Misclassifications: Not Just a Technicality

Something that’s been on my mind lately is misclassifications. And not the “oops, I used the wrong form” kind. I’m talking about classification errors that can quietly build up legal risk and financial liability in your business.

There are several types of misclassifications, but today I want to focus on two of the most common and most dangerous:

1. Misclassifying a 1099 contractor as a W-2 employee

2. Misclassifying a non-exempt (hourly) employee as exempt (salaried)

   
   

Both of these can get you into serious trouble with the IRS, the DOL, and even your own people.

I recently launched a satirical social media page to bring some humor to HR while educating business owners on what actually matters. Over there, I touch on this exact topic. Here, I’m breaking it down in more detail.

Contractor vs. W-2: It’s More Than Just a Form

A 1099 contractor is not an employee. They’re usually brought in to complete a specific project or provide a service. They:

• Operate independently

• Set their own schedule

• Can take on other clients

• Deliver results, not time

• Are responsible for their own taxes

  
  

On your books, they’re an expense, not a payroll item.

A W-2 employee, on the other hand, is someone you’ve brought into your organization in an ongoing role. You:

• Withhold and pay taxes

• Set their schedule and provide tools

• Offer training, guidance, and oversight

• Assign them recurring responsibilities

• Have them report to a manager or team

  
  

For startups and scaling businesses, this gets tricky fast. Someone may start out as a contractor, but over time their role evolves. Now they have a manager assigning tasks and providing feedback. They're expected to join team meetings, follow internal processes, and deliver work that directly supports your operations. Eventually, they’re working almost exclusively for you. At that point, they’ve crossed the line into employee territory.

You should be regularly evaluating your contractors to make sure they’re truly contractors. If they’re functioning like employees, it’s time to fix it. I’ve seen too many startups use the term “contractor” just to simplify things, but that’s not only incorrect, it’s illegal. Misclassifying workers violates the FLSA and other federal, state, and tax laws. Depending on your size and jurisdiction, additional rules might apply.

You need to run the appropriate tests: the ABC test, the Common Law test, or whatever your state or industry requires. Don’t skip this.

Salaried Doesn’t Always Mean Exempt

Another common misclassification is assuming that anyone on a salary is automatically exempt from overtime. That’s not true.

When I first started my career in HR, I worked at a company that classified their receptionist as a salaried exempt employee. That meant they weren’t paid overtime, even when they stayed late. The issue? That role doesn’t meet the duties test under the FLSA. It’s a support position that typically lacks the level of discretion or independent judgment required to qualify as exempt. In other words, it should have been classified as hourly non-exempt.

What made it worse was that the organization didn’t have a single hourly employee. With more than 150 people on staff, that wasn’t just a red flag. It was a major compliance risk. I can almost guarantee that setup violated multiple labor laws, even if it was never formally investigated.

This isn’t just a minor mistake. Misclassifying someone as exempt can mean you owe:

• Unpaid overtime going back years

• Penalties for every violation

• Additional fines from the DOL or your state

• Legal fees if the employee sues (they can and often do)

  
  

Executive Assistants are often confused with receptionists in this scenario. While EAs can sometimes qualify as exempt, it depends entirely on their actual duties. Title alone is not enough. Employers should conduct exemption tests and a proper job analysis to determine whether the role meets the FLSA's criteria. These steps are essential for ensuring compliance and avoiding costly missteps. A qualified Human Resources expert can assist with this process, review roles, and support proper classification.

Small Business, Big Responsibility

If you’re running a small or midsize business, it’s up to you to make sure you’re classifying people correctly. Even if you don’t have a full HR or legal team, you’re still responsible.

Misclassification doesn’t just bring legal risk. It damages trust, affects morale, and can lead to high turnover and reputational harm. It’s not worth the shortcut.

If you're unsure about a classification or you want help reviewing your roles, Innovative Foundations is here to support you. We’ll help you get compliant and stay that way, without the stress.

In summary

Don’t guess. Don’t assume. Take a second look. Because once the audit hits, “that’s how we’ve always done it” won’t cut it.