Organizational Wellness

Classification of Employees: A Guide for HR Departments

Last Updated Dec 9, 2024

Time to read: 13 minutes

Navigating employee classifications can feel like walking a tightrope. With legal compliance and your business needs at stake, it’s crucial to get it right. Whether you’re sorting out exempt versus non-exempt status or deciding between full-time, part-time, and temporary roles, these decisions affect more than just payroll. They impact overtime eligibility, benefits, and even how you manage performance reviews. Misclassifying workers can lead to steep fines or penalties from agencies like the DOL or IRS.

Want to get your team is classified correctly and sidestep costly mistakes? Let’s explore how to streamline your process!

Types of Employee Classifications

The first step in classifying your workers is to determine whether they are exempt or non-exempt under labor laws. (More on that in a second.)

Once that’s clear, you can define their employment status—whether they are full-time, part-time, or temporary. You’ll also need to distinguish between employees and independent contractors, as their classifications come with different obligations and rights.

Confused yet? Don’t break a sweat: Once you know what each term means, it becomes much easier to sort workers into the right categories. Doing so helps you create a structured, compliant workforce that meets the needs of your business and your people, so let’s get started!

Exempt vs. Non-Exempt Employees

Defining an employee's status as exempt or non-exempt determines their eligibility for overtime pay or minimum wage requirements (or both) as defined by the Fair Labor Standards Act (FLSA). Exempt employees usually receive a salary rather than an hourly wage and don't receive overtime pay if they work more than 40 hours weekly. Most professional, office-oriented jobs fall into the exempt category.

The FLSA sets a few guidelines for determining whether an employee is exempt, including salary, salary basis, and duties. Generally, employees who earn a minimum salary of $684 weekly — regardless of any variations in quality or quantity of work — and who perform administrative, executive, or professional duties are classified as exempt.

However, new FLSA regulations concerning employee exemption begin in July 2024, which raises the minimum salary to $844 weekly. An additional increase to $1,128 weekly goes into effect in January 2025, and the Department of Labor (DOL) will make further increases and adjustments every three years.

Non-exempt employees receive hourly wages, which must be equal to or greater than federal and state minimum wages. A non-exempt employee is entitled to overtime pay equal to at least 1.5 times their hourly rate if they work more than 40 hours weekly.

Example of Exempt Employee

Say you hire a new accountant to assist with your monthly bookkeeping. You pay the accountant a $65,000 annual salary, regardless of whether they work more or less than 40 hours weekly. The accountant's duties are professional and administrative since they perform office-based work based on their expertise.

Because the accountant meets the FLSA's salary, salary basis, and duties guidelines, you would probably classify them as exempt.

Example of Non-Exempt Employee

You hire a new HVAC repair person for your HVAC company. The new employee receives an hourly wage of $25. While they usually work a 40-hour week, sometimes business fluctuates, and you may need their assistance more frequently. It's not unusual to ask them to work on weekends or holidays, especially in summer.

You would likely classify the HVAC repair person as non-exempt since you pay them hourly, and their work doesn't fall under executive or administrative categories.

Full-Time vs. Part-Time vs. Temporary Employees

Other classifications apply depending on how frequently your employees work and whether you expect them to stay on for the long term. Some examples include full-time, part-time, and temporary employee status.

The DOL does not provide explicit guidance for classifying a worker as full- or part-time. Instead, the agency leaves full-time and part-time classification up to the employer.

However, the Affordable Care Act defines full-time employment as working an average of 30 hours weekly. The IRS uses the Affordable Care Act's full-time employment standards to determine whether an employer is liable for making special payments if it doesn't provide health coverage to its workforce.

Traditionally, most employers define full-time employment as a 40-hour workweek. However, since there are no specific rules, you may consider an employee full-time if they work 30 or 35 hours weekly or some other standard.

The DOL does not set guidelines for part-time employment, either. Employers can set their own policies for defining part-time work, just like they can with full-time workers.

A temporary employee helps fill in any short-term staffing gaps for a business. You may hire full-time, part-time, or seasonal temporary employees. While there are no formal restrictions on how long a temporary employee can work at a business, most usually stay with the company for less than 1,000 hours or one year, according to the U.S. Chamber of Commerce.

