As companies increasingly seek to expand their operations while reducing budget, they often turn to advisors or other experts to help them navigate unfamiliar legal and regulatory environments. However, one of the risks of hiring these advisors, generally thought of as independent contractor support (domestic or international) is the potential for misclassification, which can have serious legal and financial consequences for everyone involved.
What is misclassification? This is when an individual is treated as an independent contractor when, in fact, they should be classified as an employee. This can happen regardless of where the contractor is located and is a significant legal and operational risk — both inside the borders of the US as well as outside of those borders.
Misclassification can be a complex issue, as it often depends on the specific laws and regulations of the country where the contractor is working. In general, however, misclassification can result in companies being liable for salary discrepancies, penalties, interest and inflationary adjustments to the tax authorities, and any unpaid benefits that the misclassified worker should have received had he or she been properly classified. And in some cases, even jail time may be required.
To avoid the substantial risks of contractor misclassification, companies must carefully evaluate the nature of their relationship with each contractor they hire and/or the guarantee of their professional HR or EOR agency who does so on their behalf. This involves ongoing supervision of several classification factors, such as the level of control the company exerts over the contractor, the type of work being performed, and the global payment structures deployed.
Perhaps most importantly, companies must also ensure that they and/or their EOR provider are complying with all relevant laws and regulations in the country where the contractor is working, including those related to taxes, employment, and immigration. By taking these steps, companies can minimize the risk of misclassification and protect themselves from legal and financial liability — wherever in the world they happen to be hiring.
It’s no secret that workplace structures are in a tumultuous state of reshuffling. Traditional patterns of employer-employee relations have been on a course of social and technological transformation for decades now, and have likely passed a point of no return after COVID restrictions demonstrated that productivity doesn’t have to be tethered to a central office location. These remote or offsite contractual arrangements – domestic and international – are enriching the labor pool, but they often present complex compliance issues with labor and tax regulations for contractors and employees.
The New York Times reported on 10 May 2023 that the amount of empty office space now in the city could fill twenty-six-and-a-half Empire State Buildings. New York – in company with most major American cities – is scrambling to reinvent its economy from on-site business activity to a new chapter of globally distributed talent.
The implications are promising yet hazardous — poised for new opportunities yet ripe for exploitation. One substantial effect of offsite or hybrid forms of employment: workers’ advocates and the IRS have noted a sharp rise in independent contracting, often a legitimate corporate transaction but also situated for misuse. Keep reading to understand why…
A 1099 independent contractor (domestic) and W-8BEN (international) contracts are substantially different from more standard 1040 hiring arrangements. These “on-demand” or project-based workers can be very beneficial for small teams on a growth trajectory, but these benefits come with risks and limitations. Employers may be tempted to misclassify these individuals as independent contractors to circumvent training, benefits, stability and advancement, and taxes. Or, employers can simply be confused by unfamiliar laws for contract work, domestic or international.
Either way, in-country revenue services (such the IRS in the United States) treats misclassification of any individual who works in their country as a crime, and the penalties can be debilitating to your organization. One very easy way to avoid the nightmare: work with a credible EOR or HR organization structured to ensure that every hire is classified correctly, complete with filing and paperwork from the get-go.
We get it — distinctions can seem fuzzy when corporate employees often work online, drive their own vehicles (looking at you, Uber and Amazon), or set up offsite office spaces. But to any country’s revenue service, hiring professionals who are well-seasoned in managing offsite relations are expected to know the differences between a regular employee and a freelance contractor. Transgression is far more likely to be interpreted as devious or deliberate, and revenue services will certainly enforce compliance in employee classification.
Put another way: It’s infinitely easier – and far more ethical – to comply with employment codes than to answer for mistakes (or potential crimes) when a country’s revenue service comes calling.
In the United States, IRS guidelines are clearly posted for careful public scrutiny; if you’re feeling up to the task of self-regulation, make sure you do the research. Many hiring scenarios are clear cut – but time on the website does begin to reveal finer and finer categorical distinctions, especially in international hiring situations.
We’re taking our information here directly from the IRS’s website, but this is a brief article. Take time to go there yourself; know what to look for and make sure you get it right – either by working closely with an HR or EOR agency that has incorporated best practice at every stage, or by checking and re-checking your selections.
