A business is only as good as its employees. Hiring the right people is an art and may include hiring both salary and hourly workers.
At CMP, a Utah CPA firm, we work with business clients every day to help them manage their finances. Here are some key differences between salary and hourly employees to help you decide who to hire.
What is the Difference Between Salary and Hourly Wage?
Employees may be paid either a salary or an hourly wage. Salaried employees are paid a fixed amount on an annual basis. They get paid for vacation time and sick time and do not get paid extra if they work more than eight hours a day or 40 hours a week.
By contrast, hourly wage employees get paid an hourly rate when they work. They don’t get paid when they are not working. They must receive overtime pay for working more than 40 hours a week.
Exempt Versus Non-Exempt Employees
The Fair Labor Standards Act (FLSA) lays out the rules for hiring employees. It defines exempt employees as employees who are paid the same amount each pay period regardless of how many hours they work. In other words, they are salaried employees. They are exempt from the federal minimum wage and any overtime requirements but must be paid a minimum amount of $684 per week.
Non-exempt employees must be paid at least the federal minimum wage ($7.25 per hour as of 2022) and receive overtime pay equal to one-and-a-half times their usual hourly rate if they work more than 40 hours in any seven days. There is no FLSA requirement to pay extra if an employee works on a holiday or Sunday unless they also happen to work overtime on those days.
Tax Implications of Salary & Hourly Wage Employees
There are important tax implications for businesses that hire salary or hourly-wage employees.
How Income is Calculated
Salaried employees earn a fixed amount each year. From a payroll and tax standpoint, salaried employees’ tax withholding will remain the same each pay period unless they receive a raise.
By contrast, hourly employees’ pay may fluctuate from pay period to pay period and must be calculated based on how many hours each employee worked during that period. It’s the employer’s responsibility to track the employee’s time—including overtime—and pay accordingly.
Types of Taxes Deducted for Salary and Hourly Employees
There is no difference between salary and hourly workers when it comes to withholding federal taxes because the requirements are identical.
Employers must withhold the following taxes:
- Federal income tax
- State income tax
- Social Security tax
- Medicare tax
- Additional Medicare tax (applies only to salaried employees earning more than $200,000 per year)
Federal unemployment taxes are the responsibility of the employer and that’s the case in most states, too. The three exceptions are Alaska, New Jersey, and Pennsylvania.
Filing Requirements for Salary and Hourly Taxes
All employers must report the amounts they pay to their employees to the Internal Revenue Service and their state taxing agency. At the federal level, they must choose whether to report on a semi-weekly or monthly basis. Taxes must be remitted to the IRS based on the chosen schedule. Employers are required to file Form 941 (or sometimes, Form 943, 944, or 945) every quarter.
Tax laws vary from state to state. In Utah, employers who withhold more than $1,000 in state taxes per month must remit payment monthly, while employers who withhold less than $1,000 may pay quarterly. All employers are required to file returns.
Pros and Cons of Salaried Employees
There are pros and cons of hiring salaried employees. Let’s start with the pros.
- You know how much your payroll will be each pay period. It doesn’t fluctuate, and for some business owners, being able to predict payroll and tax payments is important.
- You don’t have to pay salaried employees extra for overtime. They’re expected to do the work detailed in their job description regardless of how long it takes.
- Employees like knowing how much they’ll earn each pay period.
Here are the potential downsides of having salaried employees:
- If you need to save money on payroll, it’s harder to do with salaried employees unless you want to have uncomfortable conversations about cutting salaries.
- Salaried employees get paid for sick time and vacation time, meaning employers must pay them even when they’re not at work.
- There is a minimum salary an employee must earn to have exempt status, and in many cases, salaried employees may be paid more than hourly employees.
Pros and Cons of Hourly Employees
Here are the pros of having hourly employees on your payroll:
- Hourly employees are paid only for the hours they work, and you can manage your payroll expenses by scheduling hourly employees for fewer than 40 hours per week.
- Hourly employees don’t get paid for sick or vacation time, so you won’t lose money if someone is out of the office.
- Hourly employees may be full-time employees or part-time employees. If they are part-time, they may not be eligible for benefits such as health insurance or a retirement plan.
Here are some cons of hiring hourly employees to consider:
- If you need your hourly employees to work more than 40 hours per week, you’ll need to pay them at the overtime rate.