An example of a temporary employee might be hiring a worker to fill in while a full-time employee is out for paternity or maternity leave or hiring seasonal employees at a retail store during the holidays. Businesses that hire temporary employees pay them according to a defined payroll schedule, withhold payroll taxes, and send the employee a W-2 form.

Independent Contractors vs. Employees

An independent contractor is someone who works for themselves. Employers can bring independent contractors on board to help with short-term business needs or to take on project-based responsibilities. Independent contractors may work for multiple companies at once, allowing them to control how much work they do at any given time.

The DOL sets a six-factor test for determining whether a worker falls into the independent contractor or employee category. Generally, workers who retain autonomy in marketing their services, have control over their work schedule, and handle project-based assignments are independent contractors.

Independent contractors are responsible for paying income taxes on their earnings. The employer doesn't withhold taxes or provide benefits commonly available to employees, such as healthcare insurance or vacation time. That's different from the employer-employee relationship, where a worker may receive medical insurance, paid leave, and access to retirement benefits.

Legal Considerations and Compliance

How does the classification of employees affect the employer under the law? It depends. Correctly classifying workers is vital to avoid unnecessary penalties or fines from the DOL, IRS, or state employment agencies.

Federal and State Laws

The DOL oversees federal labor laws. It sets regulations like the FLSA to protect workers' rights, including setting minimum wage requirements and fair working conditions. All covered employers must comply with the provisions of the FLSA.

Under the FLSA, employees must properly categorize employees as non-exempt or exempt. Workers must receive a minimum wage and overtime pay, and employers must accurately keep records of each worker's hours, earnings, and personal information. Failing to comply with the FLSA may result in DOL-administered penalties. Employees may also seek legal remedies, including back wages and liquidated damages.

In addition to federal labor laws, states set their own labor regulations. Most state labor laws closely mirror federal policy. But they may include additional regulations, such as higher minimum wage requirements. For instance, New York State sets a $15 minimum wage, with workers living in New York City and surrounding areas receiving a $16 minimum wage. In comparison, the federal minimum wage is $7.25 for non-exempt employees.

It's important to consider federal and state labor laws that apply to your organization to avoid any unnecessary fines or penalties.

IRS Guidelines and Tax Implications

The IRS pays attention to employment classifications, mainly as they apply to independent contractors versus employees. When assessing whether a worker is a contractor or employee, it uses three tests: behavior control, financial control, and the parties' relationship.

Behavioral control includes what the worker does and how they perform the job. For instance, an employer requiring the worker to work 40 hours weekly according to a standard time schedule might fall under the employee definition rather than an independent contractor.

Financial control considers how much oversight the employer has over the worker's income and expense reimbursement. Usually, independent contractors provide their own equipment to do a job, whereas employers supply employees with company-provided resources. The IRS also considers the worker's contracts and whether they receive benefits typical of an employee, such as medical insurance or vacation pay.

Misclassifying employees as independent contractors may lead to a discrepancy in income tax withholdings, Social Security, Medicare, and unemployment taxes. Employers may be liable for paying back income taxes. Independent contractors may also be liable for their portion of taxes.

IRS guidelines may also come into play in issues concerning healthcare. Businesses with more than 50 full-time or full-time equivalent employees must provide access to affordable health insurance. Otherwise, they may incur penalties.

Since the Affordable Care Act (ACA) defines the full-time equivalent as working an average of 30 hours weekly, it's vital to accurately track the number of workers who regularly put in more than 30 hours on the job. This is even if you define them as part-time in their job description. That's especially true if your business doesn't offer healthcare insurance.

For instance, say you have 60 employees. You define part-time as working 35 hours or less weekly, and full-time as 40 hours or more. Just 20 of your employees are full-time, but the remaining 40 workers put in 30-hour workweeks. Since both employee groups meet the 30-hour workweek average, you may be subject to IRS and ACA penalties if you don't offer healthcare insurance.

Best Practices for Compliance

You can reduce the risk of worker misclassification penalties and fines by following a few best practices.

