The definition of misclassification is the act or instance of assigning someone or something to the wrong group or category.
The term misclassification is often used in relation to employee misclassification. Employee misclassification occurs when a business classifies a worker as an independent contractor for tax and legal purposes but treats them like an employee.
Why would a company misclassify a worker as an independent contractor?
A company might accidentally misclassify a worker as an independent contractor, or they may do it intentionally to evade taxes and costs associated with employing a worker.
Hiring an independent contractor is more affordable than hiring employees. Companies do not need to pay independent contractors compensation premiums, healthcare benefits, office space, and equipment costs or withhold income taxes, unemployment compensation, and unemployment taxes.
How does misclassification impact workers?
Misclassified independent contractors work without the legal protections typically afforded to employees. Legal protections include minimum wage and hour laws, workers’ compensation, and unemployment insurance, also known as unemployment benefits.
In the US, misclassified workers will have to pay all their Social Security and Medicare taxes themselves.
How do you know if a worker is misclassified?
The best way to know if a worker is wrongly classified is to look at the worker’s relationship with the company. Employees and contractors have distinct differences in how the work is performed, how they’re paid, and their responsibilities.
Type of relationship: Employees of a company typically work for a single employer who has financial control over how they pay the worker. The employer withholds payroll taxes on the employees’ salaries.
Independent contractors are self-employed, often work for multiple clients at a time, and send invoices to get paid. They pay their own income tax and self-employment taxes because they aren’t on the company’s payroll.
Control over the work: Employers directly supervise their employees’ work and control what tools, equipment, and workflows they’ll use.
Independent contractors choose their own tools and decide how they will complete the work.
Work hours and oversight: Employees typically have a fixed working schedule.
Independent contractors choose when they’re going to work.
Expertise and training: Employees receive training and long-term career development from their employers.
Independent contractors typically pay for their own training and skill development.
Government regulators such as the department of labor use and provide a range of tests and questionnaires to determine whether an employee is misclassified.
In the US, the Internal Revenue Service (IRS) has created the 20-part test, commonly referred to as the “Right-to-Control Test,” to evaluate who controls how the work is performed.
Businesses should use these tests to ensure they have not misclassified workers. In addition, companies should take steps in their internal processes and contracting arrangements to prevent future misclassification of workers.