The Employer’s Guide to Worker Classifications (Why you must get this right)

If you're a small business owner trying to figure out how to classify your team — employee or contractor, exempt or non-exempt, full-time or part-time — keep reading, because this one is for you.

This is one of the most common (and costly) areas where small businesses unknowingly make mistakes. And not because you're careless - because HR laws are complex, and frankly, most of the official resources out there sound like they were written for corporate attorneys, not real-world business owners.

So in this post, I’m breaking it down clearly and practically:

✅ What each classification actually means

✅ How to determine the right one

✅ And how to avoid fines, lawsuits, or compliance headaches

Let’s start with the basics.

Worker classification refers to how you define the working relationship between your business and the people doing work for you.

It affects:

- Pay and overtime rules

- Eligibility for benefits

- Tax withholding obligations

- Legal protections

- Risk of audits, penalties, and lawsuits

Misclassifying someone — even unintentionally — can result in:

- Back pay for unpaid overtime

- Tax liability with interest and penalties

- Benefits claims you didn’t budget for

- Wage and hour lawsuits

- Damage to your business’s reputation

The good news? You don’t need a law degree to get it right. But you do need to slow down and make thoughtful decisions.

Let’s start with one of the trickiest areas: exempt vs. non-exempt.

These terms come from the Fair Labor Standards Act (FLSA) — a federal law that governs things like minimum wage and overtime.

Here’s the difference:

• Exempt employees are exempt from overtime rules. They don’t get paid extra if they work more than 40 hours in a week.

• Non-exempt employees must be paid 1.5x their regular rate for any hours worked over 40.

Ask yourself:

• How are they paid?

  • Salary = possibly exempt

  • Hourly = likely non-exempt

• What kind of work are they doing?

  • Professional, executive, or administrative roles that involve independent judgment? Possibly exempt.

  • Routine, task-based work like customer service, warehouse, or technician duties? Most likely non-exempt.

• How much are they earning?

  • As of 2024, the federal minimum salary threshold is $684/week ($35,568/year). If they make less, they must be non-exempt — no exceptions.

📘 Want to dig deeper?

The Department of Labor’s Fact Sheet #17A offers details on exempt job duties and salary requirements.

Unlike exempt vs. non-exempt, there’s no legal definition of full-time vs. part-time in most states. You get to define what “full-time” means in your business — typically 30 to 40 hours per week.

That said, these definitions impact:

• Eligibility for benefits (especially under the Affordable Care Act)

• Scheduling and expectations

• Payroll costs

💡 Tip: Be consistent. Define these classifications in your employee handbook so expectations are clear across your team.

These workers are legitimately short-term, but that doesn’t mean they’re exempt from labor laws.

• Temporary employees work for a specific period or project.

  • Example: Someone hired for a 3-month maternity leave.

• Seasonal employees work during high-demand times.

  • Example: Holiday retail staff or summer camp counselors.

You still need to:

• Follow wage and hour laws

• Track hours for ACA or overtime thresholds

• Document start and end dates clearly

📘 Learn more from the IRS seasonal worker guide

Here’s where a lot of small businesses get in trouble.

Calling someone a “contractor” doesn't make it true — even if that’s what they prefer, or you both signed a contract.

According to the IRS, it comes down to control.

You can use the IRS 20-factor test or the newer 3-factor ABC test (used in some states), but here’s a simplified version:

✅ Contractors:

• Set their own hours

• Use their own tools/equipment

• Control how and when the work gets done

• Are free to take other clients

• Invoice for services

❌ Employees:

• Work on a schedule you set

• Use your equipment and tools

• Follow detailed procedures and receive training

• Appear on your payroll

• Are supervised and evaluated

📘 Check out the IRS guide on worker classification

💡 Not sure? File Form SS-8 with the IRS to request a formal determination — or talk to an HR consultant before moving forward.

Even if someone is properly classified as a contractor, there are rules around how you engage with them.

✅ Use a clear Statement of Work (SOW) that outlines:

• Deliverables

• Timelines

• Payment terms

• Performance expectations

🚫 Avoid:

• Dictating exact work hours

• Requiring time tracking (unless it’s for billing purposes)

• Managing them like you would an employee

📘 Learn how to structure an SOW from Thomson Reuters’ legal guide

These categories aren’t used often in small business, but here’s what you need to know:

• On-call employees: Paid for hours worked; often used in healthcare or hospitality. If they’re waiting and unable to use their time freely, they may need to be paid even when not working.

