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3 Ways Short-Term Financial Thinking Can Lead To Devastating Legal Consequences

3 Ways Short-Term Financial Thinking Can Lead To Devastating Legal Consequences

Business owners face the challenge of ensuring that each dollar spent is used in the best possible way and there are dollars in the bank at the end of each month. Faced with the pressures of running a business, managing clients and employees, and making a profit, sometimes business owners make decisions that set them up for disaster. Short-term financial thinking can be devastating. This is why working with an employment attorney is so beneficial. But beyond that, the top three biggest short-term financial mistakes that lead to long-term legal hot water I’ve seen are: 

1. Paying employees as if they were independent contractors.

Businesses may be tempted to classify workers as independent contractors to save on taxes. The company risks significant financial and legal, both civil and criminal, liability by doing this. The risk of claims based on the misclassification of workers is growing.  Intentional misclassification costs the government a lot in unpaid taxes every year. As a result, the Federal and state governments have gotten very aggressive in pursuing these claims. 

In July 2021, Virginia passed laws that classified all workers as employees unless the company could prove that the worker was an independent contractor. Damages for misclassification include paying all the benefits you would have paid if the worker had been treated as an employee. In other words, if your business offers health insurance and your misclassified worker was hospitalized while being treated like an independent contractor, your business is paying that hospital bill. Therefore, misclassification can be an expensive financial mistake. 

Your worker “wanting” to be an independent contractor is not a defense. More often than not, your worker is the one who turned your business in for the violation when they couldn’t pay their tax bill.  For example, one company paid an executive assistant as an independent contractor. Unfortunately, the assistant didn’t pay estimated taxes and was hit with a huge tax bill. He cried foul, and the IRS came knocking at the company’s door. The IRS reclassified the assistant, and the company owed the taxes on the wages, interest, and penalties. When this happens, the company is responsible for the entire tax bill without contribution from the misclassified worker. In other words, the company couldn’t get reimbursement from its employee for their share of the taxes. If your business is in the construction industry, the stakes are even higher. Your business can be responsible if your subcontractors misclassify their workers. 

Misclassifying employees as independent contractors is a wrong financial decision for your business. 

2. Not paying overtime when required.

When an employee is entitled to overtime pay is one of the more complicated areas of law that employment attorneys must deal with. Mistakes happen. “Common wisdom” can steer you badly off course. “Salaried” by itself does not mean “exempt from overtime.” In the most general terms (which vastly oversimplifies this issue), an employee has to be paid above a certain amount on a salaried basis and must perform specific job duties or have certain skills or educational background to be exempt from overtime. Employees who aren’t paid overtime are entitled to double unpaid wages over a 2- or 3-year period and recover their legal fees. Overtime claims can be company killers. 

For example, an employer treated all its “salaried” employees as exempt from overtime regardless of their position, so it didn’t pay any overtime. An administrative assistant sued for unpaid overtime. The wages owed were pretty small, about $25,000 over the three years. However, the employer’s risk based on the claim was over $250,000. Why? Because when the employee won (and she would), she’d get $50,000 (her unpaid wages, doubled), and her legal fees (likely over to $100,000), and that’s before the company paid its legal fees. Suppose the company had more than one administrative assistant. In that case, her lawyer could ask that all administrative assistants be added to the lawsuit, and then the financial risks the company faced would exponentially increase. The company’s bad financial decision not to pay overtime got it into costly legal hot water and put its continued existence at risk.

Even when a Court determines the company didn’t violate the overtime laws, the costs of defending these claims can be company-killers in terms of the time, energy and money expended. Taking steps to ensure your employees are correctly classified from the start will reduce the risk of these types of claims. Reasonable faith attempts to comply with the overtime laws will also likely reduce the time frame of any claim from 3 years under the Federal overtime laws to 2 years. They may reduce or prevent an attorney’s fee award against the company. Investing in overtime classification opinions from the company’s attorney may save the company thousands in the long term. 

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3. Taking a “What’s Yours is Mine” Approach to Company Assets.

“Commingling” is a legal term that means a business’s money and debts are mixed with its owner’s money and debts. Reasons for commingling include everything from just not knowing why it’s a problem to actively seeking to avoid tax liability on income. If the commingling is significant, the business’s owner might be responsible for the company’s debts. Why? The law recognizes a company as a separate “person” from its owners. Its assets aren’t the business owners, even if there is only one owner. There’s a “corporate shield” between the two and protects the owner’s assets from the company’s debts. 

When the company pays the business owner’s electric bill, that’s either income or a loan to the owner. It’s not “wrong” to have your company pay your debts. But, you need to record the transaction in the company’s records correctly. Treating the business owner’s debts as company debts ignores the separation between these two people and risks destroying the corporate shield. Suppose the business owner ignores the company’s separate identity. In that case, that owner runs the chance that a court will also ignore that separateness and hold the owner responsible for the company’s debts. 

A sales representative was promised but not paid a commission for years. In the meantime, the company paid all the business owner’s expenses and claimed them as business expenses. The conduct was so bad that the company wrote off charges at Victoria’s Secret and high-end department stores as “business expenses.” The sales representative sued and asked the court to hold the business owner responsible for her commissions because he had used the company as his piggy bank. She won. The business owner was responsible for over $300,000 in unpaid commissions because he’d made the wrong financial decision to blend the company’s assets and debts with his.  

These are just examples of how people get themselves in legal hot water by making bad short-term financial decisions. So, how do you avoid these mistakes? 

  1. Understand that wages and payroll taxes are not where to cut corners. Get competent advice from employment attorneys or another qualified party when classifying workers as contractors or employees and as exempt from overtime or not. These are complex areas of the law, and you should not be going it alone here. 
  2. Separate your finances from your business’s finances. If your corporate shield fails because you’ve commingled assets, whatever perceived benefit you received by blending your finances with your interactions will likely be overwhelmed by your liability for all of the company’s debts.  Work with competent professionals to determine a legitimate business expense and income or a loan to you.