Money talks. Everybody needs it. Despite its importance, however, many startups regularly make compensation mistakes that could have legal implications that are both difficult and, almost ironically, expensive to resolve.
Misclassifying Workers Can Hurt Your Startup
Uber, one of the best known and most successful startups of the last 10 years, recently reached a settlement with its drivers. The settlement avoided a potential trial which would have potentially changed the classification of Uber’s drivers from contractors to that of employees. Under employment law, workers are typically classified as either independent contractors or employees and this classification is important for liability, compensation, benefits, and tax reasons, among others. While there are several distinguishing qualities between the two classifications, the most important distinction lies with how a startup treats each worker. If a startup does not correctly classify its workers, it subjects itself to penalties imposed by the state and to potential lawsuits that may have a detrimental effect on the startup.
Deferring of Wages Conflicts with Employment Laws
Sometimes startups do not have the necessary funding to remain operational and pay the necessary wages to its employees. This can also include deferring a founder’s wages and other additional forms of promised compensation. While this sounds like a great way to help save the startup money, especially whenever funds are low, it may create both serious legal and tax problems.
Businesses must operate in accordance with both state and federal laws. One of the most important employment laws that is found at both the state and federal level includes a law regarding the payment of a minimum wage. By law, every company must pay its employees no less than the federal minimum wage; a higher state minimum wage will require compliance with that state’s minimum wage, such as the current California minimum of $10.00 per hour for employers with 25 or fewer employees ($10.50 for employers with 26 or more employees). This is true for ALL employees, and possibly even including any founders and directors.
A startup that fails to pay wages—even if it just defers payment—exposes itself to lawsuits from employees and potentially unions. This is not only time-consuming and expensive, but it could be the nail in the coffin for many startups who lack the necessary funding to operate.
It is important that startups evaluate their employee compensation plan carefully and consult with an attorney to ensure compliance with employment and wage laws.
Untimely Section 83(b) Elections Results in Significant Tax Liability
Startup founders have the opportunity to realize a one-year capital gains tax benefit early by making a Section 83(b) election. This election allows a founder to recognize income between the purchase price of restricted stock and its fair market value. In making the election, the amount of taxes a startup founder will pay on the stock are likely to decrease substantially.
Despite this election being available to startup founders, many fail to obtain the tax benefit because they do not file within the requisite time. The IRS mandates that anyone seeking to obtain an 83(b) election do so within 30 calendar days of the stock purchase. There are no exceptions to this rule. Failing to make the election means that income shall be recognized in accordance with the stock’s vesting schedule. If the startup is very successful, the resulting taxes could be significant to the shareholder.
Schedule Your Consultation Today to Avoid Common Compensation Mistakes
Startup Company Counsel features a team of experienced business attorneys who will work with your startup to identify and correct any problematic situations regarding compensation. Working with an attorney helps ensure that your startup is compliant with all laws. You can schedule a consultation with one of our experienced business lawyers by calling our office at 408-441-7500.