As global hiring accelerates, more companies are expanding their international teams. However, with this growth comes added complexities, with one key challenge being employee misclassification.
In fact, studies show that 10% to 30% of businesses misclassify at least one of their employees as an independent contractor.
Worker misclassification can be considered a serious breach of law, resulting in costly penalties that can range from hefty fines to possibly even jail time. That’s why understanding and complying with the international misclassification laws is crucial.
What Is Independent Contractor Misclassification?
Independent contractor misclassification, or employee misclassification, refers to the wrongful classification of a full-time employee as an independent contractor. This happens when a business defines a worker as an independent contractor, but local, state, and/or federal labor laws consider them to be an employee.
The distinction between “employees” and “independent contractors” is crucial because employees are entitled to benefits such as minimum wage protections, overtime pay, unemployment insurance, and workers’ compensation, while independent contractors are not.
The difference between an independent contractor and an employee is determined by several legal factors, including the level of control an employer has over the worker, the nature of the work performed, and the worker’s level of independence.
For example, if a company dictates a worker’s schedule, provides tools and equipment, and closely oversees the worker’s tasks, the worker is likely to be viewed as an employee rather than a contractor.
Misclassification is a common problem in various sectors of the economy, and it can happen unintentionally due to a lack of understanding of labor laws. However, in some cases, employers may deliberately misclassify workers.
Why Employers Might Intentionally Misclassify Workers
Although misclassification doesn’t always occur intentionally, employers engage in the practice to reduce labor costs and avoid tax liabilities.
Misclassifying a worker allows companies to bypass requirements like minimum wage laws, overtime pay, health benefits, and payroll taxes. This lets the company cut expenses while shifting costs — such as social security and taxes — onto the workers themselves.
Also, in certain industries, such as gig work, employee misclassification may be done intentionally for flexibility because, in addition to saving money, companies can avoid administrative burdens that come along with traditional employment.
Many governments are cracking down on this, arguing that gig workers, such as Deliveroo drivers in Spain, aren’t actually “self-employed.”
Why Governments Care About Employee Misclassification
Loss of Tax Revenue
The law requires employers to remit payroll taxes, such as Social Security and unemployment taxes, for every employee. When a worker is misclassified as a contractor, it means the employer avoids paying these taxes, and state and federal governments can — and do — lose billions in annual revenue.
Another consequence is that the tax burden then falls on the independent contractor, who may not even be aware of this financial responsibility.
That’s why there are strict laws in place to protect the interests of workers and the government.
It Takes Away Workers’ Rights
One of the more significant effects of worker misclassification is that the employee loses employee status rights, protections, and benefits.
Rights and protections improperly classified independent contractors may miss out on include:
- Minimum wage requirements
- Rest breaks
- Unemployment benefits
- Overtime restrictions
- Partially paid Social Security taxes and Medicare
- Pension plans
- Paid sick and leave time
- Social benefits
- Right to belong to a union
What Are the Risks of Employee Misclassification?
Misclassifying employees can result in severe consequences.
Financial Penalties and Regulatory Fines
Many governments levy financial penalties against organizations found guilty of misclassification.
Penalties may range from a slap on the wrist for genuine mistakes to costly fines for chronic rule-breakers, and the severity of them depends on several factors, including the business’s size and the length of employee misclassification.
Financial penalty costs vary by country. For instance, in the United States, the IRS fines for unintentionally misclassified workers start at:
- USD 50 for every unfiled W-2
- 1.5% of the misclassified employee wages paid + 40% of employees’ unpaid FICA taxes
- 100% of employer’s unpaid FICA taxes
Plus, interest accumulates on these amounts from the original due date. Employers may also face benefits insurance repayments and wage claim audits.
In the U.S., misclassification penalties can be quite severe if the Department of Labor determines the offense to be intentional. In this case, an employer can face criminal charges involving:
- Up to USD 1,000 per misclassified worker
- Class action lawsuits covering associated attorney fees
- Jail time of up to one year
Meanwhile, fines applied by the Labor Ministry of Mexico include the cost of employees’ benefits and severance, as well as fines of MXN 108.57 per day of misclassified employment.
In Australia the maximum penalty for each employee misclassification is:
- AUD 18,780 for individuals
- AUD 93,900 for businesses with fewer than 15 employees
- AUD 469,500 for businesses with more than 15 employees
Back Wages and Benefits
When workers are misclassified, their payroll taxes — which include payments for unemployment, Social Security, and other social programs — often go unpaid.
Because of this, companies with misclassified employees may be forced to pay back taxes, statutory benefits and other social contributions, increasing the total penalty.
