As far as I know, the admissions committee was not leery. No one ever told me. I am always a little careful about telling my story because I was admitted more than 13 years ago. It is possible the committee considered the enthusiastic support of my mentor at the lab (he told me he gave me a good recommendation) was considered as highly as a faculty member at a university. The committee had a transcript of a half dozen graduate physics courses after my Masters in 1983, and about a dozen engineering courses to consider to offset the lack of LOR's from faculty members.
I did complete my doctorate. I did not stay in academia but I did have one post-doc for about 1 -year. I am currently employed in similar government lab before I left for the doctorate in 2003. (No better no worse; no promotion) My 18 years of federal service and benefits before I left for grad school counted towards retirement, so I picked up where I left off (I felt this was even better than another post-doc).
As far as I know, grad student funding does not depend on whether you declare yourself a master's or doctoral student. Most likely you will get a tuition waiver and a teaching or research associate position. You will be paid for your service (teaching or research) to the university and department.
One note: After undergrad, my GPA was very low. When applying for grad school (now remember this is >35 years ago), I thought I would tell the committee that I was only interested in a Masters. I thought that I would get my foot in the door before suggesting I join the doctoral program instead. To my surprise, the members I talked to were more receptive that I try for the doctorate. I almost talked myself out of the position that I really wanted.
(It may also be the committee may want to see what I could do on the PhD qualifying exams, before investing a lot of time on me for a masters. In some schools, the masters is sort of a consolation for unsuccessful qualifiers. I passed the qualifiers, but later left the school for government service. These were the days of "Star Wars defense", in the early 1980's)
I did not know it but I almost talked myself out of my current position during the initial job interview by suggesting a mid level management role that I really did not want. They wanted me as a scientist. I thought I was coming over to their side of the fence, when I found out they were more in support of my goals when I was direct.
I probably should emphasize my experiences were a long time ago and my not be typical. Also I was lucky and I know it. (Younger men than I or their close family members had serious health problems that stopped them ) I was even lucky that I could pick up where I left off and my time in service and benefits counted. Two years ago, I was applying for several positions as adjunct professor at community college paying 10-20K each, without benefits and no office, if I could get them. Perhaps leaving the first lab under good terms was an important consideration when the second lab considered me (after I completed grad school). I always felt it is important not to burn bridges after crossing.