In the United States, the IRS specifies three categorical distinctions between an “employee” and an “independent contractor.” When hiring outside of the United States, these may be complicated by international circumstances but the terms are still fundamentally similar:
If the employer controls (or has the right to control) what exactly gets done and how – as in, set working hours, additional responsibilities defined in a job description, location, project timelines, training, teamwork, and restricting other channels of employment – the worker is a standard 1040 employee, and the employer must comply with well-defined regulations, including tax withholding, Social Security, corporate benefits, and clear reporting to the IRS.
If the business arranges work to be done by an independent contractor, the employer does not control the shape or timing of production hours; does not provide training, equipment, or facilities; does not supervise timelines beyond negotiated project-by-project deadlines; and has no influence over other contractual arrangements – the services are likely provided by a 1099 or
independent contractor.
If the employer/business sets structured, ongoing financial terms of employment, including defined reimbursements, payroll schedule, provision of facilities or equipment that belong to the company, and opportunities for regular advancement, the worker is a 1040 or regular employee. Once again, this means that the employer must comply with well-defined labor regulations, including tax withholding, Social Security, corporate benefits, limitation of work hours, and clear reporting to the IRS.
If the contractor negotiates the financial terms of a limited contract or project, takes responsibility for taxation, statutory contributions, benefits such as medical, dental, and life insurance, and can claim no further obligation for ongoing employment or benefits with the hiring party, the “gig” likely qualifies as 1099 or independent status. (Don’t stop here — we’ll discuss a few worrisome implications of this apparently attractive hiring arrangement below.)
This criterion overlaps the other two, providing a more holistic gauge for good judgment and legal accountability. Here’s how to assess:
These parameters only cover one country, the United States — but any reader who imagines any in-county revenue service has a sense of humor about any of this belongs somewhere well beyond the business world.
The “benefits” of misclassifying a worker as an independent contractor may seem appealing in the short term… as it pushes the complex responsibilities of withholding income tax, securing meaningful benefits and retirement, and protecting oneself against unemployment in an unpredictable market onto the worker. But things quickly get unethical and risky. If you’re constantly cheating the system — making no promises about job security or advancement, hiring key services at will, ghosting the worker when it’s convenient, and answering to no one when it comes to termination — you’re putting mission-critical projects (and compliance) at significant risk.
Put another way, it might seem profitable to circumvent most of the hard-won employee protections established in successful and wealthy democratic nations. But it’s not a good look, and it’s coming back to bite the reputations and legal standing of far too many twenty-first century organizations. (Just read the news.)
It’s not difficult to make clear, ethical, and legal judgments that distinguish between
1040 and 1099 or similar international employee classifications. At the very least, it’s not that difficult to recognize the critical importance and make sure your hiring professionals (e.g., any HR team or EOR organization you work with) are people you can trust.
Yes, remote technology has dramatically re-mapped physical proximities among employers, managers, and employees. Social and professional relationships “look” different than they did even a decade ago. COVID and other communal threats have altered traditional forms of public trust and safety. The rising generation of workers – in the United States and beyond – are encountering a professional world in the throes of reinvention. Talented, committed, and highly skilled employees deserve to be treated as such, deserve purchase in longstanding social safety nets, corporate systems of reward and stability, and trust in the companies that hire them.
Independent contracting has its place, providing valuable benefits on both sides of the contract. But misusing its classifications as a retreat from ethics, employer responsibility, and legal obligations is not only poor practice – it’s a gold-embossed envelope inviting the IRS (or several) to inspect your (mysteriously empty) office building, where they’re likely to settle in, take up your precious productive hours, and re-allocate all that money you thought you saved. And they’ll share it with the employees you’ve misclassified – accidentally or not-so-accidentally.
Misclassification has had its day. Put it high on your list of risks to avoid.
Whether you work with independent contractors, hire through an EOR, or are gearing up to scale your globally distributed workforce, it’s important to assess your strategy moving forward. Are you at risk for misclassification? Take action on the following:
With a trusted partner, hiring legally and maintaining a globally distributed workforce doesn’t have to be risky. For deep, in-country and global expertise, with a human-led team, schedule a call with our international EOR experts today.