Managing Cash and Payroll Risk in Troubled Times

February 5th, 2009

Payroll is the biggest expense for most businesses, especially young companies.  When times get lean management looks for ways to stretch cash out as far as possible.  The dilemma is that most companies would like to reduce their payroll expenses without reducing headcount, since with fewer people to do the work it may take even longer to get through a tight spot and get business flowing again.  Here are some of the biggest traps to avoid.

Note- employment law is completely different from state to state in the US, so this post is even more California-centric than most I write.  The *right* answer for a given situation is also entirely fact-specific, so don’t rely on this as advice for your company.  Use this information to be forearmed, then go talk to your lawyer about strategies that will work for you.

1) Salary reduction.  Everyone takes a haircut in their salaries.  The question is how far salaries can be reduced.  In many cases, it can go all the way down to minimum wage.  The gotcha here is that there is a “special” minimum wage for computer professionals.  I wish I knew how this law came to be, but the gist of it is that administrative employees can go down to minimum wage ($8.00 in California; $9.79 in San Francisco) but computer professionals need to be paid at least $79,050 per year (~$36/hour).  Figuring out who is a computer professional goes beyond the scope of this blog and is a job for your friendly neighborhood employment lawyer.

2)  Stock in Lieu of Cash.  This is a popular one and a major gotcha.  Don’t do it.  The IRS sees stock and cash as equal compensation, so if Startup, Inc. pays Employee $50,000 worth of stock instead of $50,000 cash, Employee will still have $50,000 worth of income to report- and no cash to pay the taxes on it.  Ouch.

California doesn’t like this strategy either.  Under California law Employee will continue to have a claim for payment of the $50,000 until it is paid in cash.  The claim can not be legally waived by payment of any other type of compensation, esp. company stock.

The even worse news is that employee wage claims are one area where directors and officers of a company can be held personally liable.  There are cases where courts have declined to hold officers liable, but don’t count on it.  The rule of thumb here is to act as if any wage-related actions are backed by the directors’ and officers’ personal bank accounts.

3)  “Deferred” Salary.  It is much easier to tell employees that you need to reduce their salaries temporarily and will catch them up once ___ event happens (e.g. a funding event, major customer deal, etc.) than to cut salaries permanently.  Don’t do this either.  In legal terms “deferred” means they are entitled to the full salary amount and can file claims for payment if it never comes through.  If you need to reduce salaries do it permanently and tell people that *if* certain positive events happen the company will do its best to offer bonuses that recognize the sacrifices employees have made. No side-of-the-mouth promises to catch up, either.  The bonus has to be truly discretionary to avoid the deferred/unpaid trap.

4)  Switching to Independent Contractor Status.  This is another common practice that can work in some cases, but gets overused.  A company can reduce payroll expense dramatically by laying people off and then re-hiring them as independent contractors.  The problem is that the IRS and California authorities have the final say as to who is a W-2 employee and who is a genuine contractor.  An audit by either entity can result in huge penalties for companies that mis-classify personnel.  There is so much gray area here as well that you can be certain either entity will find violations once they start looking.  Again, talk to an employment lawyer for more information on how to properly classify people.

Tough times require creative measures.  If my experiences during the last downturn are any guide a lot of companies will take on uncomfortable amounts of risk in the employment area so they can keep stay afloat.  I hope this helps to point out some spots where the risk outweighs the benefits.

And once again, this is not legal advice for your company. These are complex issues and you need to talk to a lawyer in order to figure out the best way to navigate your company’s own particular minefield.  Be careful out there!

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  • Re the computer-professional point, see this GC's blog posting. It sounds as though the California statute was changed so that companies wanting to avoid wage-and-hour lawsuits don't have to keep track of their computer professionals' hours worked, but instead can just establish that they pay the required minimum annual salary. (For the federal counterpart, see page two of this Dept. of Labor PDF.)

  • deffered salary is a horrible way to go. It's a means to a messy end when books show employee hours worked, versus wages paid.