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Lee Willoughby

11/06/2024

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How to Avoid Misclassification and Compliance Issues of Freelancers

It's no exaggeration to say that freelancers are the backbone of today's worldwide workforce.

The stats bear this out:

  • About 36% of US workers are part of the gig economy.
  • Nearly 60 million Americans freelanced in 2020, an increase from 53 million in 2014. Freelancing contributes approximately $1.2 trillion to the US economy annually.
  • The UK gig economy has more than doubled since 2016, with 4.7 million people now involved.
  • Gig workers constitute approximately 15% of the Canadian workforce.  
  • 47% of Millennial workers freelance, higher than any other generation.
  • Japan's gig economy is projected to grow to a market size of ¥2.7 trillion by 2025.
  • In India, the gig economy could create up to 90 million jobs in sectors such as logistics and e-commerce.

 

So, with increasing reliance on freelancers, it's imperative managers classify their workers correctly. I.e., avoid classifying employees as freelancers and vice versa, as the financial and legal consequences could negatively impact your business.

With that said, this blog post delves into the critical issue of worker misclassification, its potential risks, and strategies for ensuring compliance.

There's lots to cover, so let's dive straight in!

 

The Risks of Misclassification

Worker misclassification can have significant consequences for your company's reputation and employee relations. It can adversely affect your brand's ability to attract and retain talent, maintain positive relationships with stakeholders, and uphold its ethical standing in the marketplace.

On top of that, as we hinted in the intro, misclassifying your workers can have legal and financial consequences. Of course, regulations will vary from country to country. Still, to give you a sense of the potential ramifications, we've listed some of the consequences for different countries below:

  • The UK: UK employment law provides extensive protections for employees, including rights to a minimum wage, holiday pay, and protection from unfair dismissal. Misclassified workers may file claims with employment tribunals to seek remedies for unpaid salaries, entitlements, and compensation for loss of rights.
  • The US: If an employer misclassifies an employee as a contractor, they'll have to pay back taxes and any accrued interest. Plus, employers may face additional fines and penalties if the local government determines the misclassification was intentional. The employer responsible for misclassification may also incur legal fees and court costs if the misclassification leads to a legal dispute. Additionally, employers may lose certain tax benefits, deductions, and credits associated with proper classification.
  • Germany: Employers may be liable to pay fines for any unpaid social security contributions. These can be up to four times the amount of social security withheld for up to four years. However, this can be extended to thirty years in cases of intentional misclassification.  

To give you a sense of the potential fines and penalties associated with misclassifying employees as independent contractors, here are some real-life examples of what's happened to enterprises who have failed to comply with worker classification regulations:

Nike

At the time of writing, Nike, according to the Guardian, could face fines of over $530 million for misclassifying thousands of workers in the US, UK, Netherlands, and Belgium.

Uber

In New Jersey, the US, Uber has had to pay $100 million to the state after the Labor Department found the company incorrectly classified drivers as independent contractors.

FedEx

FedEx has agreed to pay $2.4 million to resolve a lawsuit alleging it misclassified drivers in New Jersey, the US, as independent contractors.

 

For US Readers: How to Ensure US W2 / IC 1099 Compliance

As HR professionals, your role in correctly identifying a worker's status is not just important, it's crucial. Your understanding and application of the factors below are key to ensuring accurate worker classification:

Control and independence: How much power does the worker have over how their work is performed? Employees typically have little control over their work, while freelancers operate more independently.

Financial arrangements: How is the worker paid? I.e., does the worker invoice your company, or are they on your payroll? Similarly, are their expenses reimbursed? Who provides tools and supplies?

The nature of the working relationship: Consider the nature of the relationship, including whether the worker is entitled to any benefits and the permanency of the relationship.

The Importance of Contractual Agreements

Clear, detailed contracts are not just a formality but a powerful tool in defining your worker's status. They specify the nature of the working relationship, expectations, deliverables, payment terms, and compliance requirements. Well-defined contracts help clarify roles and protect both parties in case of disputes, giving you confidence in your worker classification.

Regulatory Differences by Region/Country

While we've primarily focused on US compliance, it's crucial to understand and adhere to local, state, and federal regulations. Worker classification rules can vary significantly, and a comprehensive understanding of these regulations is critical to avoiding potential legal issues.

 

Implementing Systematic Compliance Checks

To avoid accidental worker misclassification, implementing systematic compliance checks is critical. Below, we've listed just a few of the things you can do to get up and running with that:

Establish Internal Audits

Set up a structured internal audit process to review worker classifications regularly. Audits should involve a detailed review of worker contracts, payment records, and work practices to ensure compliance with classification criteria.

Automated Compliance Systems

Invest in compliance management software to track worker status, document classifications, and flag potential compliance issues. Automation helps maintain consistency and accuracy in compliance checks and is less likely to suffer from human error.

Regular Reporting and Documentation

Regular reporting and documentation of all compliance checks and audits are essential. They ensure transparency and accountability, and it's advisable to share these findings with senior management regularly and take corrective actions as necessary.

 

Educational Training for Management

Regular training sessions should be conducted for managers and HR professionals to update them on worker classification compliance requirements.

Training should cover:

  • Classification criteria: Detailed explanations (building upon the classification listed above) of employee vs. freelancer status and the implications of each.
  • Regulatory updates: Information on changes in laws or regulations affecting worker classification.
  • Best practices: Guidance on drafting contracts, maintaining records, and conducting compliance checks.
  • Scenario analysis: Provide practical examples and case studies to help managers understand real-world applications of compliance principles.

 

By implementing these steps, organizations can significantly increase the likelihood of correctly classifying workers and maintaining compliance with US W2 and IC 1099 regulations, thereby avoiding legal issues and penalties.

 

Leveraging Technology for Compliance

Utilizing technology to manage worker classification is a highly efficient way to ensure compliance.

With Bubty's freelancer onboarding process, companies can automate their screening procedures and create custom onboarding workflows to collect compliance-related information from freelancers. This includes ID verification, KYC checks, tax verification, and local tax residency confirmation. Additionally, freelancers can sign necessary documents, such as NDAs or DPAs, directly within the platform.

When creating location-based assignments, Bubty provides contract templates and questionnaires to ensure freelancers are hired under the correct classification. For added assurance, Bubty integrates with service partners that offer full indemnification and AOR (Agent of Record) services, assuming liability for compliance.
 

Are You Ready to Avoid Freelancer Misclassification and Compliance Issues?

We hope this blog post has provided much-needed food for thought. For example, how is your organization currently handling freelancer classification and compliance?

If you could use a hand streamlining worker classification, please feel free to book a demo to experience Bubty’s solutions for simplifying freelancer management and compliance.