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Compliance

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Employee Misclassification Penalties: A Costly Mistake

Employee misclassification penalties are a common threat faced by enterprises around the world.

As you are aware, the workforce can be divided into:

  • Full-time employees
  • Independent contractors hired for a specific project or period.

As the name suggests, the former group is an integral part of your organization and is legally eligible for all benefits and compensation prescribed by their country’s labor laws. As independent contractors are hired on a contract basis, they are not entitled to receive employee benefits unless discussed and agreed by the employer through an employment agreement.

In some cases, you might misclassify a regular employee as an independent contractor, eliminating the chances of that employee receiving lawful employee benefits. This is considered an act of noncompliance with labor laws and can result in employee misclassification penalties.

As an employer, it is your responsibility to ensure the employees are classified correctly and thus stay compliant with their country’s labor laws.

Why does employee misclassification occur?

Misclassifying employees may happen for any reason.

Some common instances include:

  • A contractor-turned-employee still recorded as a freelancer due to a lack of clarity
  • A genuine error from the HR team due to ignorance of labor laws
  • An Intentional misclassification by the employer to reduce tax and benefits charges

Lack of labor law awareness is one of the leading causes of misclassification of employees. As an employer, you need to ensure that the team handling labor laws is efficient and stays updated on all the changes and details of the regulations.

5 Employee Misclassification Penalties

Whether it is a strategy of the employer to lower the expenses by cutting tax and benefits for employees or a mishap due to lack of clarity and due diligence, wrongly classifying employees can result in employee misclassification penalties. It may range from fines, as in the case of the IRS putting a fine of $50 for each unfiled W-2, or even a stop order on the work (In 2020, New Jersey passed a law permitting the state to enforce stop order on work for violation of labor laws).

Let’s briefly discuss the top five employee misclassification penalties.

Penalties related to wages and employment eligibility

The federal government, state government, and other authorities use different parameters to determine misclassification and thus lack uniformity. There are instances where the line between laws regarding permanent employment and independent contractors stays blurred.

Without professional help, companies might fall into the trap of violation of wages, overtime, and taxes. Under the Federal Fair Labor Standards Act (FLSA), businesses can be made liable for not paying overtime and minimum wages. In worst cases, wage claims may go back to three years in case of willful violation.

It indeed needs a pair of expert hands to dissect the laws and understand the minute details specified.

Fines related to payroll and taxes

Misclassifying employees can lead to payroll tax liability issues. Employers are responsible for withholding and remitting certain taxes on behalf of employees, such as Social Security and Medicare taxes. When workers are misclassified, the employer may face penalties for failing to withhold and remit these taxes properly.

Legal battles and punitive damages

Cases related to wages and employment violations can consume the company’s productive growth and bring the focus right to courtroom dramas. This can cause a negative impact on the business and may result in getting hefty penalties and compensations for the affected.

Backdated payments to the impacted employees

As discussed above, the affected employees might have to be paid from a previous date, say, from the date they joined and throughout their term of employment. Along with that, the fine, taxes, and benefits cost will add up to a considerable sum. This can be an unnecessary financial burden to the company.

Ruined reputation

Goodwill and reputation are crucial to businesses. Legal conflicts and tax violations create a negative impact and are costlier than the enormous fines. No business can afford such a tarnished reputation and still rule the market.

What kinds of penalties occurred to some common brands we are familiar with? Let’s take a look.

5 cases of employee misclassification penalties in the past

Employee misclassification occurs when an employer improperly categorizes workers as independent contractors rather than employees. This misclassification can have significant legal and financial consequences for employers. The penalties for employee misclassification vary depending on the jurisdiction and the case’s specific circumstances.

Here are five notable examples of employee misclassification penalties:

  1. Uber – In 2020, Uber settled a class-action lawsuit for $20 million in California. The lawsuit alleged that Uber misclassified its drivers as independent contractors instead of employees. The settlement required Uber to compensate the drivers and change its practices to provide more significant benefits and protections to its drivers.
  2. FedEx – In 2015, FedEx agreed to pay $228 million to settle a lawsuit brought by FedEx Ground drivers who claimed they were misclassified as independent contractors. The drivers argued that they should have been classified as employees and were therefore entitled to benefits and protections under the law. The settlement included payments to the drivers and changes to FedEx’s policies and practices.
  3. Microsoft – In 2021, Microsoft agreed to pay $22 million to settle a lawsuit alleging that it misclassified certain workers as independent contractors to avoid providing them with benefits and protections. The lawsuit claimed that these workers should have been classified as employees and were entitled to overtime pay and healthcare benefits.
  4. Amazon – In 2020, Amazon settled a lawsuit for $61.7 million in California, alleging that the company misclassified its delivery drivers as independent contractors. The drivers claimed they should have been classified as employees and were thus entitled to benefits and reimbursements. The settlement included compensation for the drivers and changes to Amazon’s practices.
  5. Jani-King – In 2016, Jani-King, a commercial cleaning franchisor, settled a lawsuit for $3 million. The lawsuit accused Jani-King of misclassifying its franchisees as independent contractors rather than employees. The settlement included payments to the franchisees and altered Jani-King’s practices to provide greater protections and benefits.

These examples highlight the substantial financial liabilities that companies may face when found guilty of employee misclassification. Employers should be aware of the legal requirements surrounding worker classification and take proactive measures to ensure compliance with applicable labor laws and regulations to avoid penalties and potential reputational damage.

How to protect your company from employee misclassification?

Companies are advised to audit the relationship with their workforce every six months to ensure they are classified appropriately. Using professional expertise for compliance is the best way to avoid misclassification altogether.

Multiplier, a SaaS-based EOR provider, handles payroll and associated employee classification as per each country’s compliance laws. Avoid misclassifying your employees with Multiplier handling your employees through smooth onboarding.

Get in touch with our qualified compliant specialists to classify your workforce efficiently and avoid any chances of penalties. Book a demo, get insights, and ensure your employees are rightly classified with Multiplier.

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