Pay structures

• Organizations distribute compensation based on pay levels and job groupings.
• Pay levels are determined by evaluations of internal and external sources, and job groupings should reflect the organization’s size, salary range, structure, and status.

Some industries have customary pay practices and levels. This may make pay or salary level evaluations easier for some organizations. However, all organizations still benefit from evaluating their pay structures based on information gathered from external sources (how much employees in local equivalent positions are compensated, for example) and internal sources (such as how competitive the organization wishes to be with their pay or salary levels). Other criteria may come into play as well.

Once this information is determined, jobs can be organized into groups — for example, executive, administrative, technical, professional, staff, line supervisors, and so on, depending upon the industry. These may also depend upon such factors as the size of the organization, the difference between the highest salary level and the lowest salary level, and the organizational structure (are there many supervisors or are there very few?). It may also depend on the status of the organization. A new company may have more vigorous promotion approach than an older, more stable company.

Pay ranges

• Organizations determine pay ranges for each job grouping based on factors such as the market average in the area.

Once the job groups are identified, the pay ranges can be examined. The minimum places the smallest value on the position, and the maximum is used to control the salary. Organizations may look at what is customary in the area, or use compa-ratios (a ration-based comparison of the salary to the market area) to help determine how actual pay levels compare to those in the market, as long as it is known that the pay ranges are based on the market average. If an employee is paid higher than the midpoint of the pay range, they receive a competitive wage in that market.

Incentive pay

• Organizations can provide their employees financial incentives (i.e., in the form of commissions, bonuses, gainsharing, or profit sharing).

Organizations may also wish to provide financial incentives to their employees. These may be commissions, bonuses, gainsharing, or profit sharing, to name a few. These types of pay should be carefully planned to be in line with the organizational goals. Tax implications and current organizational and market conditions should also be considered.

Executive compensation

• Executive compensation consists of salary, benefits, and other forms of pay, and should be determined based on the organization’s goals and culture.

Executive compensation or “total compensation” typically consists of salary, employee benefits, bonuses, supplementary pension benefits, deferred compensation, and other fringe benefits, including severance pay. The compensation program should be established according to company culture and human resource goals. The company’s pay philosophy will determine the mix of total compensation it provides to executives.

Salary

• Executives are compensated based on experience, performance, company size, and their industry peer group.

An executive’s salary may be determined by a combination of several factors (including years of experience, sustained level of performance, size of company, and industry peer group), and must often receive board or committee approval.

Awards/Bonuses

• Organizations incentivize executive employees with awards such as bonuses and stock options.

Bonuses and other awards are often determined by the performance goals in place and whether or not they are met. Incentive plans can take many forms, the most common being:

• Short-term bonuses (usually a one-year time frame) — often the greatest individual motivator.
• Long-term bonuses (more than one year — usually 3 to 10 years) — created to afford “holding power” over executives for a longer period; usually based on group performance goals.
• Stock options — rights to purchase company stock at a specified price during a specified time period; usually considered a long-term incentive.
• Restricted stock — stock is given to the executive who must wait for a specified period (usually three to five years) before selling it. Stock will be forfeited if termination occurs prior to the end of the restriction period.
• Stock Appreciation Rights (SAR) — the right to receive a dollar amount equal to the future appreciation of the company stock (rather than actual shares).

Supplemental pension plan

• Organizations may offer SERPs to management or highly compensated employees.

For a select group of management or highly compensated employees, an unqualified pension plan or a Supplemental Employee Retirement Plan (SERP) may be offered in addition to the qualified pension plan. The compensation limits are not governed by the maximum Internal Revenue Service (IRS) limitations as under a qualified plan. Therefore, the employee can take advantage of the unlimited benefits earned under this plan. There are no tax benefits associated with this type of nonqualified pension plan.

Deferred compensation

• Unlike 401(k) plans, NQDC plans are not qualified deferred compensation plans and therefore do not afford employees or employers the same tax benefits as qualified plans.

Deferred compensation may include a qualified plan such as a 401(k) plan, or take the form of a nonqualified deferred compensation (NQDC) plan. This is any elective or non-elective plan, agreement, method, or arrangement between an employer and an employee (or service recipient and service provider) to pay the employee compensation sometime in the future. These plans can include voluntary deferral of earned income and/or mandatory deferrals of bonuses, as well as other types of retirement plan vehicles. NQDC plans do not afford employers and employees the tax benefits associated with qualified plans because, unlike qualified plans, NQDC plans do not satisfy all of the requirements of Internal Revenue Code (IRC) Section 401(a).

