Updated: 20th of September 2024
To avoid employee misclassification, ensure that workers are properly classified based on their roles and responsibilities, following local labor laws and regulations. Regularly review and update contracts, consulting with legal experts if necessary, such as an Employer of Record (EOR) or Agent of Record (AOR), to distinguish between employees and independent contractors.
Working with independent contractors is nothing new. Most businesses today engage freelancers and contractors in some form or the other.
Yet, there are still a surprising number of employers who do not know what exactly are the practical differences between these workers and their employees. After all, they operate in much the same way that their remote or work-from-home staff does. What’s more significant is that employers don’t often understand that there are implications of confusing the two types of workers!
At TalentDesk, we have discussed the importance of correct employee classification before. Now, let us explore the various nuances of worker misclassification, understand their significance and see how employee misclassification can be avoided.
Let us begin by establishing the key differences between contractors and employees so that you don't end up with employee misclassification. Employees essentially are the people who work for you. As their employer, you have certain rights – you can decide their work hours, tell them where to work from and dictate how they work.
But these rights also come with responsibilities – as their employer, you will need to provide them with benefits like sick leaves, paid holidays and overtime pay. You will need to train and guide them, and ensure they have the equipment they need to do their job. You will also need to withhold taxes for your employees and offer them severance pay if you terminate their contract.
An independent contractor does not come with those rights – or the responsibilities. With them, you are free to engage them as and when business needs arise. You do not have to offer them benefits when they are working with you; nor do you have to pay a severance if you don’t renew their contract. But keep in mind that you also cannot dictate when, where and how they work, the way you do for employees.
As you may have realized, direction and autonomy are the two key factors that differentiate these workers. To define this better, the IRS has prescribed some common law rules that encompass:
Behavioral control. You can control how, when and where your employees work. With independent contractors, you only get to control the results they produce – not how they get there.So if these differences are clearly set out, why does employee misclassification happen?
1. Deliberate attempt to cut costs. Hiring independent contractors is often more economical, given that there’s no need to pay for benefits or overtime. Some companies take advantage of this by hiring employees but terming them as independent contractors to get out of these cost obligations.
2. Ignorance. Sometimes, employers genuinely do not know the practical differences between the two types of workers. They may engage an independent contractor – and then proceed to assert control over their work, not knowing that this crosses a line.
Employee misclassification, however, is punishable by law – done intentionally or not. Ignorance or lack of knowledge does not exempt you from the fallouts. The only difference is in degree – intentional misclassification is obviously worse, and may carry heavier fines and greater penalties.
Though there are rules in place, there’s still a lot of scope for ambiguity and confusion. The definitions are not always black and white, and can be open to interpretation.
For instance – there’s a lot of discussion around how delivery workers should be categorized. They usually are engaged as independent contractors. But given that many of them work on a full-time basis for e-commerce aggregators, and are essentially the on-ground driving forces behind the success of those businesses, should they be considered full-time employees?
There are similar considerations around drivers for ride-hailing cab companies. Though they are gig workers, they are core to the success of these companies. However, these businesses often define themselves as tech companies – thus arguing that the services the drivers provide are not key to their business, and hence they cannot be termed as employees. Unfortunately, this leaves the drivers open to exploitation and vulnerable to job insecurities.
These debates are not always restricted to online debates and labor law platforms. Sometimes, they blow up into courtroom dramas that lead to landmark rulings.
As the most recent example, the Nike case comes to mind. The global sportswear giant has 79,000 workers around the world, and many of these are independent contractors driving their t-shirt design, event planning, photography and marketing functions among others. However, Nike made the mistake that many employers make – they neglected to have company-wide processes to establish how their contractors should be classified.
And this mistake has the potential to cost them big! In a recent audit, 3670 entities in the US were reviewed, and more than a quarter of them were found to be potentially misclassified. That’s not all – more cases are being reviewed in Belgium, Netherlands and the UK. So far, the liabilities of these contractor misclassifications could cost Nike an eye-watering $530 million in penalties!
Another well-known misclassification case put Uber in the spotlight. The ride-hailing app has over 1 million drivers in the US, of which 150,000 are in California. Many of these drivers claimed that they were misclassified as independent contractors when they should rightfully have been seen as employees. They brought a class action lawsuit in California, which led to Uber having to pay $8.4 million in settlements.
