Employee Classification Guide for Business Owners

What is employee classification?

Employee classification is a legal determination that defines the relationship between a worker and their employer. These classifications are governed by federal and sometimes state and local laws, making proper classification essential. 

Why does employee classification matter?

How workers are classified directly affects the employer-worker relationship. It determines when and how much employees are paid, what benefits they’re eligible for, who’s responsible for withholding taxes and paying Social Security and Medicare taxes, and the employer’s recordkeeping responsibilities.
As an employer, you may believe you have discretion in deciding how to classify a worker. But in most cases, classification is determined by employment laws and other factors, including (but not limited to):

• The job duties an employee performs
• How much the employee earns
• How the employee works and how much control they have over how their work

When these factors aren’t carefully assessed, it can lead to misclassification—and that comes with real risks for your business. It can leave you open to employee claims, federal audits, fines or back pay, and potential tax liabilities. It can also affect employee retention if your workers feel they’re not being treated fairly.

Working with a professional employer organization (PEO) like G&A Partners can help alleviate the stress of classification and compliance. Our HR experts stay current on evolving laws and regulations, and we can provide the guidance needed to adjust your classifications as your business grows and evolves.

Employee classification falls into a few key categories, each with its own legal considerations. Here’s what you need to know.

1. Classification Based on Contractual Relationships

Employees vs. Contractors

The first level of classification involves determining whether a worker is an employee or an independent contractor. This classification is primarily based on a worker’s degree of control and independence in their job.

• Employees:
• Are workers who are legally considered dependent on their employer for pay, work schedules, and equipment
• Perform work that is considered a key aspect of the business
• Contractors:
• Have the right to control what they do and how they do it
• Determine how they are paid and supply their own tools
• May have a temporary relationship with the business, and their work may not be considered fundamental

As an employer, you must carefully evaluate these factors when determining whether a worker is an employee or an independent contractor. Some workers may appear to fall under both categories, making classification complicated.

So, It’s important to assess the entire relationship, with a particular focus on the extent of the worker’s control. For compliance purposes, you must document each factor considered during the classification process.

Tax Responsibilities

Proper classification will determine your tax responsibilities as an employer.

• For employees:
  • Employers must withhold and deposit income, Social Security, and Medicare taxes.
  • Employers are also responsible for paying their share of Social Security, Medicare, and unemployment taxes.
  • Employers typically do not have to withhold or pay taxes on payments.

• For contractors:
  • Employers typically do not have to withhold or pay taxes on payments.

Employees are protected by federal labor laws, including the Fair Labor Standards Act (FLSA), and state and local employment laws. Independent contractors are generally not covered by these protections.

2. Classification Based on Compensation and Legal Status (Under the Fair Labor Standards Act - FLSA)

Exempt vs. Non-Exempt Employees

One of the most complex aspects of the Fair Labor Standards Act (FLSA), the primary federal labor law, is the difference between exempt vs. non-exempt employees. Here are a few key points to consider:

• Non-exempt employees:
• Are entitled to FLSA wage protections, including minimum wage and overtime pay
• Exempt employees:
• Are not subject to FLSA rules
• Receive a standard salary per pay period, regardless of the number of hours worked

A common misconception among business owners is that exemption status is based on whether an employee is paid hourly or by salary. The process is slightly more complicated.

How to Determine If an Employee Is Exempt

To qualify for exemption under the Fair Labor Standards Act (FLSA), employers must demonstrate that an employee satisfies the following tests:

• Salary level test: Is the employee paid at least the minimum salary threshold?
• Salary basis test: Does the employee receive a full, predetermined salary for any week, regardless of the number of days or hours worked?
• Duties test: Does the employee perform job duties that fall within one of the specific exempt categories, such as executive, administrative, professional, computer employee, or outside sales?

Note: Employees classified as outside sales are exempt from the salary level and salary basis tests. Their exemption is determined solely by their job duties. Certain professions, such as teachers, lawyers, and doctors, are also exempt from the salary level and salary basis requirements.

Employees who do not meet all three tests must be classified as non-exempt and provided the wage protections required under the FLSA.

3. Classification Based on Employment Duration and Work Schedule

Full-Time vs. Part-Time Employees

Beyond employee and contractor status, other classifications can also impact your workforce and compliance responsibilities.

The federal government does not regulate the terms “full-time” and “part-time.” However, the Affordable Care Act (ACA) and state and local governments use the terms to determine eligibility for specific government benefits or mandated state leave and benefit laws.

For example, the ACA states that a full-time employee works an average of 30 hours per week for more than 120 days a year.

As an employer, you can define the hourly limits for full-time and part-time employees that determine eligibility for non-mandated company benefit packages. Most employers consider full-time to be between 30 and 40 hours per week.

Many businesses, especially those with fluctuating consumer demand, also have seasonal or temporary employees. Seasonal employees generally work for a defined period, while temporary employees may work as long as the company needs them. Most seasonal and temporary workers are classified as non-exempt and subject to FLSA regulations, including minimum wage and overtime pay laws. Some states extend leave protections to these workers, while others do not.

Most Common Employee Misclassifications

Because classification rules are complex, certain misclassifications show up more than others. Here are some of the most common (and costly) errors:

• Classifying workers who do not have independent control over their work as contractors.
  Treating a contractor like an employee (directing their work, setting schedules, etc.) without granting them FLSA protections can lead to compliance issues. G&A Partners’ team of HR compliance professionals can help you evaluate your worker classifications and ensure they align with federal labor standards.
• Classifying workers as exempt when they do not meet the minimum salary threshold.
  A worker may pass the job duties exemption test but fail the salary level test. Our G&A experts can help identify these cases and recommend next steps, such as increasing the salary for that role to meet FLSA requirements or reclassifying the role as non-exempt.
• Classifying workers as exempt whose work is not within the permitted categories.
  Exempt status is based on job responsibilities rather than job titles, which can be confusing. Our HR experts can review your current job descriptions, recommend updates based on role changes, and help ensure new or posted positions align with FLSA exemption criteria.
• Classifying all seasonal workers as independent contractors.
  Seasonal work does not automatically justify contractor status. An HR partner, like G&A, can help you determine which seasonal roles meet the legal criteria for independent contractor status and which must be classified as exempt or non-exempt employees.

Ensuring Accurate Employee Classifications

Accurate employee classification is an important part of compliance and workforce management. Every day, G&A Partners helps employers identify and correct misclassifications by reviewing job descriptions, pay data, and other relevant details. Our HR professionals stay up to date on federal, state, and local labor laws, so we can help our clients make informed decisions as their teams grows – reducing risk and maintaining compliance at every stage.