When you hire a new employee, pay is one of the first details to address. Before you can determine how you will pay an employee, however, you must establish the pay structure of both your business and your employees. This can be complicated if you don’t know the difference between pay structures, as well as the legal implications of each.
The terms “salaried” and “hourly” are typically used to define an employee’s pay structure. As a business owner, you must choose one or the other when you hire people to work for your company.
If you don’t know how to pay employees correctly, then you could run into problems with federal employment law and face a costly lawsuit. Therefore, it’s in the interests of both your business and your employees to be clear about pay from the start.
With this in mind, what are the different pay structures, and how do you determine the right model for your business?
A Guide to Pay Structures
Broadly speaking, there are three main pay structures for employees in the U.S.:
What is a Salaried Employee?
An employee who is paid a salary receives a fixed annual amount. Salaried employees are not usually required to sign a time sheet or account for their time in any way.
A salary is often considered beneficial for employees, as they are typically paid not for hours worked but on that overall salary. What this means is, if a salaried employee works more or less than a “normal” 40-hour work week, it goes undocumented by the employer.
However, not all salaried employees are entitled to overtime. It means that while they don’t get their pay docked if they work less than their contracted hours, they don’t get paid extra if they work beyond an average week.
What is an Hourly Employee?
An hourly employee is paid based on how many hours they work in a week or month. Typically, an employee who is paid hourly doesn’t have a contract and is therefore only paid for each hour worked. Hourly-paid employees usually have to record their working hours with a time sheet verified by the employer.
As an employer, you are not required to provide hourly employees with a specific number of hours of work a week. This method of working can be advantageous for the employer, as staff can be called upon as and when they are needed. However, this provides little security for the employee. Hourly employees also tend to have different pay rates and benefits from salaried employees.
What is a Commissioned Employee?
A commission is an amount that you pay to employees when they make a sale or accomplish another goal. This might be a percentage of a sale or a flat amount based on performance. Sales positions (like those in car sales or real estate) commonly adopt this pay structure.
The IRS classifies commission as “supplemental pay,” and must be paid in addition to an hourly rate or salary. Other types of supplemental pay include bonus payments, overtime pay, accrued personal time off, and back pay.
Which is the Best Pay Structure for Your Business?
To determine the best pay structure for your business, you will first need to look at how your industry works. If most companies in your field follow one particular model, you may not have a choice about your pay structure. Employees will expect to be paid a certain way. If they’re not, and they think they’re losing out, they may go and work elsewhere.
If there’s no “common” pay structure in your field, you may need to look at how your sales operate. If working hours are regular and you can offer an employment contract, you’re more likely to attract permanent staff than if you hire on a “needs must” basis. However, ad-hoc work can be better-suited to students and part-timers due to its flexibility.
Within each pay structure, you’ll need to consider whether you offer benefits and employee rewards. Some companies will pay employees a base salary, and commission of up to 100% of the annual salary for exceeding performance. Others offer hourly or salaried pay with the opportunity of a bonus if the company – or employee – meets their target per quarter.
Calculating the Hourly Rate for Salaried Employees
When you hire an employee on a salaried basis, you still need to calculate their hourly rate to be sure you are paying them fairly. This calculation relies on simple math.
For example, if a salaried employee is paid $20,000 a year, this amount is divided by the number of pay periods. If salaried employees are paid on a monthly basis, this employee will receive $1666.67 a month. This equates to an hourly rate of $9.62 an hour, assuming the employee works around 40 hours per week.
Employees will have a take-home pay after federal tax and social security is deducted. This is dependent on the state where the business is registered. If the same salaried employee earns $20,000 a year, they will take home around $17,496 annually. This amounts to a net monthly salary of $1,458,
Some experts recommend a combined salary and commission approach. This way, you are still motivating your team to meet goals, while minimizing the chances that they’ll feel disgruntled and underpaid. While this might work in some industries (such as sales and restaurant work), it won’t work for jobs where there is no clear way of measuring performance, such as administration or secretarial roles.
There is no one size fits all approach to pay structure. Every business will demand a different method of pay, and each comes with its own set of benefits for both the employer and the employee.
Although you need to determine the most cost-effective pay structure for your business, profit is not the only variable to consider when determining your pay structure. You also need to make sure you create a positive company culture. This means creating a positive employee experience that will enhance your business reputation.
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