Employee Misclassification

No matter what country you operate in, there will be specific employment laws about how many hours employees can work, the benefits they must receive, minimum wage requirements, and other obligations. If you do not follow these employment laws with your employees, it can lead to costly penalties, fines, backpay, and other consequences. 

However, you are also allowed to hire workers as independent contractors. As an organization, it is essential to understand the difference between an independent contractor and an employee so that you can avoid an accidental employee misclassification. 

Learn more about how employee misclassifications work by reading on.

As a business, you likely hire vendors and independent contractors to handle some of your company’s day-to-day tasks. For example, many companies hire landscapers to maintain their grounds, tax accountants to handle their annual tax returns, and payroll providers to deal with monthly payroll requirements. 

In many of these cases, the worker you hire is considered an independent contractor. Independent contractors aren’t considered employees because they have control over their hours, work situation, and profitability. Because of this, you don’t have to provide them with employee benefits, like unemployment insurance or health insurance.

The problem occurs when worker misclassifications happen. In these instances, an employee is paid like an independent contractor and doesn’t receive the benefits they should have. If the company is audited or if anyone reports this misclassification, it can lead to costly repercussions. 

While some businesses deliberately misclassify workers to save money, this issue often happens unintentionally. For example, a worker may become injured at the job site and be unable to work for an extended period of time. When this happens, they or a loved one may do some reading and discover that the worker is owed workers’ compensation because their employment status was misclassified.

Unfortunately, this type of circumstance is very common. To protect your company, it’s essential to understand the difference between an employee and an independent contractor.

The difference between an independent contractor and an employee varies from one place to another. In general, countries decide on this distinction based on how much control the worker has over how they perform work and if they can profit from their work. Some places, like the Netherlands, require independent contractors to register with local authorities before they can be classified as independent contractors. 

If you have misclassified a worker, it can lead to steep penalties and even criminal charges. To gain a better understanding of the difference between an employee and an independent contractor, we’ll look at how this distinction plays out in Germany, Canada, and the United States.

To see an example of how the difference between an independent contractor and an employee plays out, let’s look at the Fair Labor Standards Act (FLSA) in the United States. Each country has different rules about employee classifications, so this is one example of how the classification might play out. 

• Control Level: For the worker to be considered an independent contractor, they must have some degree of control over when and how they work. If the employer retains more control over hiring, firing, pay rates, and disciplining the worker, then the worker is likely an employee. For example, if you require workers to work from 9 to 5 at your office headquarters, then they’re likely considered employees. 
• Opportunities for Profit and Loss: Under the FLSA, another key factor is whether the employee has the opportunity to earn profits or losses through their own managerial skill.
• Capital and Entrepreneurial Investments: If someone makes capital or entrepreneurial investments, they are more likely to be classified as an independent contractor.
• Permanence in the Work Relationship: Project-based or short-term work is more likely to indicate that someone is an independent contractor. If it’s a long-lasting relationship without a fixed end date, the individual is likely an employee.
• How Essential the Work Is to the Employer’s Business: When the work is an integral part of the company’s business, such as picking tomatoes at a tomato farm, the worker is an employee. If they are doing non-essential work to the employer’s business, such as running payroll or handling your tax filing, the individual is more likely to be classified as an independent contractor.
• Skills and Business Initiative: Another FLSA consideration is whether the worker uses specialized skills and business initiative during their work. However, regular employees can be highly skilled as well, so business initiative must also be present for it to tilt the scales in favor of classifying someone as an independent contractor.

In Germany, employee classifications are held to similar rules as they are in other countries. It’s referred to as “Scheinselbstständigkeit” which can be freely translated into “false-freelancing”. The courts consider whether the worker reasonably controls how, when, and where they perform work. If the employee is misclassified, the employer may be charged with fraud, and the contractor must be reinstated to an employee relationship. They may also have to pay unpaid social security contributions, taxes, and retroactive employee benefits.

Meanwhile, Canadian worker classifications are governed by the Canada Labour Code. To decide if the worker is an independent contractor or not, Canada considers a few factors. If all of the following situations are true, then the worker should be considered an employee.

• Training is provided by the company.
• The contractor uses the company’s tools and equipment. 
• The work performed is integral to the company’s business.
• The business supervises all of the individual’s work.
• Profits and losses are earned by the company.

If the individual is an employee, they are entitled to notice periods and other benefits. There is also a special category of workers who are known as dependent contractors. Because of their added dependence, these contractors are entitled to reasonable notice if their employment is discontinued.

If you end up misclassifying a worker, you may face a range of consequences. Besides legal and financial issues, your company may also take a hit to its brand image.

Back Taxes

When a worker is misclassified as an independent contractor, your company may experience significant tax bills and penalties. Employers normally have to pay employment taxes, such as Social Security and Medicare. Once the misclassification comes to light, you’ll have to repay all of your missing tax payments.

Retroactive Benefits

Additionally, you may have to pay retroactively for any benefits that the employee was denied. Often, employers have to pay penalties for missed benefits and interest.

Legal Penalties and Fines

There are many legal penalties and fines that can happen because of an employee misclassification. For example, the Department of Labor in the United States is allowed to pursue retroactive overtime pay and back pay for minimum wage violations. In Spain, fines can reach 100% to 600% of the unpaid taxes, but they are normally set between 50% and 150% unless there are aggravating factors involved. Additionally, employers can face one to five years in jail.

Struggling Workers

Being a good employer helps to boost worker satisfaction, employee retention, and productivity. When workers aren’t provided the employee benefits they are due, they can suffer from the lack of legal protections and support. For example, they may not have the paid leave and health insurance they need to get care when they’re sick. In turn, this can cause your company’s productivity to suffer as well.

Harm to Your Brand

If your company frequently misclassifies workers, it can end up damaging your reputation. Many customers don’t want to work with a business that is known for treating its workers poorly.

While each country is different, there are a few common steps you can take to avoid employee misclassifications.

Conduct Regular FLSA Audits Internally

One of the most effective ways to avoid worker misclassifications is by regularly auditing your company’s employee classifications. In the United States, this is done through an internal FLSA audit. This type of audit helps you ensure you’re correctly classifying workers so that you can rectify any problems before a whistleblower or a government auditor brings the issues to light.

Review Your Job Descriptions for Compliance

Next, you should take time to review your job descriptions for compliance. Your worker classification decisions and FLSA audit should always start by carefully reading through the job description to see if it describes an employee or an independent contractor.

Work With an Employment Law Professional in Each Country

You don’t have to learn the ins and outs of employment law on your own. There are Professional Employment Organizations (PEOs), HR providers, and employment attorneys who can discuss what it takes to classify workers properly in your market area. 

Err on the Side of Caution

You are not going to be punished for giving a worker more benefits than they are legally owed. If you are uncertain about someone’s worker classification, you should err on the side of caution and classify them as an employee. 

Train Your Managers

Finally, make sure to train your managers on worker classifications. If a manager is overseeing many independent contractors, they should be aware that controlling the workers’ hours and work situation could result in a misclassification. Your managers are on the front line of your operations, so they need to understand how to correctly classify workers.

Whether you are running a multinational business or a mom-and-pop shop, it’s essential to understand how worker classifications work (in every jurisdiction). A misclassified worker can lead to significant fees and penalties. As such, we recommend finding a suitable Employer of Record service, to take care of proper classification on your behalf. An EOR can help any firm to compliantly turn independent contractors into full-time employees and put them on a local payroll.