Fringe benefits (Prerequisites or "perks")

• Fringe benefits are a form of taxable income given to executive employees that exceed normal employee benefits.

Corporate executives often receive extraordinary fringe benefits that are not provided to other corporate employees. Any property or service that an executive receives in lieu of or in addition to regular taxable wages is a fringe benefit that may also be taxable income. These types of benefits begin where the usual employee benefits end and are typically not performance based.

The following lists some of the most common fringe benefits provided to executives.

• Athletic skyboxes/cultural entertainment suites
• Club memberships (i.e., country clubs)
• Corporate credit cards
• Executive dining room privileges
• Loans
• Outplacement services
• Security-related transportation
• Spousal/dependent life insurance
• Transportation (company automobiles)
• Chauffeurs
• Employer-paid parking
• Relocation expenses
• Non-commercial air travel (company jets)
• Employer-paid vacations
• Spousal or dependent travel
• Wealth management (financial planning services)
• Retirement planning services
• Employee shares of Federal Insurance Contributions Act (FICA) taxes paid by employer

Severance package

• The terms of an executive employee’s severance package should be agreed upon at hire.

Most executives of larger companies insist upon a written employment contract at hire, which will include a severance package (often called a “golden handcuff”) and is usually prepared or approved by an attorney. The amount of severance pay (often referred to as a “golden parachute”) varies and may include several months of pay, or several years of pay in some situations, upon termination of employment or a change in control. Because of the potential loss of future income, severance pay benefits are highly important to executives; the terms of the employment agreement should be specified in the contract.

Overtime wage exemptions

• Employees qualify for overtime exemption under FLSA if their job duties and salary meet the criteria.

Section 13 of the FLSA provides an exemption from both minimum wage and overtime pay for individuals employed as bona fide executive, administrative, professional, outside sales, and certain computer employees. To qualify for exemption, employees generally must meet specific criteria regarding their job duties and be paid on a salary basis, at not less than the minimum federal level.

Job titles do not determine exemption status. In order for an exemption to apply, an employee’s specific job duties and salary must meet all the requirements of the Department of Labor’s regulations.

Employers must be extremely careful when classifying employees and should ensure that exempt employees meet any applicable requirements of state law as well as the federal requirements that are summarized below.

Executive exemption

• Executive employees qualify for exemption under FLSA if their job duties and salary meet the criteria.

To qualify for the executive employee exemption, all of the following tests must be met. The employee must:

• Be compensated on a salary basis at a rate not less than $684 per week;
• Have the primary duty of managing the enterprise, or managing a customarily recognized department or subdivision of the enterprise;
• Customarily and regularly direct the work of at least two or more other full-time employees or their equivalents; and
• Have the authority to hire or fire other employees; or, their suggestions and recommendations as to the hiring, firing, advancement, promotion, or any other change of status of other employees must be given particular weight.

Challenges

Common challenges and issues related to this exemption include:

• Is the person really salaried? Inappropriate deductions or fluctuations tied to hours worked may result in the loss of salaried status and the exemption.
• Is the person really in charge? In order to be exempt, the person must be in charge of a department or subdivision, not an assistant.
• What is the person’s primary duty? For exemption, that duty must be managing, not production work.

Administrative exemption

• Administrative employees qualify for exemption under FLSA if their job duties and salary meet the criteria.

To qualify for the administrative employee exemption, all of the following tests must be met. The employee must:

• Be compensated on a salary or fee basis at a rate not less than $684 per week,
• Have the primary duty of performing office or non-manual work directly related to the management or general business operations of the employer or the employer’s customers, and
• Have primary duties that include using discretion and independent judgment with respect to matters of significance.

Challenges

Common challenges and issues related to this exemption include:

• Is the person really salaried? Inappropriate deductions or fluctuations tied to hours worked may result in the loss of salaried status and the exemption.
• Is the person’s primary duty work that is office or non-manual? This is a white-collar exemption. It does not apply to those who produce the product.
• Does the person have primary duties that include discretion and judgment? Highly specialized skills are not the same as judgment. Note that the judgment must relate to matters of significance.