• Volunteers: Must be unpaid and should only work for nonprofits or public organizations. You can’t have a “volunteer” at your for-profit business.

📘 DOL Fact Sheet on Volunteers

Here’s what can happen if you get it wrong:

• Unpaid overtime claims

• IRS audits and tax penalties

• Unemployment claims

• Workers’ comp violations

• Benefit disputes

• Wage & hour lawsuits

I wish I could say that misclassifying a worker is no big deal, but the truth is—it can get expensive, fast. Even if it’s an honest mistake.

Here’s what’s on the line:

• The Department of Labor and IRS can issue back wages for unpaid overtime, minimum wage violations, and payroll taxes.

• You may be liable for penalties and interest on top of what you owe.

• If multiple workers are misclassified, those fines add up quickly.

• Employees who believe they were misclassified can file a wage and hour claim or lawsuit.

• Misclassification may also trigger class action lawsuits, especially if it involves exempt vs. non-exempt status.

• Independent contractors are responsible for their own taxes. If you misclassify someone and don’t withhold taxes, the IRS can come after you for unpaid employment taxes, including Social Security and Medicare.

• Independent contractors are responsible for their own taxes. If you misclassify someone and don’t withhold taxes, the IRS can come after you for unpaid employment taxes, including Social Security and Medicare.

• Misclassified workers might claim they were wrongly denied access to benefits like health insurance, paid leave, unemployment, or workers’ comp—exposing your business to further liability.

• If an independent contractor is injured on the job but later determined to be an employee, your business could be on the hook for medical bills and lost wages.

• If a contractor is terminated and files for unemployment, that claim might trigger a state audit.

📘 The DOL’s Misclassification Page outlines common employer mistakes and enforcement priorities.

As someone who’s spent over 30 years in HR, I can tell you:

Most misclassification is accidental.

Small business owners are trying to:

• Move fast

• Keep overhead low

• Work with flexible or part-time help

But speed and simplicity can't come at the expense of compliance.

You don’t want to discover you made a classification mistake after someone files a claim, or worse, after you’re audited.

Here’s what I recommend to every small business owner I work with:

✅ Get Your Classifications in Writing

Use job descriptions that clearly define:

• Duties and responsibilities

• Pay structure (hourly or salary)

• Reporting relationships

• Whether the role is exempt or non-exempt

For contractors, use a clear contract and Statement of Work (SOW) that defines:

• Deliverables

• Deadlines

• Payment structure

• Autonomy and control of work process

✅ Avoid “Title Traps”

Calling someone a “manager” or “consultant” doesn’t make them exempt or a contractor.

Regulators look at what they actually do, not what their title says. Make sure job descriptions are clear and accurate for every role.

✅ Document the Decision

Keep a simple record of why you classified a worker the way you did — especially for borderline cases. If you ever need to defend that decision, you’ll be glad you did.

✅ Don’t Try to Work Around the Rules

Offering someone a 1099 “to save on taxes” or to avoid payroll is a huge red flag.

If they work like an employee, they probably are one.

“What if the worker agrees to be a contractor?”

It doesn’t matter. The law determines classification, not what you both agree to.

“Can I classify someone as exempt if they’re salaried?”

Not automatically. They must meet both the salary threshold and job duties test under FLSA.

“Can a worker be both an employee and a contractor?”

Not for the same work. If someone is doing tasks under your direction, they can’t also invoice you as a contractor.

If you’re unsure about a role or worker, here are your options:

• Consult with an HR professional (like me!)

• Review the DOL’s FLSA Advisor for job duties guidance

• Request a worker status determination from the IRS using Form SS-8

You don’t need to navigate this alone. And you definitely shouldn’t guess.

Getting employee classifications right isn’t just about compliance — it’s about creating a stable foundation for your business.

When your classifications are clean:

• Payroll runs smoother

• Team expectations are clearer

• You reduce legal risk

• And you sleep better at night

The truth is, building a business the right way means taking care of the people doing the work — and making sure your systems support them (and you) legally and operationally.

If reading this has you second-guessing a few roles in your business, that’s a good thing. It means you care. Now it’s time to take the next step.

If you're not sure whether you've classified your employees or contractors correctly — or you're about to make your next hire — I can help.

At On Demand HR Solutions, I specialize in helping small business owners:

• Audit current roles and classifications

• Set up compliant systems from the ground up

• Draft job descriptions, contracts, and policies that keep you protected

👉 Book a free consultation here

You don’t need a full-time HR department to get this right.

You just need the right guidance — at the right time.