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A guide to avoiding employee misclassification

Scale your contingent workforce without hassle by ensuring correct employee classification every time

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In this article

What is employee misclassification?

Worker or employee classification is the process of identifying the legal category of a worker you’ve hired; employee misclassification refers to a situation where a worker is incorrectly classified as an independent contractor instead of an employee. This means that your working relationship constitutes that of an employee/employer relationship in the eyes of the local government, but you’ve neglected to inform them.  

Misclassification results in the worker being denied important employment rights and benefits, such as minimum wage, overtime pay, health insurance, unemployment benefits, and workers’ compensation. At the same time, companies don’t pay the taxes they owe. 

What are the causes of employee misclassification? 

In some cases, employers intentionally misclassify contractors in a move to save on taxes and dodge the costs that come with following employee labor laws. 

More commonly, however, companies unintentionally misclassify employees as a result of not understanding the local laws in the country where they are hiring. As Head of Legal and Compliance at Multiplier, Shalini Sugumaran identifies, there are a lot of questions that companies need to consider and these can change dramatically across regions and over time.

“It is a misconception to think that just one factor may cause a risk,” Sugumaran says. “Companies need to ask questions like: Will the contractor be managing a team? How embedded is the contractor in your internal systems and performance management processes?” 

As well as staying on top of changes to legislation, companies need to monitor their working relationships as neglecting to do so can often cause misclassification. For example, if a company starts to assert more control over when and where a worker completes their tasks, this could reclassify them as an employee in certain regions. 

The risks of employee misclassification

If governments detect misclassification, they often conduct wage audits to determine the extent of unpaid wages, benefits, and taxes owed. These audits can lead to significant costs. As Sugumaran says “Courts can award high sums pertaining to loss of employee benefits and even fines and employee misclassification penalties.” 

In some cases, companies also face employee misclassification lawsuits initiated by workers or groups of workers who feel they have been wrongly classified and seek compensation. This process requires companies to dedicate extensive legal resources and can take up huge amounts of time. 

It’s worth noting that another potential risk of misclassification is the impact on a company’s reputation. Negative publicity surrounding misclassification cases can damage trust with employees, clients, and stakeholders; you’ll undoubtedly have heard of some of the famous examples of misclassification – including, recently, Nike who was fined $530m for misclassifying thousands of workers. 

Why employee misclassification matters to governments

Governments have a huge incentive to chase down misclassification cases and retrieve lost funds. Over the past few years, more people have chosen to become freelancers and contract workers. In fact, in the USA alone there are over 6.9 million contractors. If even a small percentage of these workers are incorrectly classified, the government is missing out on thousands—or even millions—in tax revenue. 

What’s more, governments have a responsibility to ensure that everyone in the workforce is treated equitably and fairly. As Sugumaran points out, “If a worker 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.”

Avoid fines and lawsuits with our misclassification quiz
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How to avoid employee misclassification

If you’re not sure whether some of your workforce have been misclassified, it’s best to consult legal support. An Agent of Record (AOR) uses local experts to help you identify workers who may have been incorrectly classified according to the laws in the country where you hired them. 

They also help you stay on top of changes in legislation and avoid changes in your working relationship impacting classification status. Multiplier, for example, automatically stays on top of compliance with real-time updates and automated auditing. 

If you are, however, going to handle employee classification on your own, here are some tips to help you avoid errors:

  • Maintain records. Keep track of work hours, deliverables, duration of work, and hourly wage rate. 
  • Create compliant contracts. These should outline the scope of work, payment terms, the contractor’s autonomy, and termination periods. 
  • Conduct regular audits. Conduct an audit of independent contractors every six months, and regularly undertake local employee classification tests.
  • Monitor your working relationship. Make sure that you have taken into account whether any changes in how you work with the contractor will impact their classification. For example, if you start setting strict work hours, assigning detailed tasks, providing tools and resources, the contractor may be deemed an employee. Equally if the worker begins working solely for your organization or works with you for a long period, this could reclassify them as an employee in some regions.

How Multiplier can help you support contractors & stay compliant

Whether you’re hiring a growing number of contractors or a single worker overseas, compliant classification can be incredibly time-consuming. Multiplier helps you avoid the work (and stress!), by taking the risk off your shoulders. 

With the fastest set-up time in the industry, we can help you onboard contractors efficiently, generating locally compliant contracts, and ensuring that you continue to classify them correctly. We also pay contractors in their preferred currencies and methods, helping you avoid transfer fees, exchange rate issues, and payment delays.

Hire with confidence across the globe. Book a demo to find out more. 

Frequently asked questions

Q. Is employee misclassification illegal?

Although labor laws differ for several countries, deliberate misclassification of employees violates tax and employment laws across regions.

Q. How can you correct employee misclassification?

If you think that you have unintentionally misclassified a worker, you should reclassify them in accordance with relevant labor laws and address any outstanding obligations, such as paying retroactive wages, overtime, back taxes, and benefits owed to the reclassified employees.

Q. How much is the penalty for employee misclassification?

Employee misclassification penalties vary across regions and change all the time. However, in the US, to take an example, they can be as high as $1000 per worker, 100% of employees’ unpaid taxes, and 20% of missed employee wages.

Q. What is the difference between a contractor and an employee? 

The definition of what classifies employees and contractors varies across regions. However, here are the criteria that typically define the distinction:

  • Autonomy and control. Contractors have control over when, how, and where they complete work whereas employees work under company direction. 
  • Benefits. Employees receive benefits such as health insurance and paid leave, while contractors are responsible for their own.
  • Payment terms. Contractors are typically paid per project/milestone or on a time basis (billing rate per hour/day), while employees receive a regular salary.
  • Taxes. Employers withhold taxes when making payments to employees, but don’t when paying contractors. 
  • Tools and equipment. A company provides tools and equipment to an employee, but not to a contractor. 
  • Work hours/schedule. Employers often outline set working hours for employees (such as a 9 to 5 schedule) but contractors typically work to their own schedule. 
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