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Employee misclassification refers to the improper designation of a worker as an independent contractor when they should be classified as an employee.
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Back to Glossary
Employee misclassification refers to the improper designation of a worker as an independent contractor when they should be classified as an employee.
Misclassification often leads to the worker being denied essential benefits and protections that employees are entitled to, such as health insurance, overtime pay, and retirement plans. For example, in the U.S., employee misclassification can affect both federal and state taxes, leading to issues with income tax, Social Security, and Medicare contributions.
Some employers unintentionally misclassify workers due to a lack of understanding of local labor laws in a particular region, or don’t know the differences between employees and independent contractors.
Sometimes, employees are classifying workers as independent contractors because employers seek to reduce their labor costs. Independent contractors do not have the same rights as employees, meaning businesses can avoid paying for benefits like health insurance, unemployment insurance, and overtime wages.
Misclassification can also reduce the employer's obligation to pay employment taxes, for example Social Security and Medicare taxes in the U.S.
For employers, these apparent cost savings are not worth the risk: they can face significant repercussions if found guilty of misclassifying workers, especially if they do so knowingly.
Misclassifying employees can lead to significant financial penalties for employers – it differs from country to country what these penalties consist of.
For example, in the U.S., the penalties include back wages for overtime and minimum wage violations, unpaid Social Security and Medicare taxes, as well as federal tax penalties for failing to withhold income taxes. The Department of Labor can impose fines for violating wage and hour laws, and in severe cases, employers may face criminal charges or class action lawsuits. Additionally, companies could be required to pay workers for missed benefits, such as health insurance and retirement contributions.
Correctly distinguishing between employees and independent contractors depends on local employment law in a specific country. That said, check out our table below on some common ways to differentiate between employees and contractors:
In the U.S., the Department of Labor and the IRS use several criteria to correctly classify different types of workers. Some common tests used to distinguish between workers in the U.S. include the common-law test, the Economic Reality test and the reasonable basis test. Read our full guide on the subject here.
These guiding principles can help employers to avoid employee misclassification:
An example of employee misclassification is when a delivery driver works full-time for one company, follows a set schedule, uses company equipment, and is subject to detailed oversight, but is classified as an independent contractor.
Another example could be a web developer who works on-site for a company, adheres to the company’s work hours, and receives direct instructions on how tasks should be completed but is wrongly classified as a contractor.
In both cases, these workers should likely be classified as employees due to the level of control and dependence on the company.
As a real-world example: In 2015, FedEx reached a $228 million settlement in a legal case around the misclassification of 2,300 Californian drivers as independent contractors.
To correct misclassification, the employer must reclassify the worker as an employee and provide any back pay for unpaid wages, overtime, and benefits. For example, in the U.S., employers should file the necessary payroll and tax adjustments and might need to retroactively pay Social Security and Medicare taxes.
Yes, misclassifying workers can be illegal, especially if done intentionally to avoid tax and labor law obligations. Violations can lead to fines, back pay, and other penalties.
Misclassified employees lose access to essential benefits. For example, in the U.S., this includes health insurance, unemployment benefits, overtime pay, and protections under labor laws like the Fair Labor Standards Act (FLSA).
In extreme cases, where employee misclassification is part of a willful scheme to evade taxes and labor laws, employers may face criminal charges, particularly for large-scale violations.
Misclassification often leads to the worker being denied essential benefits and protections that employees are entitled to, such as health insurance, overtime pay, and retirement plans. For example, in the U.S., employee misclassification can affect both federal and state taxes, leading to issues with income tax, Social Security, and Medicare contributions.
Some employers unintentionally misclassify workers due to a lack of understanding of local labor laws in a particular region, or don’t know the differences between employees and independent contractors.
Sometimes, employees are classifying workers as independent contractors because employers seek to reduce their labor costs. Independent contractors do not have the same rights as employees, meaning businesses can avoid paying for benefits like health insurance, unemployment insurance, and overtime wages.
Misclassification can also reduce the employer's obligation to pay employment taxes, for example Social Security and Medicare taxes in the U.S.
For employers, these apparent cost savings are not worth the risk: they can face significant repercussions if found guilty of misclassifying workers, especially if they do so knowingly.
Misclassifying employees can lead to significant financial penalties for employers – it differs from country to country what these penalties consist of.
For example, in the U.S., the penalties include back wages for overtime and minimum wage violations, unpaid Social Security and Medicare taxes, as well as federal tax penalties for failing to withhold income taxes. The Department of Labor can impose fines for violating wage and hour laws, and in severe cases, employers may face criminal charges or class action lawsuits. Additionally, companies could be required to pay workers for missed benefits, such as health insurance and retirement contributions.
Correctly distinguishing between employees and independent contractors depends on local employment law in a specific country. That said, check out our table below on some common ways to differentiate between employees and contractors:
In the U.S., the Department of Labor and the IRS use several criteria to correctly classify different types of workers. Some common tests used to distinguish between workers in the U.S. include the common-law test, the Economic Reality test and the reasonable basis test. Read our full guide on the subject here.
These guiding principles can help employers to avoid employee misclassification:
An example of employee misclassification is when a delivery driver works full-time for one company, follows a set schedule, uses company equipment, and is subject to detailed oversight, but is classified as an independent contractor.
Another example could be a web developer who works on-site for a company, adheres to the company’s work hours, and receives direct instructions on how tasks should be completed but is wrongly classified as a contractor.
In both cases, these workers should likely be classified as employees due to the level of control and dependence on the company.
As a real-world example: In 2015, FedEx reached a $228 million settlement in a legal case around the misclassification of 2,300 Californian drivers as independent contractors.
To correct misclassification, the employer must reclassify the worker as an employee and provide any back pay for unpaid wages, overtime, and benefits. For example, in the U.S., employers should file the necessary payroll and tax adjustments and might need to retroactively pay Social Security and Medicare taxes.
Yes, misclassifying workers can be illegal, especially if done intentionally to avoid tax and labor law obligations. Violations can lead to fines, back pay, and other penalties.
Misclassified employees lose access to essential benefits. For example, in the U.S., this includes health insurance, unemployment benefits, overtime pay, and protections under labor laws like the Fair Labor Standards Act (FLSA).
In extreme cases, where employee misclassification is part of a willful scheme to evade taxes and labor laws, employers may face criminal charges, particularly for large-scale violations.
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