Employee Misclassification Guide for Employers

June 8, 202112:59 pm1125 views
Employee Misclassification Guide for Employers
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Does your new recruit fall under permanent employee or independent contractor? The debate over employee misclassification pervades the modern fissured workplace. 

Earlier this year, in January 2021, Judge Edward M. Chen of the Northern District of California issued an order partially granting and partially denying the plaintiffs’ motion for class certification in a driver misclassification suit against Uber. Uber cited that their drivers are not engaged in the companies’ core mission and thus cannot qualify for benefits. Uber also claimed that their drivers are independent contracts rather than employees.  The court, however, stated that Uber drivers are/were classified as Uber employees rather than independent contractors under five legal claims. The court added that “whether Uber misclassified its drivers as independent contractors is a common question that satisfied the commonality requirement.”

The Uber case is not unique. There are some other cases where employers misclassified their employees and thus face legal issues, such as Lyft and Google cases. 

What is employee misclassification? 

Employee misclassification is a practice of labelling workers as independent contractors, rather than employees. The practice allows employers to avoid paying benefits and other taxes on workers, and from covering the workers on compensation and unemployment insurance. Workers who are misclassified as independent contractors also work without legal protections typically afforded to employees, such as wage and hour laws, employee compensation, and other benefits. 

Although the practice of employee misclassification reduces labour costs for the employer, it creates an unlevel playing field when businesses are involved in competitive bidding on projects. Often referred to as an underground economy, employee misclassification also has negative consequences for state and federal governments, such as million dollars loss in tax revenue. 

See also: Research Shows Why Immigrants Help Businesses Grow 

The difference between contractor and employee

The differences between an employee and an independent contractor largely involve compensation and control. Independent contractors will incur reimbursed business expenses throughout the course of the contractor’s work. However, independent contractors will not be covered by most basic labour standards, such as minimum wage, overtime, and the fundamental proposition that one should be compensated for their hours of work. 

In addition, the contractor will likely have invested significant funds for the equipment used, is able to make their services available to others, and is typically paid a flat fee. Contractors are also responsible for paying all federal and state payroll taxes, making appropriate contributions as both an employer and employee. If the contractor fails to pay their responsibility to the state, the individual will get penalties. 

On the other hand, employees do none of what contractors did. Instead, an employer is the one who is responsible to pay taxes, wage, and compensation/benefits to employees. Regardless, many employers misclassify employees as independent contractors for monetary reasons. 

Corporate lawyer Matthew Lapointe in his article mentioned that employee misclassification is one of the most common legal issues for businesses, especially new companies. New business owners routinely misclassify their workers as independent contractors, wrote Lapointe. Various reasons came up when Lapointe asked why do business misclassify their workers, including: 

  • The business is not required to withhold income tax, pay social security and Medicare taxes, pay unemployment compensation taxes or provide worker’s compensation insurance for independent contractors. 
  • Independent contractors are not subject to minimum wage or overtime pay requirements. 
  • Independent workers are not eligible to participate in employer-sponsored health plans and retirement plans. 

In Singapore, there were more than 300 worker misclassifications in 2019. The reasons for misclassifying employees are mostly to avoid legal documentation and to avoid paying a contribution to employees, such as non-payment of CPF obligation under the Central Provident Fund Act, bypassing minimum protection under the Employment Act, and work visa quotas. 

Professor David Weil explained the growing trends and why many organisations make the mistake of misclassifying employees. Weil wrote that the use of independent contracting has grown dramatically in the past decade, going from 6.9 percent of employment in 2005 to 9.6 percent in 2015. In his investigation, Weil found that a significant portion of independent contracting does not pass the smell test and, in fact, represents misclassification of workers. 

Consequences of misclassifying employees 

In the United States, under Employer’s Supplemental Tax Guide issued in 2021, the Department of the Treasury Internal Revenue Service disclosed that if an employer classifies an employee as an independent contractor and has no reasonable basis for doing so, the employer is liable for employment taxes for that worker and the relief provision. 

Singapore’s Ministry of Manpower (MOM) also takes a serious view of employers who misclassify employees in order to avoid their statutory obligations and will take stern action against such errant employers. According to MOM, employers who practice employee misclassification will be fined and/or imprisoned for breaches of the CPF Act. Employers will also need to deal with administrative penalties, including being blacklisted. As stated on MOM website, regular employees who believe they have been misclassified by employers as self-employed persons (SEPs) can approach MOM for help. 

Practical recommendations for engaging independent contractors 

Besides paying a myriad of fees and fines, employee misclassification can also damage an organisation’s reputation. It can put a company in the public eye which can lead to negative publicity. Therefore, when employers are intended to hire contractors, they need to assure the hires know their contract and position in the company. Here are some practical tips for engaging self-employed contractors: 

  • Document the relationship with your contractor in writing, clearly and precisely;
  • Only engage individuals via an agency or a company;
  • If possible, there should be no obligation on the company to provide work and no obligation on the individual to carry out the work;
  • If possible, include an unfettered right for the individual to substitute someone else to carry out the work;
  • Reduce restrictions on how, when, and where the services are provided;
  • Avoid exclusivity clauses and post-termination restrictive covenants;
  • Ensure that the communications to the board member do not conflict with self-employed status;
  • Engage individual to carry out particular tasks or projects;
  • Determine the fee by reference to a daily/hourly rate or a project fee is possible. If there is a contract, make sure to abide by it;
  • Contractors should be distinguished from employees, thus it is generally inappropriate to invite contractors to employee events;
  • Ensure the individual provides their own tools and bears their own expenses; and 
  • Training, appraisals and discipline should be provided by the contractors’ employers, not the organisation that hires the contractor. 

Read also: Employee Monitoring: Ethics and Laws Employers Must Know