Business Penalties and Bans
Generally, disciplinary action against misclassification isn’t limited to financial penalties. Even after paying fines owed to the government and unpaid benefits to the employee, an employer may still incur additional penalties.
These could include stop-work orders for the business within certain states or countries — or even bans from doing business there at all.
For example, in 2022 the U.S. Department of Labor issued stop-work orders to five out-of-state contractors who misclassified construction workers in New Jersey.
Legal Disputes with Workers
Misclassified employees can bring legal action against an organization under employment law. If a court rules in the employee’s favor, the business must compensate the individual for owed benefits, wages, and vacation days for the specific period they were misclassified.
Operational Disruptions
Between legal proceedings and regulatory agency investigations, it’s no surprise that misclassifying workers results in disrupted business, hurting both productivity and profits.
Reputation Damage
Misclassifying employees can also result in serious damage to a company’s employer brand, making it more difficult to hire talent in the future.
Examples of Companies Fined for Misclassification
To get a better understanding of the consequences of employee misclassification, let’s take a look at a few examples of companies recently fined for violating such labor laws.
In 2023, UK Research and Innovation, a non-departmental public body of the U.K. government, was fined GBP 36 million in backdated taxes when it was discovered that the body had misclassified contractors’ statuses.
A federal U.S. court ordered Holland Acquisition Inc. to pay more than USD 43 million in back wages and damages after a U.S. Department of Labor investigation found that hundreds of workers had been misclassified as independent contractors.
In the U.S. state of Delaware, the owner of G&R Drywall and Framing was sentenced to prison time for misclassifying 30 construction workers.
Even major corporations are at risk of misclassifying employees as independent contractors. Nike could face USD 530 million for potentially misclassifying workers in the U.S., U.K., Netherlands, and Belgium.
How Employers Can Avoid Employee Misclassification
Adopt these best practices to prevent the misclassification of employees — and the risks associated with it.
Regularly Assess Worker Classifications
Periodically review workers’ classifications to ensure compliance with labor laws and regulations.
This assessment should consider factors such as the level of control exercised by the employer, the nature of work performed, and the worker’s level of integration into business operations.
Establish Clear Classification Guidelines
Develop comprehensive policies and procedures for classifying workers and regularly update them in accordance with relevant labor laws and regulations.
Educate Managers and Supervisors
Anyone responsible for hiring and managing workers should receive frequent training on classification laws and compliance requirements. Such training should cover the factors used to determine worker status and the consequences of misclassification.
Maintain Accurate Documentation
It’s crucial to keep detailed records of worker classifications, including documentation supporting classification decisions. Accurate records can be vital in defending against misclassification claims or audits by government agencies.
Consult Legal Experts and Use Government Resources
Legal professionals can provide guidance tailored to specific regional regulations, such as differences between the United States’ 1099 misclassification rules and the United Kingdom’s IR35 regulations.
Additionally, employers should take advantage of government resources and self-assessment tools to aid in proper classification.
Partner with an Employer of Record
Working with an Employer of Record like RemoFirst provides businesses with peace of mind that their workers are properly classified by assuming legal responsibility for compliance with evolving labor laws across multiple countries.
How to Correct Employee Misclassification
What exactly should you do when you discover that an employee has been misclassified? Here are the steps to take.
Assess the Extent of Misclassification and Notify HR
Conduct a thorough review to determine which workers were misclassified, the duration of the misclassification, and the associated financial implications.
This assessment should encompass wages, benefits, taxes, and any other entitlements that the worker may be owed. Also, be sure to notify your HR and/or legal department.
Reclassify Workers, Update Documentation, and Notify Affected Employees
Reclassify the affected individuals as employees, ensuring that all employment records, contracts, and documentation accurately reflect their new status.
This involves enrolling employees in benefit programs, updating payroll systems, and communicating any changes to their employment status and newly available benefits.
Settle Any Financial Obligations
Address any outstanding financial obligations resulting from misclassification. This may involve paying back wages, benefits, and employment taxes owed to both the employees and government agencies.
Take Advantage of Voluntary Settlement Programs
Many countries have programs like the IRS’ Voluntary Classification Settlement Program that may permit companies to reclassify workers as employees for future tax periods with partial relief from federal employment taxes.
Ensure Proper Worker Classification for Your Global Team With RemoFirst
Hiring global employees shouldn’t mean putting your company at risk for employee misclassification.
RemoFirst protects your business from compliance penalties related to worker misclassification by enabling you to hire employees in 185+ countries in full compliance with local employment laws, including worker classification, payroll, taxes, and mandatory benefits.
By properly classifying your workers, you ensure their rights, benefits, and protections while safeguarding your business from hefty fines, penalties, and reputational damage.
Book a demo to learn how RemoFirst can help you build your global team.
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