between the two types of employees, especially if you’re considering turning an hourly basis employee into a salaried one.
As the name suggests, hourly employees are paid based on how many hours they work. Generally, they are part-time employees. The small business establishes a schedule for the hourly employees, and the employees need to use a time-card system to show the employer when they have clocked in and out. It’s critical that the timekeeping system be accurate, as that is how their pay is determined. Hourly employees do not get paid for hours they don’t work.
On the other hand, a salaried employee is paid an annual amount split into pay periods — the amount of money earned every period is the same (determined by the salary level). Some salaried employees have contracts, and others do not (hourly employees do not have employment contracts). The factor to understand with salaried employees is that their pay cannot be reduced based on the quality or quantity of their work as long as they are ready and willing to do their job.
The Costs of a Salaried Employee
If your business is considering hiring salaried employees, it’s important to determine the costs. While the costs of hourly employees are related to how many hours they work multiplied by their hourly wage, a salaried employee’s costs are more complex.
Keep these costs in mind when thinking about hiring a salaried employee:
- Gross wages: This is the amount you will pay your salaried employee each pay period. You can divide the annual salary basis by the number of pay periods you have in your business. For example, if you have 24 pay periods and you pay your employee $35,000 annually, then his wages each pay period will be $1,458.33.
- Payroll taxes: Every time you run payroll, you have to pay state and federal payroll taxes. FICA (which covers Social Security and Medicare) is 7.65% of the employee's salary, FUTA taxes are 6% of the first $7,000, and there is also state unemployment insurance.
- Employee benefits: While these are not required, benefits help to attract top talent, especially salaried employees. Benefits include retirement plans, life and disability insurance and health, dental and vision insurance. These costs can vary greatly.
- Workers’ compensation insurance: Most states require employers to carry this kind of insurance if they hire either hourly or salaried employees.
So, how do you know whether you’re ready to move your hourly employee to salary? Consider how many hours he works, what essential functions he provides and whether you can afford the additional expense of moving him up to an annual salary. Ensure you’ll have enough cash flow each month, as you’ll be paying him a consistent amount unlike an hourly employee.
Knowing the Rules for Overtime
In addition to being classified as hourly or salaried, employees are also categorized as exempt employees or nonexempt employees. This refers to whether they are eligible for overtime pay. Nonexempt employees are eligible to receive overtime pay if they work over the number of hours in a full-time workweek. The overtime rule is one and a half times the hourly rate paid on every hour worked above the full-time 40 hours.
Typically, hourly employees are nonexempt, so they are eligible to receive overtime pay. In most cases, salaried workers are exempt status, so they are not eligible for overtime pay. However, there are some exceptions for exempt workers.
Understanding Your Business Tax Requirements
It’s important to ensure that you’re withholding the right amount of taxes for your salaried employees and reporting the right information to the IRS. In order to report wages for each employee, you have to fill out Form W-2. To find out how much tax to withhold, you’ll need to follow the IRS’s rules in the withholding tables, which outline each wage bracket and the tax percentage that applies.
Keep in mind that you have to deposit the taxes you withhold following IRS regulations. In addition to federal tax requirements, you also have to figure out your state labor department’s requirements. For example, if you hire an employee on an annual salary of $65,000, then you’ll end up paying $5,428 in California in employment taxes but only $5,414 in New York.
When Is the Right Time to Hire a Salaried Employee?
Usually, moving an hourly employee to a salaried position is considered a promotion because the pay is higher. However, if that employee frequently collects overtime, her paycheck may actually be impacted negatively by moving to a salary. It all depends on what her salary is and whether she needs to work overtime on a regular basis.
Keep in mind that many salaried jobs offer flexibility that hourly employees may not have. When working hourly, employees need to clock in and out at specific times. On salary, they may be able to come in and leave on a less-strict schedule.
Note that there are often different expectations associated with hourly and salaried employees as well. Hourly employees may have more task-related job descriptions, while salaried employees may have jobs with less-measurable outcomes. It’s illegal for hourly employees to have to work off the clock, while salaried employees may be able to take some work home with them after regular hours of work if it needs to be done.
Benefits of Having Salaried Employees
One of the key benefits of having a salaried employee versus an hourly one is that your payroll remains stable regardless of how many hours are worked. This makes it easier to predict your payroll expenses each month. It’s also easier to calculate the vacation pay and sick-time pay, as these are paid at a daily or weekly rate.
A nonfinancial benefit is that you get to focus on the results of the job rather than the hours worked. You don’t need to worry about figuring out whether you will have to pay overtime this pay period because your salaried employees are tasked with meeting their objectives regardless of how long it takes — within reason, of course.
From the employees' perspective, they get a stable income each month, an employment contract and benefits such as health insurance and a retirement plan.
Understanding Legal Protections for Employees
If you’re considering firing an hourly or salaried employee, it’s best to be aware of both the federal and state employment laws. It is illegal to terminate any employee because of gender, race, religion, marital status or age. Permissible reasons for firing an employee include poor performance, unprofessionalism at work, gross misconduct, stealing and general layoffs. Legal protections for employees differ from state to state.
If an employee has an employment contract, that may outline the reasons or process for termination. It’s important to follow the terms of the contract in addition to meeting all federal and state laws. If the employee does not have an employment contract, then it’s critical to abide by federal and state laws.
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