Reduce the risk of employee misclassification

Employee misclassification denotes the incorrect classification of someone who should be treated as an employee but is instead labelled, often, as an independent contractor.

When misclassification occurs, individuals may miss out on employment benefits and protections such as health insurance, workers' compensation and unemployment insurance. Misclassification also changes the employer’s obligations to pay taxes, for example Social Security and Medicare taxes

Contractor arrangements suit temporary roles where you need specialist expertise or additional capacity for short-term projects.

However, independent contractors should not be treated as long-term permanent staff, put in charge of major initiatives, or given responsibility for managing others if you wish to avoid misclassification risks.

Unlike employees, independent contractors run their own businesses, set their own working hours and methods, and are not subject to the same degree of control by the hiring company.

The labels "worker", "employee" and "contractor" describe different work relationships. An "employee" normally works under an employment contract, is subject to the employer’s control and receives benefits such as health insurance and pension schemes.

A "contractor" operates independently, often under a contract for services, and does not receive employee benefits. "Worker" is a broader term that can refer to anyone who performs work, including both employees and contractors, but it does not specify the exact nature of the employment relationship.

Keep in mind that in certain countries, like the United Kingdom, the legal definition of the term "worker” is different.

Some employers create relationships with workers that amount to ‘pseudo-employees’. The employer treats the person as a contractor, but under local legislation the worker would likely be regarded as an employee.

Those ‘pseudo-employees’ often work full-time and function as ongoing staff whose duties and working conditions are set by the company, yet they are recorded as independent contractors. Such arrangements breach strict misclassification laws and may attract severe penalties and corrective measures to secure compliance.

The simplest way to assess your risk level is to use our free employment misclassification tool (see the top of this page).

There can be serious consequences for misclassifying workers, whether accidentally or deliberately.

The cost of employee misclassification can include substantial fines and back taxes. You may also be liable for retroactive compensation to workers found to have been misclassified, including unpaid wages, any employee benefits they were denied as contractors, and further legal penalties.

Misclassification can also give rise to additional legal claims from workers, unions or other groups harmed by the incorrect classification of staff.

However, using contractor management software can help reduce this risk. These platforms often include features such as localised contracts, compliance tools and indemnity cover to protect against misclassification. It is also important to keep up to date with labour law changes and ensure any software you choose provides comprehensive compliance support.

What determines contractor misclassification?

Contractor misclassification happens when a worker is wrongly classed as an independent contractor rather than an employee. This distinction matters because it affects legal rights, benefits and protections.

Determining misclassification typically depends on several factors:

• Control. If the company dictates how, when and where the work is done, the worker is likely an employee. Independent contractors normally have more freedom to decide these matters.

• Financial dependence. Employees typically rely on the employer for a steady income and often do not provide services to other clients. Contractors generally operate their own businesses and may have multiple clients.

• Nature and duration of the working relationship. An ongoing relationship that is integral to the business suggests employment. Contractors are usually engaged on a temporary basis to complete specific projects.

• Equipment and supplies. Employees are often provided with the necessary tools and materials by the employer, while contractors usually use their own resources.

• Benefits. Employees are eligible for benefits such as health insurance, pension contributions and paid leave, whereas contractors are not.

• Tax treatment. Employers withhold taxes for employees, while contractors are responsible for paying their own self-employment taxes.

Legal frameworks and tests for determining misclassification vary by jurisdiction and can change. However, they generally look at these elements to assess the true nature of the working relationship.

Read our in-depth guide for more information on employee misclassification and how you can avoid it.

In the UK, Uber was required to reclassify its drivers from contractors to the 'worker' category; that highly publicised case took five years to progress through the legal system. After a ten-year court battle in the US, Swift Transportation paid out over $100 million in damages to 20,000 workers who had been misclassified.

There have been numerous other cases around the world in recent years. Beyond the financial impact, these disputes can damage reputation: staff may leave; prospective employees may view your company less favourably, and customers might reassess their relationships with you.

Even if you are not affected by contractor misclassification today, it is important to understand the risks. Businesses should act proactively: make sure every worker is correctly classified, run regular reviews of classification status and maintain compliance in all countries where their workers are based.

Businesses can reduce the risk of employee misclassification by using tools like Remote Contractor Management, which helps businesses hire, pay and manage contractors efficiently.

The platform helps employers comply with regional regulations through localised contracts, offers added security with indemnity coverage, and keeps companies informed about labour law changes worldwide. It includes built-in misclassification and tax tools to protect businesses from compliance risks.

Remote helps protect against misclassification risks by offering services that ensure compliance with local labour laws and regulations. Remote provides tools and resources to correctly classify workers as either employees or contractors based on the legal requirements in their respective countries.

Remote also manages payroll, benefits, taxes and compliance documentation, reducing the administrative burden on companies and minimising the risk of costly legal mistakes. By handling these aspects, Remote helps companies maintain proper classification and adhere to employment laws, thereby safeguarding against potential misclassification issues.

Remote’s Contractor Management Plus service provides extra safeguards against misclassification, including indemnity coverage of up to $1 million.