What is worker classification?
Worker or employee classification is the process of identifying the legal category of a worker you have hired. This determines their rights, benefits, and obligations, ensuring compliance with local labor regulations and tax requirements.
Most often, this question comes down to whether the worker should be classified as a contractor or employee. This will differ based on the local legislation of the country where you are hiring.
To take one of the most common employee classification examples, let’s say a company based in the UK is hiring a contractor from Spain. According to the employment laws of the UK, that individual might be correctly classified. To name a few key criteria, they work their own hours, use their own equipment, and don’t get benefits… The issue comes when the company takes a closer look at the employment laws in Spain where, if a contractor generates 70% of their work from a single employee, they are considered a dependent contractor and granted employee-like privileges.
Now they are misclassified and the UK company could face fines, misclassification penalties, and even wage audits where, after investigation, they are forced to retroactively provide the contractor with benefits, back pay, and other entitlements.
Governmental involvement can be extensive. As Shalini Sugumaran, Head of Legal & Compliance at Multiplier says, “Governments are also committed to ensuring that its workforce is treated equitably. If a worker is providing services more suited to an employee role but is marked as a contractor and not entitled to employee benefits and protections under the law, this is something that governments and regulatory authorities take seriously.”
Four steps to classify workers correctly
Though it’s always best to consult an Agent of Record solution to ensure compliant worker classification across regions, here are the steps to follow if you’re going to classify workers yourself.
Understand your hiring needs
While hiring an individual based on your company’s requirements, you must identify their employment type, terms of the contract, and most importantly the nature of your engagement.
As Sugumaran identifies, hiring contractors is not always a straightforward process. “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 the criteria that typically define what makes a contractor vs an employee:
- 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.
Common employee classification categories
Below are the most common employee categories and how they are typically categorized across regions.
Full-time employees
Employees are hired to perform specific duties under an organization’s control and direction. They work regularly, follow company-set schedules, and are entitled to benefits such as wages, health insurance, paid leave, and retirement contributions. Employers are responsible for withholding taxes and complying with labor laws to protect employee rights.
Independent contractors
Independent contractors are self-employed individuals who provide their services to an organization. They often work for multiple clients and are responsible for managing their own taxes.
Part-time employees
Part-time employees typically work fewer than 30 hours per week and are often paid on an hourly basis. Their hours may vary depending on the employer’s needs, and they may have a flexible schedule that allows for greater work-life balance. However, part-time employees may not receive the same benefits as full-time employees. The eligibility for benefits like health insurance, paid leave, or retirement contributions depends on company policies and local labor laws.
Temporary employees
Temporary employees are hired for a specific duration, usually to cover short-term needs such as maternity leave, illness, peak business seasons, or special projects. They can be hired directly by the company or through a staffing agency. Temporary workers generally do not receive the same benefits as full-time employees, but they may be entitled to basic protections under labor laws, such as minimum wage and workplace safety standards.
Seasonal retail workers, administrative assistants, housekeepers, and performers are also classed as temporary employees.
2. Research local laws
Classification laws vary across regions and change regularly, so you need to research classification tests, fill in the correct forms, and regularly conduct internal audits to stay compliant. It’s also highly advisable to consult with local legal experts to avoid employee misclassification.
3. Create compliant contracts
Creating compliant contracts and confidentiality clauses for independent contractors is crucial to protect both parties and maintain legal compliance. Some key elements include:
- Defining the relationship. Outline the scope of work, payment terms, and the contractor’s autonomy.
- Ensuring compliance. Clearly state the contractor’s independent status and align with local labor and tax laws.
- Addressing confidentiality and IP. Include clauses to safeguard sensitive information, attach an NDA, and transfer IP rights to the company.
- Setting termination terms. Define notice periods and outline what will constitute the end of the agreement. This could be a particular date or completion of a task.
- Outlining liability and disputes. Clarify the contractor’s responsibilities and specify dispute resolution methods.
- Using clear language. It’s best to consult legal professionals to avoid misclassification risks.
4. Monitor your working relationship
As your working relationship evolves, it’s important to check that your contractor is still classified as a contractor according to local laws. Changes in how the relationship operates, such as adjustments in responsibilities, benefits, or control, can affect their classification status so watch out for:
- Increased control. If you start setting strict work hours, assigning detailed tasks, or directing how work should be performed, the contractor may be deemed an employee.
- Exclusive engagement. If the contractor begins working solely for your organization, this could reclassify them as an employee in some regions.
- Provision of tools or resources. Supplying the contractor with company tools, equipment, or resources beyond what’s agreed in their contract may reclassify them as an employee.
- Prolonged engagement. Hiring a contractor for an indefinite period could result in misclassification.
How can an Agent of Record help with employee classification?
Staying on top of classification across regions can be incredibly time-consuming. And, when you’re spending hours researching local laws, you’re opening yourself up to risk. An Agent of Record like Multiplier takes this risk off your hands, by handling classification on your behalf.
When you identify a contractor you’d like to work with, our legal experts will conduct a worker classification assessment to ensure they’re classified correctly in line with local laws.Then we 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, we take a proactive approach to ensuring compliance. As Sugumaran says, “The legal expertise we have helps us mitigate these risks to a minimal level.” This means real-time compliance updates, automated auditing, and iron-clad indemnity against misclassification risks.
We also offer the fastest set-up time on the market so you can secure top contractors before the competition and your contractors can get started quickly.
Hire with confidence across the globe with our stress-free compliance solution. Book a demo to find out more.
Frequently asked questions
Are volunteers full-time employees?
No, they work part-time with the organization without committing to working hours.
How does employee classification affect taxes?
Employee classification affects taxes by determining whether a worker is treated as an employee or an independent contractor. Employees have taxes withheld by their employer, while independent contractors are responsible for self-employment taxes and quarterly estimated payments.
How can misclassification of employees lead to penalties?
Classifying employees as independent contractors when they should be classified as employees can lead to penalties, including back taxes, interest, and fines, as well as potential legal action. Employees themselves can raise complaints or file lawsuits and governmental bodies may initiate investigations or enforcement actions.
What is 1099 classification?
In the United States, “1099 classification” refers to the designation of workers as independent contractors rather than employees.