Professional exemption

• Professional employees qualify for exemption under FLSA if their job duties and salary meet the criteria.

To qualify for the learned professional employee exemption, all of the following tests must be met. The employee must:

• Be compensated on a salary or fee basis (as defined in the regulations) at a rate not less than $684 per week;
• Have a primary duty of performance of work requiring advanced knowledge (defined as work which is predominantly intellectual in character and which includes work requiring the consistent exercise of discretion and judgment);
• Have advanced knowledge in a field of science or learning; and
• Have advanced knowledge that was customarily acquired by a prolonged course of specialized intellectual instruction.

To qualify for the creative professional employee exemption, all of the following tests must be met. The employee must:

• Be compensated on a salary or fee basis (as defined in the regulations) at a rate not less than $684 per week; and
• Have a primary duty of performance of work requiring invention, imagination, originality, or talent in a recognized field of artistic or creative endeavor.

Computer employee exemption

• Computer employees qualify for exemption under FLSA if their job duties and salary meet the criteria.

To qualify for the computer employee exemption, the following tests must be met. The employee must be:

• Compensated either on a salary or fee basis (as defined in the regulations) at a rate not less than $684 per week or, if compensated on an hourly basis, at a rate not less than $27.63 an hour; and
• Employed as a computer systems analyst, computer programmer, software engineer, or other similarly skilled worker in the computer field performing the duties described below.

The employee’s primary duty must consist of:

1. The application of systems analysis techniques and procedures, including consulting with users to determine hardware, software, or system functional specifications;
2. The design, development, documentation, analysis, creation, testing, or modification of computer systems or programs, including prototypes, based on and related to user or system design specifications;
3. The design, documentation, testing, creation, or modification of computer programs related to machine operating systems; or
4. A combination of the aforementioned duties, the performance of which requires the same level of skills.

Outside sales exemption

• Outside sales employees qualify for exemption under FLSA if their job duties and salary meet the criteria.

To qualify for the outside sales employee exemption, all of the following tests must be met. The employee must:

• Have a primary of making sales (as defined in the FLSA), or obtaining orders or contracts for services or for the use of facilities for which a consideration will be paid by the client or customer; and
• Be customarily and regularly engaged away from the employer’s place or places of business.

This exemption is the focus of numerous suits. Note that this exemption applies only to sales personnel who are engaged in making sales away from the employee’s place of business.

Highly compensated employees

• Highly compensated employees qualify for exemption under FLSA if their job duties and salary meet the criteria.

Highly compensated employees performing office or non-manual work and paid a total annual compensation of $107,432 or more (which must include at least $684 per week paid on a salary or fee basis) are exempt from the FLSA if they customarily and regularly perform at least one of the duties of an exempt executive, administrative, or professional employee identified in the standard tests for exemption.

Payment systems

• Organizations use different payment schedules to determine when their employees’ pay will change.
• For example, pay can be increased on a schedule or through a level system, and be based on units produced or knowledge or competency increase.

Another thing to consider is the payment schedules. How will the base pay be handled? Will there be a single or a flat-rate system? Will employees get raises based upon merit, performance? What about time-based payment systems?

Examples of payment systems

Some positions have customary pay or salary structures. Some organizations increase pay on certain schedules; for example, every year they raise employees’ pay by a certain percent. Sometimes the percent raised may fluctuate based upon performance (i.e., an organization may decide to provide all employees a 2.5 percent raise every year and from that level, the employer can determine how much more can be added for good performance).

Some organizations may have levels of pay to which employees advance, and in some cases, employees may skip levels if their performance warrants it.

An organization may compensate employees on a piece-rate system, meaning they get paid based upon units produced (units can be anything from customers serviced, items created, or phone calls made). These employees have a pay structure based on productivity, whereby the employees are paid a base salary and receive extra pay based on how many units they produced during a pay period. Other such pay adjustments may include cost of living raises or increases for seniority.

Some payment structures are based upon employees’ knowledge or competency. This is common for people such as professors or scientists. As their knowledge or competency increases, so do their salary levels.

Pay range

• Pay ranges can vary for several reasons, including pay compression and overtime.

