How Not to Cut Costs

How Not to Cut Costs Why Working Out an “Arrangement” on Employee Overtime is a Terrible Idea By Jonathan Watts

When the time comes to trim the budget, employee overtime is an obvious target. After all, employees on overtime earn at least 1.5 times their normal wages, and this increase (as if not enough in itself) leads to higher social security and workers compensation costs. But employers be warned: Tampering with employee overtime can expose you to a wide variety of civil and criminal liabilities. Suppose Tom owns a construction business with operations in California and Nevada, and employs several employees who accrue lots of overtime. Tom is horrified by the size of his overtime payroll costs, and the resulting increase in his workers’ compensation insurance premiums and social security contributions. Because he has a good relationship with his employees, Tom decides to approach them to work out a solution. They decide that the employees will keep informal track of their overtime instead of reporting it on their time cards. Tom will pay them for their overtime at their usual rates (instead of 1.5 times their usual rates) in the form of cash outside of the payroll system. Tom gives his employees a bonus to thank them for their cooperation. At first, the new system works beautifully. Tom's payroll costs drop dramatically, and he also saves money on social security and workers’ compensation insurance. Because no taxes or social security contributions are withheld from employees' overtime pay, they are happy too. All goes well until an employee is charged with transporting marijuana in one of Tom’s trucks. To save himself, the employee squeals on Tom, who calls Al, his corporate attorney, for reassurance. Al does a little research and reports back with some grim news. Tom’s arrangement with his employees violates at least five (5) different statutory schemes: The California Labor Code, the California Revenue and Taxation Code, The California Insurance Code, the Federal Fair Labor Standards Act, and the Federal Internal Revenue Code. Tom and Al begin searching for a criminal defense attorney experienced in tax and labor law. In the meantime, Al briefs Tom on some of the civil and criminal penalties he could face if the government authorities move against him. Potential Penalties Under the California Labor Code The California Labor Code provides for civil penalties for failure to pay overtime. Tom's agreement with his workers violated a Wage and Hour Order requiring payment overtime at 1.5 times the employees' regular wages. The penalty for the initial violation is $50 per underpaid employee per pay period, plus the unpaid wages. The penalty for each subsequent violation is $250 per underpaid employee per pay period, plus unpaid wages. These penalties can be assessed for violations that occurred up to three years past. At $250 per employee per pay period, Tom's penalties add up very quickly. Tom could also be found guilty of a misdemeanor under the California Labor Code, which requires employers to provide a wage and hour statement with each paycheck. Potential Penalties Under the California Insurance Code More seriously, Tom could be facing prosecution for felony insurance fraud. California Insurance Code section 11760 provides that "It is unlawful to make...any knowingly false or fraudulent statement,...of any fact material to the determination of the premium, rate, or cost of any policy of workers' compensation insurance, for the purpose of reducing the premium, rate, or cost of the insurance." Violation of this section is punishable by a $50,000 fine and up to five years in prison. Of course, Tom can stand on his Fifth Amendment rights and refuse to testify against himself. But if Tom's premiums vary by the number of hours his employees work, a jury could conclude that he knowingly falsified his payroll records to reduce the cost of workers compensation insurance. Potential Penalties Under the California Revenue and Taxation Code The California Revenue and Taxation Code contains troublesome criminal provisions that could affect Tom. Section 19701 provides that any person who "Aids, abets, advises, encourages, or counsels any person to evade" the state income tax is liable for a penalty of up to $5,000, and is guilty of a misdemeanor punishable by a fine of up to $5,000 and imprisonment of up to one year. Section 19705 of the Code is more serious. It provides that any person who "Willfully aids or assists in, or procures, counsels or advises the preparation of" a false or fraudulent return is guilty of a felony punishable by a fine of up to $50,000 and imprisonment. Because Tom and his employees agreed that employee overtime would be paid in cash "under the table" without reporting or withholding taxes, a jury could determine that Tom encouraged and counseled tax evasion by his employees in order to save overtime expenses. Potential Penalties Under the Federal Fair Labor Standards Act Tom also faces liability under the federal Fair Labor Standards Act ("FLSA"). The Wage and Hour Division of the federal Labor Department may assess civil penalties of up to $1000 for each "repeated" or "willful" violation. The authorities are supposed to consider several factors in assessing the fine, including the size of the business, whether the employer has made good-faith efforts to comply with the FLSA, whether the employer has a valid excuse, the employer's previous history of violations, the interval between the violations, the number of employees affected, whether there is a pattern to the violations, and the employer's commitment to future compliance. Potential Penalties Under the Federal Internal Revenue Code. Any person who "Willfully aids or assists in, or procures, counsels, or advises the preparation ... of a return ... or other document which is fraudulent or false as to any material matter" is guilty of a felony punishable by a fine of up to $100,000 and up to 3 years in prison. And an employer who willfully fails to collect or pay the tax withholdings required by law is guilty of a separate felony, punishable by a fine of up to $10,000 and imprisonment for up to 5 years. Tom could be found guilty of both of these felonies. He could also be found guilty of a misdemeanor for failing to accurately report wages and tax withholdings to his employees. Finally, Tom may be personally liable for the taxes that he did not withhold, plus penalties and interest. Conclusion While this discussion is not an exhaustive list of Tom's potential liabilities (such as civil suits by employees), it includes the most serious penalties he is likely to face. The moral is clear: falsifying employee overtime is not an effective cost-cutting tool. If Tom has a clean record and the local prosecutors are busy, he will probably avoid a felony conviction after paying substantial penalties and making up the missing overtime pay. But he faces serious consequences, including felony convictions and prison time, if the authorities decide to throw the book at him. Either way, he will have to cope with anxiety, embarrassment, and attorney's fees that he could easily have avoided. Jonathan Watts practices law at the Riverside office of The Partners, An Incorporated Law Firm. His practice emphasizes business planning, business law, and estate planning. He can be reached at 909-684-8400 or [email protected].