The 8 warning signs of misclassifying your contractors
Misclassifying employees as independent contractors is a more widespread issue than most people realize. Companies are often ready to take on the risk of misclassification because it's cheaper to hire contractors than employees. There's also a widespread mentality of "it won't happen to me—my company won't be audited.”
But misclassification can result in significant risks for both employers and workers.
- For employers, misclassification can lead to legal and financial liabilities, including penalties for failure to comply with labor laws, back pay for wages and benefits owed, and lawsuits brought by workers.
- For workers, misclassification can result in the loss of important benefits and protections, such as minimum wage, overtime pay, workers’ compensation, and unemployment insurance, as well as the ability to collectively bargain for better working conditions.
Companies of all sizes can be held liable for violating labor laws—with massive penalties:
- In 2020, UK-based courier company CitySprint was ordered to back pay holiday pay to five couriers who were misclassified as independent contractors. CitySprint had previously lost misclassification cases in 2019 and 2017.
- In 2019, Handy Technologies, a cleaning and handyman services company based in New York, agreed to pay $1.2 million to settle a lawsuit that alleged it misclassified workers as independent contractors and denied them benefits such as minimum wage and overtime pay. Handy had under 1,000 employees at the time.
It's vital that companies know the warning signs of misclassification—and commit to classifying their workers correctly.
One of the key differences between employees and independent contractors is that employees are typically subject to more control and supervision by the company, while independent contractors have more autonomy over their work. If a company is treating independent contractors like employees, it could be a sign that those workers are misclassified.
In our own analysis, we've identified eight signs of misclassification that can put your company at risk. Note that none of these are sure signs of misclassification on their own, but if several of them apply to any of your workers, you may want to check their classification—especially if you have a number of contractors in a given country.
Sign #1: Using a company email
It's very common for a contractor to receive a company email address from a client—typically for access reasons.
But when a worker uses a company email address, it can suggest that they're more integrated into the company's operations and are potentially under more control from the company than an independent contractor would be. This is because employees typically use company email addresses, while independent contractors would typically use their own personal or business email addresses. This sign becomes more concerning when compounded with another sign.
Sign #2: Working continuously for longer periods, like more than 12 months
In general, employees tend to work for a company for an indefinite period of time, whereas independent contractors are typically hired for a specific project or set period of time, with no guarantee of ongoing work.
That's why, if a worker has been continuously working for a company for longer periods, such as for more than 12 months, it may suggest that they're more likely an employee than an independent contractor.
Sign #3: Receiving equity
Equity compensation, such as stock options or restricted stock units, is often used to incentivize employees and align their interests with the company's success. Equity compensation is typically required to vest over a longer time period before it can be optioned, creating an incentive for employees to stay in their roles for the long term. For plans that allow independent contractors to receive equity compensation, a continuous engagement for multiple years, and as mentioned above, i.e., working through a vesting period could be a red flag that the independent contractor is misclassified.
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Sign #4: Being paid in regular intervals
Generally, employees are paid on a regular and consistent basis, such as weekly, bi-weekly, or monthly. Independent contractors, on the other hand, are usually paid on a per-project or per-deliverable basis, rather than a regular and consistent basis. Unlike employees, independent contractors are generally expected to track their progress in deliverables, project milestones, or project hours. They also tend to negotiate the frequency of pay and invoice their clients before receiving payment.
Sign #5: Expense reimbursement
Typically, employees are reimbursed for business-related expenses incurred in the course of their employment. Independent contractors, on the other hand, are responsible for their own expenses, as they are considered to be running their own businesses. As such they either build in expenses to their negotiated rates or ensure that their engagement agreement outlines the expense-related fees that their clients will pay.
Sign #6: Participating in employee engagement surveys
The terms of engagement are different for employees and independent contractors. As such, any sort of engagement survey would be asking different questions of independent contractors than of employees.
Many companies encourage independent contractors to participate in employee engagement surveys as a way to improve communication and engagement with their contracted workforce.
But if a company is using employee engagement surveys as a way to measure the satisfaction or productivity of workers who are classified as independent contractors, it may suggest that the company is blurring the line between employees and independent contractors.
Sign #7: Receiving company training
Receiving company training is not necessarily a warning sign of misclassification on its own. It is common for independent contractors to receive context and insights from the companies they work with in order to better understand the project requirements and expectations.
It's the level and nature of the training provided that companies need to be cognizant of—this can be a factor considered in determining whether a worker is an employee or an independent contractor. Generally, employees receive more comprehensive training than independent contractors (such as conscious bias training, sexual harassment training, etc.) because they are more closely integrated into the company's operations and culture.
If a company is providing extensive training to a worker who is classified as an independent contractor, it may suggest that they are exerting a level of control and supervision over that worker that is more consistent with an employment relationship. This could be another lesser-known warning sign of misclassification.
Sign #8: Integration with performance management software
Performance management software is often used to track and evaluate employee performance. If a company is using performance management software to track the work of independent contractors in a manner similar to employees, it may suggest that the company is treating those workers as employees rather than independent contractors.
Contractors don’t participate in typical company processes—like performance improvement plans or salary reviews—or enjoy the same benefits as full-time employees. They’re typically responsible for their own work and travel expenses, and shouldn’t receive equipment from their employer to perform work-related tasks. These are all signs of integration that could indicate an employer-employee relationship instead of a contractor one—especially if any of these signs exists in tandem with the contractor using their client's performance management software.
Misclassification can happen accidentally. You can learn more about risk scenarios and penalties in part 2 of our guide.
Protect yourself and your company with Rippling's worker classification analyzer, and find out in just 90 seconds whether there are potential issues with your workforce classifications—across the globe. Take the quiz.
Rippling and its affiliates do not provide tax, legal, or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for tax, legal, or accounting advice. You should consult your own tax, legal, and accounting advisors before engaging in any related activities or transactions.