Pay ranges help to categorize jobs and control costs, but sometimes an employee may end up being compensated outside the range. If an employee is paid higher than the maximum of a pay range, it is known as a red circle rate; if an employee is paid lower than the minimum of a pay range, it is known as a green circle rate.

Organizations should consider adjusting the salary level of employees being paid within these rates to bring them into the pay range. For example, an employee may have been promoted from an electronic technician to a supervisor. The employee’s pay is below that of the minimum range for supervisors, a green circle rate, so to compensate for the promotion, the employee’s pay should be adjusted to be within the pay range of supervisors.

Given the variety of jobs that must be compensated, employees in the same job may be compensated differently for many reasons. One employee may work overtime or a different shift and receive higher wages because of a shift differential. An employee may receive emergency pay for being called into work when they were not scheduled, or hazard pay for performing particularly dangerous tasks; they may be compensated just for being ready to be called in to work (on-call).

Payroll systems

• Payrolls systems (either through an outside agency or in-house) aid administrators in keeping track of employee compensation.

To organize and upkeep all of this information requires an efficient payroll system. This system also aids in the keeping of records required by the federal government. Most organizations use some type of computerized payroll system. These systems range from outsourcing the function by using a payroll service bureau, to doing the work in-house.

Income tax

• Salaries, vacation allowances, bonuses, commissions, fringe benefits and compensation paid to former employers all qualify as wages subject to income tax.
• Form W-4 determines how much income tax to withhold.

Wages subject to federal employment taxes include all pay given to an employee for services performed. The pay may be in cash or in other forms and includes salaries, vacation allowances, bonuses, commissions, and fringe benefits; it does not matter how the payments are measured or made. Also, compensation paid to a former employee for services performed while still employed is subject to employment taxes.

To know how much income tax to withhold from employees’ wages, the employer should have a Form W-4, the Employee’s Withholding Certificate, on file for each employee.

Social Security/Medicare

• Employers withhold Social Security and Medicare taxes, which finance federal systems of insurance, from wages and pay a matching amount.

The Federal Insurance Contributions Act (FICA) provides for a federal system of old-age, survivors, disability, and hospital insurance. The old-age, survivors, and disability insurance part is financed by the Social Security tax. The hospital insurance part is financed by the Medicare tax. Each of these taxes is reported separately.

Generally, employers are required to withhold Social Security and Medicare taxes from employees’ wages and to pay a matching amount of these taxes. Certain types of wages and compensation are not subject to Social Security taxes. Generally, employee wages are subject to Social Security and Medicare taxes regardless of the employee’s age or whether they are receiving Social Security benefits.

Federal Unemployment (FUTA) Tax

• FUTA tax is not withheld from wages but is paid by the employer.

The Federal Unemployment Tax Act (FUTA), with state unemployment systems, provides unemployment compensation payments to workers who have lost their jobs. Most employers pay both a federal and a state unemployment tax. Only the employer pays FUTA tax; it is not withheld from the employee’s wages.

Employer Identification Number (EIN)

• Employers are issued EINs by the IRS to identify their tax account on their employees’ tax forms.

If an employer is required to report employment taxes or give tax statements to employees or annuitants, they need an Employer Identification Number (EIN).

The EIN is a nine-digit number that the IRS issues. The digits are arranged as follows: 00-0000000. It is used to identify the tax accounts of employers. The EIN must appear on all of the items sent to the IRS and SSA.

Basic compliance requirements

• Companies must follow basic requirements when reporting taxes and wages to the IRS.

Below are the basic requirements for tax and wage reporting compliance:

