Small Business Compliance: The Top 2 Most Common HR Mistakes

For small businesses, HR compliance can be time-consuming and costly, yet failing to do so is even more expensive. Many companies unintentionally violate labor and tax laws each year. The most common HR pitfalls? Misclassifying employees and mishandling overtime rules, both of which can trigger costly fines and audits. 

The Top HR Compliance Mistakes

• Employee Misclassification: Mislabeling employees as independent contractors or exempt staff can trigger audits, back taxes, and penalties.

• Overtime and Exempt Status Errors: Failing to track hours correctly or pay required overtime can result in costly violations of the Fair Labor Standards Act (FLSA). 

• Payroll Inaccuracies: Errors in payroll processing, deductions, or filings can lead to compliance violations and potential fines.

• Outdated Policies and Handbooks: Policies that don't reflect current labor laws or regulations leave businesses exposed to legal risk. 

• Poor Onboarding: Inconsistent or incomplete onboarding can create gaps in compliance training and lead to a lack of understanding of company rules among employees. 

• Ignoring Performance Management: Lack of proper documentation and performance oversight can increase disputes and heighten legal exposure. 

The True Cost of Compliance vs Non-Compliance

Regulatory compliance is a perennial headache for small business owners because it’s incredibly time-consuming and costly to enforce. Indeed, the only thing more expensive than compliance is … non-compliance.

Time-wise, the National Small Business Associations says that nearly half of small companies spend 40 hours or more annually on federal regulations; over a quarter spend more than 80 hours. Financially, non-compliance costs 2.71 times as much as compliance, according to the Ponemon Institute.

That’s because a wide variety of costs associated with compliance violations can aggregate quickly: initial incident response; business disruption; customer loss; penalties and fines; legal fees, settlements, and judgments; and more can lead to staggering expenses when a business violates or is believed to have violated tax law, labor law, and/or privacy and cybersecurity regulations.

But here’s the real rub: it’s surprisingly easy to fall afoul of regulations. Here are two of the most common compliance violations committed by small and midsize organizations, often unintentionally.

Mistake #1: Employee misclassification

The National Employment Law Project (NELP) says that as many as 30% of employers (or more) misclassify employees as independent contractors. These employers risk owing back taxes and penalties if the IRS audits them. In fact, sometimes the misclassification is an intentional violation to avoid paying employment taxes, but often it’s because the business doesn’t clearly understand the rules around classifying employees. The guidelines can be genuinely confusing.

The risk is often higher than employers realize, too, because they may not have to wait for the IRS or state authorities to audit. A report from Harvard Law School says that 71% of state authorities initiated investigations in response to complaints filed by affected workers.

Mistake #2: Overtime and Exempt Status Errors

Technically, this is another area of employee classification: are workers exempt from being owed overtime pay or non-exempt. Specifically, the Fair Labor Standards Act (FLSA) mandates that non-exempt employees be compensated at 1.5 times their regular hourly rate for any hours worked more than 40 hours per week.

As with employee versus contractor classification, exempt versus non-exempt classification can be complicated. At its simplest, it comes down to two questions: how much the employee is paid (if they make under a certain amount, they are automatically non-exempt), and what the employee’s duties are.

Complicating matters, overtime pay can be owed for after-hours work the employer may not have realized was happening, such as checking work-related email in the evenings. This payroll headache can compound if the employer lets non-exempt employees set their own hours.

Other HR Mistakes to Watch Out For

Payroll Inaccuracies 

Beyond compliance penalties, payroll errors can hurt employee trust and morale. Mistakes like missed bonuses, incorrect benefits deductions, or delayed payments can increase turnover and spark disputes. Automating payroll or using a reliable payroll system can reduce errors and help small businesses stay audit-ready.

Outdated Policies and Handbooks

Old policies don’t just risk non-compliance; they can create confusion for managers and employees. For example, if your handbook doesn’t reflect remote work rules or updated leave laws, it can lead to inconsistent enforcement and potential legal claims. Regularly reviewing and updating policies ensures clarity, fairness, and compliance with evolving labor laws.

Poor Onboarding

Onboarding isn’t just paperwork. It sets the tone for employee engagement and adherence to company policies. Skipping compliance training, benefits orientation, or clear role expectations can result in mistakes that cost the business later. A structured onboarding program ensures employees understand rules, processes, and expectations from day one, reducing risk and improving retention.

Ignoring Performance Management

Neglecting performance reviews and documentation can create gaps in accountability and increase legal risk. Without proper performance tracking, managers may struggle to enforce policies fairly, address misconduct, or make defensible termination decisions. Implementing a consistent performance management process helps protect the business and supports employee growth.

CoAdvantage helps small businesses stay compliant and avoid costly HR missteps. From payroll accuracy to up-to-date policies, our team provides the structure and support to scale confidently while staying aligned with regulations and growth goals. Contact us today to see how we can help your business stay on track.

**The information provided on this website is for general informational purposes only and does not constitute legal advice. While we strive to ensure the accuracy and completeness of the information, we make no guarantees about its correctness, completeness, or applicability to your specific circumstances.  Laws and regulations are subject to change, and you should consult a qualified legal professional before making any decisions based on the information provided here.