Worker misclassification penalties: What are they and how can you avoid them
With companies like Nike and Microsoft shilling out millions to cover misclassification cases, you wouldn’t be blamed for wondering: what exactly are the penalties for worker misclassification? And could they impact your company?
In this guide, we look at the current most common misclassification penalties that are in place across the globe. We also offer advice for staying compliant and avoiding costs, with insights from our Head of Legal & Compliance, Shalini Sugumaran.
What is worker misclassification?
As an employer, it is your responsibility to ensure workers are classified according to the laws of the country you’re hiring in. Employee/worker misclassification refers to a situation where a worker is incorrectly classified as an independent contractor instead of an employee. This means your working relationship constitutes that of an employee/employer relationship in the eyes of the local government, but you’ve neglected to inform them.
In this case, you won’t be paying taxes or giving your employee the benefits they are legally entitled to; this is an issue governments take extremely seriously. In the words of Sugumaran, “It’s a tax issue, but it’s also about equity. If a resource is providing services more suited to an employee role but is marked as a contractor and is not entitled to employee benefits and protections under the law, this is something that governments and regulatory authorities take seriously.”
The main employee misclassification penalties
Employee misclassification penalties vary across regions, change frequently, and often differ depending on whether the misclassification was deemed intentional or unintentional. In this section, we explore the most common types of penalties across the globe, looking at real-life examples of each.
It’s important to note that the financial risks associated with employee misclassification are not the only ones. Negative publicity surrounding misclassification cases can damage trust with existing and prospective employees, clients, and stakeholders.
1. Taxes and fines for misclassifying independent contractors
Employers who misclassify employees as independent contractors are often required to pay back taxes that should have been withheld. In the US for example, this can include up to 100% of unpaid taxes.
However, the costs don’t stop there. Organizations also face fines as a result of failing to file the appropriate tax forms. And as time goes on, companies might also have to pay interest penalties on the amount owed. This means that the longer the debt remains unpaid, the more it will grow.
2. Retroactive pay requirements
Misclassifying workers as independent contractors often catches up with employees who then have to pay a percentage of the benefits, overtime pay, and other compensation owed. In 2021, for example, Holland Services paid over $43milion in back wages to employees who were misclassified as contractors.
3. Employee lawsuits
Misclassified workers may file lawsuits against their employers to seek compensation for lost pay. These lawsuits can lead to significant legal expenses and require extensive resources. Ride-hailing company, Lyft famously settled a class-action lawsuit out of court by paying $27 million.
How to protect your company from employee misclassification
It’s always best to consult an Agent of Record to ensure compliant worker classification across regions. The right solution will use local legal experts, real-time compliance updates, and automated auditing to ensure that every contractor you hire (or have hired) is classified correctly.
Here are the steps to follow if you’re going to classify workers yourself.
1. Ask questions
As Sugumaran identifies, hiring contractors is not always straightforward. “It is a misconception to think that just one factor may cause a risk,” she says, “You need to ask lots of questions like: will the contractor be managing a team? How embedded is the contractor in your internal systems and performance management processes?”
Here are some key questions to consider when looking at employee classification. These are based on the criteria that typically define what makes a contractor vs an employee across regions:
- Who determines when, how, and where the work is completed, and does the individual follow company direction? If you exert significant control, it’s likely that the relationship would be considered employee/employer.
- Does the individual receive benefits like health insurance and paid leave, or are they responsible for their own? A contractor typically doesn’t receive benefits.
- Is the individual paid per project, milestone, or hourly, or do they receive a regular salary (as an employee would)?
- Are taxes withheld by the employer, or does the individual handle their own taxes? A contractor is responsible for paying their own taxes.
- Does the company provide tools and equipment, or does the individual supply their own? In some regions, contractors are required to use their own tools.
2. Investigate local laws
Classification laws vary across regions and change regularly, so answering the above questions is not enough. Instead, you need to research classification tests, fill in the correct forms, and regularly conduct internal audits.
3. Create compliant contracts
Make sure you include these key points in your contracts to help you avoid legal disputes further down the road:
- Include the scope of work, payment terms, and termination date.
- Clearly state the contractor’s independent status and responsibility to pay tax.
- Clarify the contractor’s responsibilities.
4. Monitor your working relationship
Companies are advised to audit the relationship with their workforce every six months to ensure they are classified appropriately. This includes checking that none of the following points have changed:
- Increased control. If you start assigning detailed tasks, setting strict work hours, or directing how work should be performed, the contractor may need to be reclassified as an employee.
- Provision of tools or resources. Giving the contractor company tools, equipment, or resources beyond what’s outlined in their contract may reclassify them as an employee.
- Exclusive engagement. If the contractor begins working solely for your organization, this could mean they are classed as an employee in some regions.
- Prolonged engagement. Hiring a contractor for an indefinite period could result in misclassification issues.
How an AOR can help you support contractors and avoid misclassification
An Agent of Record helps you ensure correct classification every time, taking the responsibility and risk off your shoulders.
When you identify a contractor you’d like to work with, our experts will conduct an assessment to make sure they’re classified correctly in line with local laws.Then we’ll create compliant contracts and manage payments to ensure your contractors get paid on time, in their currency of choice, and in line with local requirements.
Unlike other Agent of Record solutions, Multiplier takes a proactive approach to ensuring compliance, We also offer the fastest set-up time on the market so your contractors can get started quickly.
Make compliance stress-free. Book a demo.