• Determine EIN requirements. Complete and submit EIN Request Form SS-4 if you do not have an EIN.
• Determine employee status and verify work eligibility by filing Form I-9.
• Request Form W-4, Employee’s Withholding Allowance Certificate, verify employee social security number (SSN), and receive, if applicable, earned income credit (EIC) eligibility by filing Form W-5. Employers should not pay the advance credit out if the employee doesn’t qualify. Internal Revenue Code (IRC) requires that on any tax return claiming the EIC, a SSN must be used (not an individual taxpayer identification number).
• Calculate and deduct employees’ income tax, Social Security, and Medicare amounts.
• Make required deposits of taxes withheld plus any related employer taxes.
• File Form 941 quarterly, and Form 940 annually. Send in Form(s) W-4 each quarter with Form 941 when the employee claims more than 10 withholding allowances or exemption from withholding, and their wages would normally be more than $200 per week.
• Other forms may also be required (e.g., Form 943 for agricultural labor).
• File Form(s) W-2 (Wage and Tax Statement).
• File Form(s) W-3 (Transmittal of Wage and Tax Statement).
• File Form 945 (Annual Return of Withheld Federal Income Tax for non-payroll payments).
• File Form 1096 (Annual Summary and Transmittal of U.S. Information Returns).
• 1099 Forms — For certain types of income, a Form 1099 must be used with the federal tax return. Employers will not usually attach a 1099 series form to their return, except when they receive a Form 1099-R that shows income tax withheld. Keep all other 1099s with tax records. There are numerous types of 1099 forms.
• File Form 8027 (Employer’s Annual Informational Return of Tip Income and Allocated Tips).
• Check for required information returns and file those applicable to your business. Complete Form W-5 (Earned Income Credit Advance Payment Certificate). This form is retained by the employer.
• Determine business tax and wage reporting records to be kept, determine period to be kept, and maintain records.

Recordkeeping

• Organizations must keep records of employment taxes for IRS review.

The IRS requires that employers keep all records of employment taxes for at least four years. These should be available for IRS review. Records should include:

• EIN.
• Amounts and dates of all wage, annuity, and pension payments.
• Amounts of tips reported.
• Records of allocated tips.
• The fair market value of in-kind wages paid.
• Names, addresses, SSNs, and occupations of employees and recipients.
• Any employee copies of Forms W-2 and W-2c that were returned as undeliverable.
• Dates of employment.
• Periods for which employees and recipients were paid while absent due to sickness or injury and the amount and weekly rate of payments the employer or third-party payers made to them.
• Copies of employees’ and recipients’ income tax withholding allowance certificates (Forms W-4, W-4P, W-4S, and W-4V).
• Dates and amounts of tax deposits that the employer made and acknowledgment numbers for deposits made by the Electronic Federal Tax Payment System (EFTPS).
• Copies of returns filed, including Form 941 TeleFile Tax Records and confirmation numbers.
• Records of fringe benefits provided, including substantiation.

Definition of “commercial motor vehicle”

• Commercial motor vehicles are vehicles that weigh more than 10,000 pounds.
• Drivers with vehicles lighter than 10,000 pounds do not qualify for the motor carrier exemption.

In August 2005, amendments to the federal law inadvertently added the requirement that the vehicle must be a “commercial motor vehicle” defined as more than 10,000 pounds. Employers who use the motor carrier exemption, but who operate lighter vehicles, may not actually be eligible to apply this exemption to their employees.

Revisions

The FLSA refers to the Motor Carrier Act, and the 2005 legislation revised some definitions in that Act. Before these changes, the term “motor carrier” was defined as “a person providing motor vehicle transportation for compensation.” Also, the term “motor vehicle” was defined as “a vehicle, machine, tractor, trailer, or semitrailer propelled or drawn by mechanical power and used on a highway in transportation.”

The revision simply added the word “commercial” before the phrase “motor vehicle” in the definition, so that a “motor carrier” is now defined as “a person providing commercial motor vehicle transportation for compensation.”

Since a “commercial motor vehicle” is defined in 49 CFR 390.5 to include a vehicle which “has a gross vehicle weight rating or gross combination weight rating, or gross vehicle weight or gross combination weight, of 4,536 kg (10,001 pounds) or more, whichever is greater” there may be employers with drivers who operate lighter vehicles and do not qualify for the exemption.

Pay compression

• When pay rates within a range don’t vary much, this is considered pay compression and organizations should reevaluate employee pay.

When the differences in employees’ pay rates within a range do not vary much, it is known as pay compression. There may be someone with seven years’ experience who is paid $15.50 an hour working with someone who has only two years’ experience who is paid $15.00 an hour. This can result from raising starting salaries without adjusting those of current employees. There may be other causes as well. In this situation, pay adjustments should be considered.

Cost of living

• The cost of living in any given area will sometimes affect employee pay.

Another element that may influence pay rates is geographic area. Employees in Chicago, Illinois may be paid at a higher rate than employees in Beaumont, Texas, simply because the cost of living is higher in Chicago than it is in Beaumont.