Ensuring that employees are correctly classified is essential for all businesses, but it can be trickier to manage when you have international or distributed teams. Many employers opt to hire independent contractors when expanding into new global markets; however, this comes with several risks. One of the most significant risks is the increased chance of employee misclassification mistakes being made.
Misclassifying employees as independent contractors can result in legal, financial, and reputational risks for employers. But what can employers do to correct employee misclassification mistakes both before and after they happen? In this guide, we'll provide a brief overview of the basics of employee classification, how to avoid misclassification, and how to correct it if it does happen.
Employee classification basics
There are two main categories of worker classification: employees and independent contractors. Crucially, each country has its own laws that define what an independent contractor is and what legal protections employees are entitled to. Broadly speaking though, independent contractors are not on an employer’s payroll, but rather submit invoices for their work, provide their own work equipment, set their own hours, and don’t receive employee benefits.
Misclassification happens when an employer classifies a worker as an independent contractor when they should be classified as an employee or vice versa. For example, suppose an employer hires a worker as an independent contractor but mandates specific working hours at the company’s office. In that case, the worker should likely be classified as an employee instead.
Consequences of employee misclassification
Employers who misclassify employees can face lawsuits, fines, tax penalties, and cause lasting damage to their business’s reputation. Workers, insurers, clients, and business partners may pursue legal action against a company for misclassification. The specific fines and tax penalties a company faces for employee misclassification vary by country and jurisdiction but usually require the employer to pay the affected employee(s) and governing tax authorities. Regardless of what country you're employing in, these penalties can be steep, so it’s best to take preemptive actions to avoid misclassification mistakes before they happen.
How to avoid employee misclassification
So, what steps can you take to ensure your business avoids misclassifying employees? Here are four best practices to follow to avoid misclassification mistakes.
Familiarize yourself with the relevant laws
Employment laws and regulations change frequently, so staying up-to-date on any changes that may impact your workforce is essential. In particular, pay close attention to any changes that are relevant to employee classification and tax regulations. If you’re a smaller business, this may be a lot to keep up with in addition to the rest of your responsibilities. In this case, consulting with local employment law experts is best to ensure your employment contracts are compliant.
But what if you employ talent in multiple countries? As we’ve already mentioned, employment laws vary by location, so maintaining compliance in multiple countries can be daunting for employers. In this case, partnering with a global Employer of Record (EOR) might be the best option to avoid misclassification mistakes.
Partner with an Employer of Record (EOR)
When you partner with a global EOR, the EOR becomes the legal employer of your employees and assumes all responsibilities for maintaining compliance with local employment laws. Doing so makes it significantly easier for your business to employ international talent and expand into new global markets without worrying about misclassifying employees. For instance, if your company is based in Canada and you want to hire local talent in Germany, an EOR could employ talent in Germany on your behalf and ensure all compliance is maintained. At the same time, you still retain control of relationships with the new hires and their work.
Working with a global EOR like Omnipresent allows you to easily convert your international contractors to employees. Not only does this help avoid misclassification mistakes, it also avoids the other risks associated with hiring independent contractors and helps you retain talent so they can become valuable team members.
Train your HR team and hiring managers on misclassification
Although employee misclassification is sometimes done maliciously and purposefully by companies to avoid paying their fair share of taxes, it’s also often the result of simple mistakes. Everyone is prone to making mistakes, and while most of them are relatively harmless, employee misclassification is a costly one. That’s why proper training on employee classifications is essential for all members of your HR and hiring teams.
This should consist of periodic training sessions led by legal experts on relevant legal guidelines, common misclassification issues, and best practices for avoiding misclassification. Such training sessions are especially vital any time after there are relevant changes to employment laws.
Conduct regular audits
If your company works with multiple independent contractors, conducting annual (or more frequent) employee classification audits will help ensure that workers are correctly classified. The audit should include things like reviewing job descriptions, employment agreements, and payroll records to ensure that they accurately reflect the nature of the working relationship.
Correcting employee misclassification
But what if it’s too late to avoid the mistake and you, an employee, or another third party discover that your company has already misclassified employees? Know that there are steps you can take to correct the error, and doing so will require full transparency and cooperation with the law. Putting it off will only cause more problems in the future, so it’s essential to treat the matter with the urgency it deserves.
If you’ve misclassified workers, you’ll need to work with the applicable local tax authorities and government to correct the issue. This may include the tax authority auditing your company to discover any additional errors.
The only way to truly correct employee misclassification is to make all the affected parties whole again. That includes the workers, tax authorities, and governments affected by the misclassification. In addition to paying back wages and taxes, this may also include employee benefits, fines, legal fees, and more.
Some countries have programs that make it easier for companies with worker classification issues to proactively disclose issues while mitigating further risks. For example, in the US, employers can apply for the Voluntary Classification Settlement Program (VCSP). If eligible, this allows employers to correctly reclassify independent contractors as employees while only paying 10% of the amount of employment taxes that would have been due for the workers during the previous tax year.