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Penalties for misclassification of independent contractors

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Penalties for misclassification of independent contractors

Employers that work with global talent can access a highly diverse workforce that isn't restricted by geographical limitations. This means that no matter where your business is located, you can hire international employees and partner with foreign independent contractors, provided you comply with the local laws where these employees and contractors live.

While this can benefit your business, it also has the potential to cause significant damage, as international employers face a more complicated legal landscape and significantly higher risks associated with non-compliance.

If you plan to work with foreign independent contractors, one of the most significant risks you will need to be aware of is the misclassification of employees as independent contractors.

Continue reading to learn what employee misclassification is and what penalties for misclassifying independent contractors you will need to be aware of.

What is employee misclassification?

The misclassification of employees is when employers inadvertently or purposefully misclassify an employee as an independent contractor. This means that the working relationship, although legally portrayed as a business-contractor relationship, actually falls under an employer-employee relationship based on local employment laws.

Many employers opt for hiring independent contractors, as it can save them money on supplementary payroll costs, such as healthcare, paid leave, social security contributions, and more. In addition, the working relationship between an employer and an independent contractor is significantly less restrictive for both parties.

However, working with independent contractors poses risks to businesses that may be liable for back pay and taxes if an independent contractor is found to be an employee.

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How does the misclassification of independent contractors happen?

Typically, employee misclassification as an independent contractor is not intentional, as most business owners are familiar with the risks.

However, international employers face considerably more risk when partnering with independent contractors, as the employment laws regulating what separates an independent contractor from an employee vary significantly by country.

When you work with an independent contractor, you are subject to the regulating laws in the country where they live, which means you'll be expected to familiarize yourself with these limitations before entering into a working relationship.

Your risk increases with each new country, as this means you will have different rules restricting how you engage with contractors living in different places.

Penalties for misclassification of independent contractors

Employers who partner with employees and independent contractors based in foreign countries must be additionally aware of local employment laws. The following is a list of the employee misclassification penalties you will need to be aware of.

Consulting with Skuad's local experts can help you avoid risks like misclassifying independent contractors and learn how to correct employee misclassification.

IRS penalties

In addition to potentially owing an employee backpay, employers may be subject to the following IRS penalties:

If you are found to have misclassified even one employee as an independent contractor, you are likely to be audited, which means your company will face severe financial scrutiny by the IRS.

Federal authorities penalties

In addition to the fines associated with employee misclassification, employers can face significantly more financial implications. Beyond owing the IRS money, you may face legal implications as well.

When you misclassify employees as independent contractors, you are breaking state and federal laws that would otherwise dictate how your business operates and how your employees are treated.

Depending on the severity of the misclassification, you are at risk of being sued for breaking these laws.

Damaged reputation

Lastly, in addition to the financial ramifications you may face, your business may also be subject to less tangible damages resulting from a tarnished reputation.

You may struggle to find reputable talent after a misclassification experience, as misclassification will also result in complications for any contractors and employees who currently (and sometimes previously) work for you.

Additionally, business operations may be interrupted or lessened, resulting from your financial and legal situation, which means your relationships with vendors, peers, and customers may also suffer.

How can you avoid misclassification penalties?

Avoiding misclassification penalties is easier said than done, especially for international employers, who will need to remain compliant with classification laws in every country where they work with independent contractors.

If you would like more information on how to avoid penalties for the misclassification of independent contractors, read Skuad's employee misclassification checklist.

How Skuad can help

Skuad is an international employment and payroll platform that manages onboarding, payments, compliance, and other aspects of global hiring in more than 160 countries.

Book a demo today to see how we can help you avoid employee misclassification and get started growing your global team.

FAQs

What is the federal penalty for the intentional misclassification of an independent contractor?

The federal penalty for the intentional misclassification of an independent contractor is subject to change. However, it can include fees associated with each contractor found to be an employee, back taxes, and penalties on top of the back taxes owed.

How do I report 1099 misclassification to the IRS?

If you're an employer who believes you may have inadvertently misclassified any employees, you can file IRS Form SS-8, "Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding."

If you're an employee who believes your employer has misclassified you as an independent contractor, you can file IRS Form 8919, "Uncollected Social Security and Medicare Tax on Wages."

Does the IRS audit independent contractor status?

The IRS does audit independent contractor status. Therefore, if you do not classify your employees correctly at any point in time, you may face the risk of being audited.

About the author

Catalina Wang is a Human Resource Consultant. She manages recruitment, onboarding, and contract administration staffing for many organizations and remote teams. She’s passionate about efficient HR management and the impact of tech on hiring practices.

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