What is the #1 Compliance Gap for Small Employers….(and how to fix it)

On this week’s episode of The HR Connection, Sabrina breaks down the biggest HR gaps we see when onboarding with new small employer (1-500 employees) clients. She shares several areas broken into our main 3 categories of HR: compliance, infrastructure and strategy. 

If you want to watch or listen to her detail many of the gaps we see, you can do that here. 

If you just want to know the #1 compliance gap we see, keep reading.

For most of our clients, being legally compliant is top of mind. Being a small employer means budgets that can’t afford defending lawsuits or paying large wage and hour fines. While we advocate for closing all HR gaps, even we start with the compliance ones to mitigate legal risk. 

And the biggest problem we see: misclassifying employees.

That is, misclassifying non-exempt employees as salaried, exempt employees, or worse, classifying employees as contractors. 

It’s easier to make everyone salaried and not worry about overtime. It’s even easier to make employees contractors and not have to pay taxes or offer benefits and time off. But easy isn’t always legal and this mistake can be costly. 

HR Connection Podcast with Sabrina Baker - Episode 4: What is the #1 Compliance Gap for Small Employers….(and how to fix it)

There are federal and state laws that govern how an employee should be classified and whether or not someone can be considered a contractor. For the federal laws, check out the Wage and Hour website here. For your state laws, your state Chamber of Commerce will likely have that detail. Remember that where the federal and state laws differ, always err on the side of which is more generous to employees. 

Here is the Cliff Notes version:

• For an employee to be salaried exempt, they should meet both the minimum salary threshold and be performing job duties that qualify them for exemption. Paying them the minimum salary threshold is not enough.

• For someone to be a contractor, control of the work, financial burden and scope of work matter. If you are having them come onsite, use your equipment, manage them like an employee and they are doing the same work as employees, they are an employee.

In a state such as California, it is really difficult to have someone as a contractor. They basically have to have their own business and not be doing the work for you that you do to make money. That’s a simplified version, but here is an example.

Clients hire us to manage their HR. They don’t offer HR services. We are a business and do work other than their core service. We can be considered contractors for them. We receive a 1099 from many who mark us that way. 

Was he though?

We had a client who misclassified one employee as a contractor and, before reductions, their initial fine was nearly $70k. This is a devastating number for many small orgs. 

How do you ensure this gap is closed? Here are the steps we take or train on.

1. Understand the FLSA Requirements

Start with a solid understanding of the Fair Labor Standards Act (FLSA), which governs exempt vs. non-exempt classification. Key aspects include:

• Exempt employees are not eligible for overtime pay.

• Non-exempt employees must be paid overtime (1.5x regular rate) for hours over 40/week.State laws, like California, may require overtime per day not week.

2. Evaluate the Salary Threshold

Check whether the employee meets the minimum salary requirement:

• As of today, the Federal minimum salary threshold is $684 per week ($35,568 annually). Remember, your state may have a higher minimum so check state laws.

• If an employee earns less than this, they are generally non-exempt, regardless of duties.

3. Apply the Duties Test

If the salary threshold is met, analyze whether the employee’s job duties qualify under one of the exempt categories:

• Executive Exemption – Manages people, has hire/fire authority, primary duty is management.

• Administrative Exemption – Performs office/non-manual work related to business operations; uses discretion and judgment.

• Professional Exemption – Work requires advanced knowledge (usually a degree); includes learned or creative professionals.

• Computer Employee Exemption – Applies to specific tech roles (e.g., systems analysts, programmers).

• Outside Sales Exemption – Regularly works away from the employer’s place of business, making sales.

Job title does not determine exemption—actual duties matter. This is a high level overview of the exempt categories, for the full list, look here. 

4. Document the Classification Process

Keep written records of how you made the classification:

• Job descriptions aligned with duties tests

• Salary calculations

• Date and basis for exemption decision

This provides protection in case of an audit or claim.

5. Review State Laws

Some states (like California or New York) have stricter rules than the FLSA. Ensure you follow the most employee-protective standard.

6. Reassess Regularly

• Review classifications annually or when jobs change significantly.

• Promotions, reorganizations, or shifting responsibilities might require reclassification.

7. Train Managers and HR

Educate supervisors and HR on:

• What qualifies someone as exempt

• What overtime rules apply to non-exempt staff

• Proper timekeeping and break laws

8. Consult Legal or HR Experts

If you’re unsure, let us help you. Misclassification risks include:

• Overtime back pay

• Penalties and fines

• Class action lawsuits

If I were embarking on an audit, this is the first place I would start as it is often an area that needs revision. Small employers sometimes think they won’t get caught because they are too small to be on anyone’s radar, but the reality is it only takes one phone call from a disgruntled employee to get the ball rolling. The client who faced a misclassification issue was found out when the contractor applied for unemployment.. Something so simple can trigger an audit. It isn’t worth being out of compliance. 

For the full list of HR gaps listen to the podcast, but if you want to make sure you are compliant with the biggest one, definitely start here. 

HR doesn’t have to be reactive. We’ll help you get ahead.

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