Start by documenting your procedures for defining a worker's classification. While federal and state guidelines outline exempt, non-exempt, employee, and independent contractor classification rules, you have some leeway with part-time and full-time employees. Writing the rules for classifying employees sometimes helps avoid judgment errors since your HR team can easily access the guidelines when bringing a new worker on board.

Labor laws frequently change, so staying abreast of any newly introduced regulations is important. You might consider subscribing to the DOL's email notification service, which is free and provides details on upcoming legislation that may impact your business. Your state may offer a similar service, so check your local state employment website, too.

Some professionals join HR-related groups like the Society for Human Resource Management (SHRM). It hosts events and webinars and shares resources concerning new and existing employment regulations and other HR-related topics to help keep you up to date. You may find SHRM a great resource that helps keep you informed of HR-related issues, including labor law changes.

Another option is seeking legal guidance from an experienced employment law attorney. An attorney may advise you on one-off employment classification questions, or you might ask them to review your procedures for classifying workers.

Impact on HR Management

Worker classification doesn't just affect taxes and labor law compliance. It can also impact how your organization pays employees, the benefits you offer, and how you evaluate performance.

Compensation and Benefits

Different laws influence how you pay workers and the benefits they're entitled to. For instance, wage laws set minimum hourly pay for non-exempt employees. Failing to compensate employees in line with minimum wage rates under federal and state laws may lead to fines and penalties — and unhappy workers.

Other compensation and benefits that arise from worker classification issues include:

Not providing access to healthcare insurance if you have 50 or more eligible workers.
Not complying with COBRA continuation insurance coverage rules when an employee leaves the company.
Failing to provide eligible workers with Family Medical Leave Act (FMLA) benefits.
Not compensating employees appropriately for overtime.
Mistakes in withholding income taxes, Social Security, Medicare, and unemployment taxes.

Some employers provide benefits based on a worker's classification. For instance, a part-time employee might not be eligible for your company's healthcare plan, but full-time workers are. Or, you might reimburse employees for job-related expenses but require independent contractors to cover their costs. If your organization mistakenly misclassifies workers, your employees may miss out on all the benefits available to them.

Of course, you don't want a simple error to cause a barrage of unnecessary issues for your employer or workers. By adhering to best practices and remaining aware of regulations concerning worker classification, you can avoid compensation and benefits mistakes.

Performance Management and Development

How you classify employees may also affect the way you evaluate your team's performance. While performance review systems vary from workplace to workplace, many employers use assessments based on reaching established goals during a period, such as a quarter or a year. The employee's manager or supervisor usually holds the review. But other insights from colleagues, committees, or departments may also be involved.

An issue may arise if an employer misclassifies workers, making them ineligible for a performance review. For instance, maybe the employer only reviews full-time employees versus part-time or temporary workers. Such a discrepancy might lead the employee to lose out on a bonus or career progression opportunity.

If your workplace handles performance reviews according to worker classification, ensuring proper classification is essential so all employees can access the performance and developmental opportunities available.

Tools and Resources for Employee Classification

There are various resources you can turn to for help with employee classification. Start with the DOL's FLSA fact sheets and reference guides. You may also use the site's Fair Labor Standards Act Advisor to help you determine if an employee is exempt or non-exempt.

You might also check your state's Department of Labor website for local employee classification regulations and wage information. Every state has its own approach to labor laws, so make sure you review the ones applicable to your organization.

Some professionals join the SHRM or similar HR-related networking groups to remain up-to-date on HR-related issues. Other options besides SHRM include the National Human Resources Association (NHRA) and the International Association for Human Resource Information Management (IHRIM).

Employee Classification Influences the Benefits You Offer

Providing your workers with a comprehensive compensation and benefits plan starts with proper classification. Start by determining where your workers fall in the various classification options. Are they exempt or non-exempt? Part-time, temporary, or full-time? Employee or contractor?

How you classify your workers impacts their earnings and benefits options, and a mistake can make them ineligible for some of your best perks — like a wellness program. This can have a major impact on employee satisfaction when over 90% of employees state their wellbeing is more important than their salary.

Keep every employee happy with a workforce wellness program. Speak with a Wellhub Wellbeing Specialist today!

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