Seven Employee Classification Types in the US and How to Identify Them Correctly
Employee classification defines how an employment engagement is structured. With ongoing shifts in the workforce terrain, staffing agencies and recruiting firms in the US face a classification quandary as they navigate possible expansion into new areas or streamlining their services. Clients tend to prefer independent contractors because they can be more efficient in budget, operations, or both. Candidates for placement may have questions around classification as an employee versus an independent contractor if they are currently freelancing.
Regardless of client or candidate preferences, there are clear divisions in worker classifications that are important for every company to pay attention to. The risk of misclassification can mean hefty fines, fees, and back taxes for the employer.
There are seven employee classifications that are recognized in labor regulations. To avoid derailing your agency down the road, here are some key strategies to help you stay on track.
The Seven Employee Classifications Overview
When it comes to employment classification in the US, having a clear roadmap can make the difference between smooth navigation versus a bumpy road for staffing agencies. Regulations at the federal and state level may be subject to modifications at any time. Even if employees are classified correctly under the current laws, the scale of remote and hybrid workers over the past few years has accelerated the trend towards freelancing, which means that governing bodies still need to catch up to shifting trends.
Who Determines Employee Classifications?
Employee classification in the US is determined at both the Federal and State level. Employment Classification at the federal level in the United States is governed by the Fair Labor Standards Act (FLSA), which sets the minimum wage, overtime pay, record keeping, and youth employment standards that affect employees in the private sector and federal, state, and local governments. Keep in mind that changes in legislation may affect your agency as well. For example, the US Department of Labor updated its regulations in April of 2021 to protect tipped workers. One of the key revisions states that employers can no longer keep the monetary tips of their employees, which had a heavy impact on the restaurant industry that habitually collects and remits tips as a normal part of their daily operations.
While the Federal government set general rules and parameters around defining full-time hours and overtime, further definitions regarding minimum wage, part-time definitions and payment by employee classification types vary at the State level. Remote employees who like to work from different locations can present a challenge from a State compliance level.
Seven Employee Classifications
The Society for Human Resource Management (SHRM) offers a breakdown of employment classifications:
- Full-time Employee (FTE): an employee that is regularly scheduled for 40 hours per week.
- Part-time Employee (PTE): an employee that is regularly scheduled for more than 20 hours and less than 40 hours per week.
- Contract: an employee that has a clearly defined time period of employment.
- Independent Contractor (IC) or Freelancer: considered to be self-employed, independent contractors are responsible for the associated taxes; definitions vary at the state level and misclassification of an employee as an IC can have major repercussions.
- Temporary: employment may be full- or part-time and should not exceed a period of 90 days.
- On-Call: employees that are not regularly scheduled for work but are employed as needed by the company. This special employment classification requires companies to reevaluate their position every 180 days.
- Volunteer/Interns: Employed for a specific period of time, like a school semester, these roles have a special status designation.
In addition, your agency should understand whether an employee classification is exempt versus a non-exempt employee.
- Exempt means the employee is paid a salary regardless of hours worked (i.e., the VP of Marketing at a toy company would fall under this classification, as would a Product Designer in the educational division at the same company.)
- Non-exempt means the employee is paid hourly (i.e., a healthcare aide might be listed under this status.) On the other hand, hourly workers can be designated as exempt if they are salaried.
Why Classifying Employees Correctly is Important
Staffing agencies and recruitment firms are expected to know and understand the diverse types of employee classifications and how they function, including new classifications that may become part of the landscape in the future. Employee classification can change at any time and laws can be challenged in court. A recent example of an employee classification about-face was Proposition 22 in California. California voters voted this legislation into law in November 2020, but a California state judge recently overturned it. Proposition 22 was a ballot-box initiative promoted by gig-economy companies, including DoorDash, Uber, and Lyft, to classify delivery drivers as independent contractors. Many labor groups decried the initiative, stating it enabled companies to limit employee benefits under the IC classification. The judge declared that the Prop 22 law was unconstitutional and the measure was unenforceable. The companies who proposed the law in the first place have stated they will continue to advocate for new laws like Proposition 22.
Another critical reason staffing agencies need to understand employee classification is that misclassifications can have legal repercussions. Recently, federal agencies have begun to crack down on employers who misclassify employees as independent contractors (IC). The Federal agencies involved in employment misclassification claims include, the Department of Labor (DOL), National Labor Relations Board (NLRB), and the Internal Revenue Service (IRS) means there will be an increase in employment misclassification cases.
Staffing agencies also need to keep in mind that classification in the US under a corporate banner may not translate in other countries. In Canada, a recent class-action lawsuit was launched against Pizza Hut, one of the biggest pizza chains in the world, for misclassifying its delivery drivers as independent contractors.
The cost of misclassifying employees can include potential fines, payment of unpaid wages, overtime wages, insurance premium adjustments, and other penalties both at the state and national level including the possible removal of your business license. In addition to the financial ramifications is the damage to your reputation, the consequences of which can be far-reaching.
Setting Up Employment Classification Discovery
When it comes to due diligence pertaining to employee classification, hiring agencies should implement a detailed checklist as part of an overall protocol. When determining an employment relationship, there are three key categories:
- Relationship Consideration: How are the parties working together? What is the employer-employee agreement around employment hours, length of time, and compensation?
- Behavioral Considerations: These questions define how the employee will be working, including instructions to do the work, what equipment will be used for the work, and a timeline for when work will be done. In general, the more control a company has over the person doing the work, the more likely they should be classified as an employee rather than an independent contractor.
- Financial Considerations: How much of the employer’s contributions equate to the employee’s total compensation? Just because a person relies solely on one company for employment does not automatically mean that they should be classified as an employee.
Changing Employment Type
Staffing agencies and recruitment firms should also consider “trouble-shooting” possible scenarios or situations where employment classifications might change. For example, if a staffing agency places an IC in a tech firm that ends up becoming a direct-hire, it not only means a finder’s fee for the agency it also means reclassification. That process can be tricky if proper documentation is not adhered to. Here are a few examples of other scenarios:
- An FTE to an IC is complex because it must show that the classification change is due to changes in employment and is not strictly an “on paper” change.
- Temporary Staff or IC to FTE is less complex because the person would be hired directly as an employee with the applicable exempt or non-exempt status for the work they would be doing.
- Temporary Staff to IC might occur if the temporary contract ends and the company wants to hire the person as an independent contractor. In this case, the reclassification documentation would be fairly straightforward if the temporary contract had an expected end date.
When it comes to employment classification, knowledge is critical both for labor laws and tax purposes. Not sure how to classify employees? Need help reviewing employee classifications? Contact the experts at People2.0.