Stipend vs. Salary: A Practical Guide for Small Business Compensation

Adding new members to your team is a sure sign of success, but it also means navigating the nuances of payroll compliance. You want to pay your people correctly, but the line between a 'salary' and a 'stipend' can sometimes feel blurry. Stipends and salaries both involve paying someone money, but they serve different purposes and carry distinct legal implications. This guide breaks down the practical differences and shows when each is appropriate.

What is a Salary?

A salary is the recurring compensation you pay to an employee in exchange for work performed under an employment relationship. When you pay someone a salary, you're establishing an employer-employee relationship with specific legal obligations. Key characteristics of salary compensation include:

• Employment Relationship: The person receiving a salary is your employee.

• Tax Withholding: You must withhold federal and state income taxes, Social Security, and Medicare from salary payments.

• W-2 Reporting: All salary payments get reported on Form W-2 at the end of the year.

• Benefits Eligibility: Salaried employees may qualify for health insurance, retirement plans, paid time off (PTO), and other benefits.

• Labor Law Protections: Employees who receive a salary have the right to minimum wage, overtime (if applicable), a non-discriminatory workplace, and other protections under the law.

When someone joins your team to perform ongoing work that benefits your business operations, the appropriate compensation approach is usually a salaried position. That's the case whether they're full-time, part-time, or working on a specific project basis as an employee.

What is a Stipend?

A stipend is a fixed payment intended to support living, training, travel, or other specified costs. Unlike salaries, stipends often support educational or training activities rather than compensating for work performed. Common stipend characteristics include:

• Support Payment: Stipends offset costs rather than compensate for labor.

• Variable Tax Treatment: Depending on the recipient's status and the stipend's purpose, tax implications vary significantly.

• Limited Duration: Most stipends cover a specific period or program.

• No Automatic Benefits: Stipend recipients usually don't receive employee benefits.

• Documentation Requirements: Clear documentation of the stipend's purpose and eligibility helps avoid misclassification.

Universities often use stipends for graduate students and research fellows. Businesses might offer stipends for internships, professional development, wellness activities, or reimbursements for specific expenses, such as home office setup costs.

Tax Implications for Stipend Versus Salary Compensation

The tax treatment of a stipend versus salary payments creates one of the most significant practical differences for small businesses. The Internal Revenue Service (IRS) provides detailed guidance on the taxation of stipends and salaries, helping clarify these rules. Here's an overview:

Legal and Compliance Considerations

It's important to establish the right payment structure to minimize the risk of misclassification and avoid potential legal issues. The Department of Labor (DOL) and the IRS look at the actual working relationship when determining proper classification, not the labels. The DOL created a flexible test to analyze the working relationship.

The Primary Beneficiary Test

The DOL's "primary beneficiary" test enables you to examine the economic reality in internships and training programs and avoid misclassifications. It takes seven factors into account:

1. Educational Environment: Does the experience extend classroom learning?

2. Academic Credit: Is the internship integrated with coursework?

3. Academic Calendar: Does timing correspond with academic commitments?

4. Duration: Is the relationship limited to the beneficial learning period?

5. Job Replacement: Does the intern's work complement rather than displace employees?

6. Job Entitlement: Both parties understand that no job guarantee exists.

7. Primary Benefit: The intern, not the employer, gains the primary advantage.

If your contributor performs work that primarily benefits your business operations, minimum wage and overtime rules apply regardless of stipend payments.

State-Specific Rules

State laws add another compliance layer. Some states have stricter rules for classifying interns or different workers' compensation requirements. California, for example, requires most interns to enroll in qualifying educational programs. Before implementing stipend programs, verify your state's specific requirements.

When to Use Stipend vs. Salary

Making the correct choice for your business depends on several factors:

Use Salary When:

• Someone performs ongoing work for your business

• You direct how, when, and where work gets completed

• The person's efforts primarily benefit your operations

• You need someone available during specific hours

• The role requires employee benefits or protections

Consider Stipends for:

• Educational or training programs where learning is primary

• Specific expense reimbursements (but accountable plans may be better)

• Academic fellowships or research positions

• Short-term programs with defined educational objectives

• Participants who aren't performing employee-type work

Best Practices for Small Businesses

Both stipends and salaries have their use cases in business. Because of their differences in taxes and flexibility, it's essential to weigh each option carefully. Here are some tips to consider for your business while supporting your team members appropriately:

1. Document Everything: Create written agreements that outline the payment purpose, eligibility, duration, and expectations. Clear documentation is your first defense against misclassification claims.

2. Evaluate the Substance: Focus on actual activities and relationships, not titles. If someone functions as an employee, treat them as one regardless of payment labels.

3. Consider Alternatives: For expense reimbursements, accountable plans requiring receipts may work better than taxable stipends. For temporary help, properly classified contractors might be a better fit than stipend recipients.

4. Communicate Clearly: Explain tax implications to stipend recipients. Many don't realize they'll owe quarterly estimated taxes if they don't have employer withholding.

5. Review Regularly: As the employment relationships evolve, reassess the classifications. You should reclassify an intern who assumes employee-type responsibilities to avoid compliance issues.

Small businesses that partner with a Professional Employer Organization (PEO) benefit from compliance support and expert guidance on classification decisions. This ensures proper tax withholding and reporting for all types of employee compensation.

Managing Compensation Complexity

The difference between stipend and salary payments raises deeper questions about work relationships and fair compensation. While stipends serve valuable purposes in specific contexts, many small businesses find that straightforward employment relationships with proper salary structures create fewer headaches. Resources like compensation agreement templates help structure these arrangements properly.

When evaluating stipend vs. salary options, prioritize compliance and transparency. Document your reasoning and follow applicable tests and guidelines. When in doubt, err on the side of treating workers as employees. The modest additional costs pale compared to potential penalties for misclassification.

Simplifying Compensation Management with Justworks

Understanding the difference between a stipend and a salary is just the beginning. Implementing proper payroll and onboarding systems ensures you handle each compensation type correctly. Get started with Justworks today.