Salaried vs Hourly Employees: (Must Know) Tax Implications

From an employer’s perspective, it’s not the same to hire a salary and hourly employee. It’s worth knowing the tax implications of salaried employees vs hourly employees before ramping up your hiring. We’ll look at if salary employees are taxed differently than hourly employees and which type of employee may be best for your business.

Basic Differences Between Salaried and Hourly Employees

salary vs payroll binders

When you think of salaried employees, you probably often think of someone making $75,000 a year or $125,000 a year and working 40 hours a week. Businesses can have salaried employees working less than 40 hours a week like 37.5 but generally 40 hours is standard.  Usually, salaried employees are ineligible for overtime pay but if they make less than the Fair Labor Standards Act (FLSA) salary threshold of $684 per week or $35,658 a year and meet the qualifications for one of the FLSA’s overtime exemptions then they may be eligible for overtime pay. For most salaried employees, this isn’t the case.

Hourly employees are as they sound. They are paid by the hour.  Once they hit a 40-hour work week then they are eligible for overtime pay. We’ll get into how this can be good and bad but we’ve laid the basis for what is a salaried and hourly employee. There are two more designations to keep in mind.

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Exempt Employees vs Non-Exempt Employees: What is the Difference?

The Department of Labor (DOL) sets tests that help employers determine if they are hiring exempt or non-exempt employees. As we mentioned before non-exempt employees are subject to overtime pay. Let’s look at a definition of each-

Exempt employee: An employee exempt from Fair Labor Standards Act (FLSA) overtime and minimum wage requirements.

Non-exempt employee: Subject to the Fair Labor Standards Act (FLSA) overtime and minimum wage requirements. Hourly employees and low paid salary employees.

Tax Implications of Salaried Vs Hourly Employees

As you hire on employees, you’ll quickly realize there are a lot of costs to having an employee in terms of taxes. Employers bear the responsibility of withholding taxes for:

  • Federal income tax
  • State income tax
  • Social Security tax
  • Medicare tax

 There is also an additional Medicare tax for individuals earning more than $200,000 per year. Almost all states also require the employee to pay unemployment tax.

When Do You Need to File Taxes as An Employer

hourly employee doing bills on tablet

From an employer standpoint, you have an obligation to report your taxes to the Internal Revenue Service and your state. That is why payroll is such an important obligation in a business when you start hiring employees. There are a lot of moving parts.

You’ll need to report monthly or semi-weekly to the IRS. Additionally, you’ll need to file Form 941 quarterly which is the form used to report income taxes, social security tax and Medicare held from employees’ paychecks.

That’s just one portion. You’ll also need to remit state taxes. These tend to vary state by state but one general theme is that you’ll have to file state returns similar to the federal level for reporting purposes.

What Should You Hire? Salaried or Hourly

As a business owner, you probably know there is a lot of thought that goes into hiring. You can go with salaried, hourly or contractors. That said, any employee needs to be justified before bringing them on.  There are pros and cons to each.

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Salaried Employees: What to Consider Before Hiring

With a salaried employee, you can pretty much calculate their full pay package year to year. The fluctuation won’t be too high and cutting payroll is straightforward. The amounts don’t change weekly, but it isn’t ideal for every business. 

There can be a large cost to bring on a salaried employee but often you are getting a skilled worker in return. Part of that cost is the salary but often the benefits which often include health insurance and a retirement plan.

Hourly Employees: What to Consider Before Hiring

With hourly employees, you’ll need to budget your hours and pay grades. Ask yourself, do you expect your employees to work overtime? If so, you’ll need to budget more and include that higher pay rate.

One thing to be aware of when hiring hourly employees is having a good set of internal controls when it comes to tracking time. Places like grocery stores still use digital timeclocks to punch in and out. You’ll need a way to track hourly employees’ time so you avoid overcharged hours as an employer. Not something you have to worry about with salaried employees.

While you can save money during the slower periods with hourly employees, you’ll have to pay overtime when you need additional labor resources. This doesn’t preclude you from having part-time or full-time hourly employees. Just keep in mind that these employees may be eligible for benefits depending on their number of hours worked.

Salaried vs Hourly Employees: What is Right For Your Business?

It should be pretty obvious when you are getting into business if you need hourly or salaried employees. Most white-collar jobs tend to have a salary while companies that fluctuate in revenue and may be more labor driven tend to lean toward hourly employees. Think of landscaping or retail as an example.

Don’t forget to consider the benefit of exempt employees and overtime for non-exempt employees when making a decision.  

Switching an Hourly Employee to a Salaried and Vice Versa

One more situation that is worth looking at is when employers move their hourly employees to salaried or vice versa. Often this is due to a promotion or just a change in pay structure. While it’s not hard to do on paper, you’ll need to keep in mind that it is often a switch from non-exempt to exempt employees or the opposite. The biggest changes will be in the benefits and in cutting payroll from week to week.

Final Thoughts on Tax Implications Before Hiring Employees

Whether you hire salaried or hourly employees, you will still face similar tax implications as a business. The two main pieces to keep in mind are correct payroll with proper tax withholdings but also tax reporting. If you want to hire employees make sure you have the help to correctly process the payroll and tax component, if not, be sure to get some help.

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