- Hourly employees may resent having their hours cut, and employee turnover can be an issue.
- Overtime hours and pay can add up quickly, meaning hourly employees can be expensive.
You’ll have to evaluate your labor and business needs to determine whether you want to risk having to pay overtime to hourly employees.
How Employers Decide Whether to Pay Salary or Hourly
Since there are advantages and disadvantages to hiring employees on a salary or an hourly basis, here are some things to help you decide whether an employee should be paid hourly or put on an annual salary.
Your Business Requirements
Seasonal businesses are most likely to benefit from hiring hourly employees whose hours may be cut or expanded as needed. A business with steady, year-round needs will most likely benefit from having salaried employees and predictable payroll.
Industry standards play a role because if employees in your industry are accustomed to being paid an annual salary, they may not be interested in working for a company that pays hourly wages. The reverse is true, too, since some employees may prefer hourly pay.
Seniority and Experience
Recruiting an employee for a senior role is typically an indication that they should be paid a salary, but that’s not always the case. Some companies outsource key executive roles such as CFO and in that case, the employee may receive an hourly rate instead of being salaried.
Federal and State Laws
FLSA and state requirements may play a role in determining whether you hire an employee on a salary or hourly basis. If an employee is classified as exempt, you’ll need to pay them the FLSA minimum and adhere to state requirements. For example, in California, exempt employees must be paid twice the state minimum wage.
The job market may dictate how you compensate employees. If people in similar roles receive a salary, then it’s probable that candidates for a job will expect an annual salary. In 2021, 55.8% of employees in the US received hourly wages. A prospective employee applying for an advanced position may require a salary, while someone applying for an entry-level position may be content with hourly pay.
Can Employers Switch Back and Forth Between Salary & Hourly Wages?
Switching back and forth between salary and hourly wages is possible but may cause complications depending on the employee and their expectations.
Switching an employee from hourly wages to a salary is usually an uncomplicated choice. Many hourly employees may desire a salary because it provides a predictable income and hours and usually comes with better benefits than an hourly position. However, if an hourly employee has been accustomed to a flexible schedule and overtime wages, it’s possible that switching to a salary may mean less income and the employee may resist the change.
If you switch an employee from hourly pay to a salary, you’ll need to make sure that their pay complies with FLSA regulations and any state laws that require them to be exempt.
The other option is one that typically comes with more complications. An employee with a full-time position who is accustomed to receiving a salary may be resistant to switching to hourly pay. For that reason, it’s not recommended unless it is necessary. You will need to check the employee’s contract to make sure you aren’t violating its terms.
If you decide to move an employee to an hourly rate, you’ll need to determine a fair hourly rate and get them to agree. In some cases, the hourly rate may be lower than what they were receiving as a salary, and you should tread lightly. You will also need to change their job description to reflect their new status and include information about overtime wages.
Which Businesses Benefit from Salary and Hourly Employees?
Your monthly business expenses and how they fluctuate may dictate whether you should hire most employees on a salary or hourly basis.
If your company is not seasonal and doesn’t experience significant fluctuations in revenue from month to month, you may prefer to have employees on a salary. Paying salaries makes it easy to predict your payroll and quarterly taxes. If you do what many small companies do and perform employee reviews and salary increases at the same time, you can remove almost all fluctuation from your payroll.
Companies whose revenues fluctuate from month to month or season to season may prefer to pay their employees an hourly rate. During slow times and off-seasons, you can reduce your payroll and the resultant taxes by cutting back on employee hours or even letting some of your hourly employees go.
You must consider other ways that having salaried workers or hourly employees can impact your bottom line. Having even one exempt employee who abuses their sick time can decrease your revenue because you may need to pay hourly employees to do their work or risk burning out other exempt employees who are required to pick up the slack.
Hourly employees may rely on working a certain number of extra hours each pay period and resent you if you cut their hours to save money. If they leave, you’ll need to absorb the costs of hiring and training a new employee—something that’s far more expensive than retaining an existing employee.
CMP Can Manage Payroll for Your Salary and Hourly Employees
Having the right mix of hourly and salaried workers can significantly impact your company’s profits and success. You should evaluate your choices based on employees’ expectations and market norms to decide whether an employee should be paid hourly or put on a salary.
Do you need help managing your payroll for salary and hourly employees? CMP offers payroll and bookkeeping services for businesses.