With more and more of these high-profile cases making the headlines, we are seeing industry standards going through an irrevocable change. Employers are sitting up and taking notice of the very real and practical implications of worker misclassification.
Aside from raising general awareness, this is paving the way for legal changes too. For example, in the US, the National Labor Relations Board went back to a previous standard of determining worker status. This standard uses a list of common-law factors to establish worker status and had originally been passed as a result of a 2014 FedEx case. It had subsequently been overturned in 2019 – but that move was seen to have increased cases of worker exploitation, thus leading to the standard being reinstated now.
As we have seen, the legal framework is not static – it is constantly being updated in different countries. The recent years have seen many new legislations and rulings coming into play, all aiming to determine worker status.
One such law passed in the UK was IR35, which aims to prevent worker misclassification. As per its most recent update in 2020, the legislation shifted the responsibility of classifying workers on to private sector employers (as opposed to the responsibility being on the contractors themselves, previously).
In California, the Assembly Bill 5 (AB5) was signed in 2019, which put forward the ABC test to determine worker status. This test examines whether a worker is under the control and direction of the employer, whether the scope of their work falls within the employer’s core business, and whether they are engaged in an independently established trade.
Meanwhile in Spain, the Royal Decree Law 9/2021 was enacted, leading to the Law 12/2021 being passed. Under this, their Labour Act was amended to bring digital platform workers under the scope of employment.
While legislations like these are meant to make the labor economy fairer and more equitable, the impact is not always so straightforward. The challenge lies in prescribing rules that discourage worker exploitation – without limiting entrepreneurial opportunity. This is why each new law or standard undergoes heavy debate, with new nuances emerging every day.
Even as the laws evolve and change, it is up to employers to adhere to the current standards and prevent employee misclassification. Not using an employee misclassification tool and getting this wrong can open the employer up to immense risks like:
The best course of action thus, is to take every possible step to ensure that you don’t breach the misclassification laws so that you don't end up with penalties for misclassifying employees. Having a formal strategy or an employee misclassification tool in place is crucial.
When working with just a few contractors, you may be able to guarantee that you are personally involved in each interaction. But you’ll find that quickly becomes impossible as your team gets bigger. So it’s not just enough that you understand the various aspects of worker classification – anyone in your company involved in hiring or working with freelancers and contractors must be equally knowledgeable too.
As per the latest update, the U.S. Department of Labor (DOL) introduced a new rule to determine worker status. Effective from 11 March, 2024, this involves a 6-factor test to establish the economic reality of whether a worker is an independent contractor – or is actually an employee.
To clarify, there is an independent contractor rule in place already, which also prescribes a multi-factor test. But this test puts greater weight on the degree of control the employer has over the worker, and on the financial opportunities and obligations of the worker.
Now, this will be rescinded with the new rule coming into play. What’s more, the new rule will give equal weight on all the 6 factors, namely:
So what happens if you analyze your current worker contracts and find that some of them are indeed misclassified as independent contractors? There are some immediate steps for how to correct employee misclassification.
At TalentDesk, our Agent Of Record (AOR) service is designed to help you stay compliant with your worker contracts, now and in the future. We ensure this right from the start – by verifying your workers for you and classifying them correctly even before you bring them on board.
As an employee misclassification tool, we handle all the necessary contracts and onboarding formalities – so you can rest assured that every document or form that should be collected, will be. What’s more, we offer you a shield service where we sign the contracts on your behalf, reducing your liabilities.
The contracts are then stored safely and compliantly, all in one place, in the cloud. This makes it incredibly easy to pull them up when you need to file your 1099 forms or conduct audits. We do offer this AOR support globally, so we can guarantee compliance no matter what country you engage your contractors in.
What’s more, TalentDesk has now partnered with Atlas to offer a comprehensive service that provides our AOR expertise with Atlas’ global Employer of Record (EOR) service under one roof. This partnership enables users to access TalentDesk’s full suite of onboarding, contractor management, payment, and project management functionalities, together with Atlas’ global EOR capabilities.
Whether you’re engaging freelancers or employees, our combined service ensures compliant classification and onboarding of talent across the globe. With our expert guidance, you can identify risks, flag potential issues, and take the right steps to reduce compliance concerns.