How to Avoid the Risk of Independent Contractor Misclassification
When you are running a business, hiring the right talent should be one of your top priorities. It is one of the most important assets your business can possess. However, it’s important to remember that “hiring” is a relatively flexible term. You can hire many professionals and leverage their talent to boost your business without making them employees.
The ability to hire “independent contractors” gives you many of the benefits that hiring permanent employees do with relatively little downside. However, it does come with one risk – independent contractor misclassification.
Independent Contractors vs. Employee
Before we delve into independent contractor misclassification, we must understand the differences between independent contractors and employees and how they might vary from country to country. These differences permeate every facet of either’s connectivity with your business, from first contact to separation.
Unlike employees hired through a combination of HR and the department they are being hired into, independent contractors usually come through the department. They are typically identified/chosen based on their technical expertise and skills that are not available in-house. Their working conditions are more flexible, and they usually have more control over their hours than employees. Even if they work within the premises and directly near regular employees, independent contractors might still function even if they are a cultural misfit simply because it’s a temporary arrangement.
Then there are the finances. As a business, you are responsible for withholding a certain amount of an employee’s salary for income taxes in most countries, but it’s not something you do with independent contractors. They are liable for their taxes. They also don’t have access to benefits like social security that you, as an employer, would pay into or medical benefits. All these things are priced into your arrangement with the independent contractors. Instead of payroll, independent contractors usually get paid through invoices.
Another characteristic that differentiates independent contractors and employees is that the latter is exclusive to a business (in most cases). In contrast, independent contractors can connect and work with multiple businesses simultaneously, though it may have certain exceptions like a conflict of interest or defense-related contracts.
The Risks Associated With Independent Contractor Misclassification
Employees and independent contractors are different, and their classifications vary from country to country, even within collective sets (like the European Union) that follow many similar laws. In France, for example, an independent contractor is the individual that dictates the terms of a working arrangement with the client business and has a complete say over their working hours, conditions, etc. In the UK, the definition is mainly limited to paying taxes and handling their finances.
Therein lies the problem of independent contractor misclassification. In France, you may be penalized for misclassifying your independent contractors if you build much oversight into your contracts. That would be akin to making them your employees without taking on the relevant social security and tax responsibilities. In contrast, you may get more leeway in the UK.
Some of the risks associated with independent contractor misclassification are:
Fines: You may have to pay possesses for each misclassified employee in certain countries, including the US. The penalty is different from any other compensation you may have to make.
Back Pay/Back Wages: Unlike independent contractors billed for their work and only for hours mentioned in the invoice, the employees have to be paid for the entire time they are connected to your company through an employment contract. A misclassified independent contractor may be entitled to back wages.
Tax Implications: If your business is found guilty of misclassifying employees as independent contractors (based on their working conditions and arrangements), you may have to comply with all the taxation responsibilities for the period they have been connected to your business.
Jail Time: It’s relatively rare, but in some cases, employers may go to jail for misclassifying independent contractors.
Reputational and Regulatory Risks: Regulatory bodies, especially the taxation entity in the country you are operating in, may treat independent contractor misclassification as a compliance breach and may impose certain restrictions on your business activities. It may also hurt your reputation, especially in the talent market, which may prevent you from hiring top talent or paying more for the same skill.
It’s important to remember that the contractors carry some risks of independent contractor misclassification. For example, IT contractors in Poland are subject to lump-sum tax, and if their working conditions are equivalent to employees, they may lose this taxation status.
How to Avoid the Risk of Independent Contractor Misclassification
A few simple steps you need to take to avoid the risk of independent contractor misclassification are:
- Become well-versed in the definition of independent contractors in every country you operate in. This includes working conditions, compensation, duration after which a contractor might be considered an employee, etc. If you adhere to these requirements for every independent contractor agreement you execute, you may significantly lower the chances of misclassification.
- Have separate independent contractor hiring contract templates for every country/jurisdiction you operate in instead of one universal template. Each country’s template should reflect its independent contractor laws and definitions.
- Look into the litigation history surrounding independent contractor misclassification in your operating countries. Understanding how different legal systems interpret business-independent contractor relationships and how they deal with misclassification should give you insights into how to avoid this issue.
- Refer to guidelines/instructions offered by regulatory bodies specifically dealing with independent contractor misclassification.
- Avoid leaning too heavily on independent contractors. Short-term employment contracts subject to a specific project may be a more practical alternative to hiring independent contractors and can help you avoid the misclassification risk.
The proper contracts and adhering to the best hiring and HR practices can help you avoid the risk of independent contractor misclassification, regardless of the country you are operating in.
As a business owner, you are always looking for ways to expand your operations and increase your profits. One of the best ways to do this is by hiring independent contractors from around the world. However, finding and managing these contractors can be a daunting task, especially if you are not familiar with the local laws and regulations.
This is where Aadmi comes in. Aadmi is a global expansion service that specializes in helping businesses hire independent contractors from around the world. With Aadmi, you can easily find and hire the best talent from anywhere in the world, without having to worry about the legal and logistical challenges of managing a global workforce.