The Definitive Employer Guide to Worker Classification

Worker classification is more than just a legal formality. It’s how your organization determines whether individual team members are entitled to essential benefits and workplace protections.

If you misclassify workers and deny them these rights, your business could face serious legal and regulatory consequences. What’s more, you could suffer significant reputational harm as employees, partners, and customers lose trust in your brand.

The challenge is that the distinction between employees and independent contractors isn’t always clear. While your company may have good intentions, you might misinterpret the legal criteria and unwittingly violate local laws.

Our guide covers all the issues surrounding employee misclassification to help you maintain compliance and a strong employer brand. We explore how to classify workers correctly, the legal consequences of misclassification, and some examples of classification criteria from different countries.

What factors dictate worker classification?

Worker classification is typically determined by a combination of factors concerning your business and financial relationship with individual team members. Below, we outline the most common factors and what they mean for employees and freelancers:

Are there only two worker classifications?

Not always. Some countries recognize a third category that acts as independent contractors but still qualifies for certain protections, such as minimum wage, time off, and rest breaks. They might operate like freelancers, but the government treats them as employees for tax purposes. In the US, this category is called “statutory employees” while the UK refers to them just as “workers”.

However, this worker classification is rare and often only applies to specific categories. For example, the IRS only names four types of workers eligible for statutory worker status: drivers, insurance sales agents, full-time salespeople, and piece workers.

If you’re unsure whether someone falls into this category, seek legal counsel or use open resources like the UK’s Check Employment Status for Tax (CEST) tool.

For absolute certainty, use a global service like Deel Contractor to classify workers. All you need to do is answer a few questions about the individual and your business, and we will send you an indication of their employment status.

What are the consequences of misclassifying workers?

The consequences of misclassifying workers depend on the local labor laws and the nature and degree of the violation. Here are all the possible repercussions to be aware of:

• Repayments: In most cases, you must address any unpaid taxes, wages, and benefits for misclassified workers upfront
• Audits: Your business may become subject to extra government scrutiny, tying up many of your processes in bureaucracy
• Penalties: You may receive a penalty for each offense. For example, in the US, the IRS charges you up to 20% of the total unpaid amount for late payroll tax withholdings
• Prison time: In particularly severe or repeated cases, leaders could face criminal charges and jail time
• Lawsuits: Workers may file individual or class action lawsuits against your company for lost wages and denied benefits. For instance, two drivers successfully took Uber to court with significant ramifications for the entire company
• Reputational harm: If worker misclassification becomes public knowledge, it can damage your employer brand and erode trust with employees.

How to avoid misclassification risks

Misclassification isn’t always intentional. Sometimes the relationship between a contractor and a client company can become blurred, especially with long-term contracts.

You can minimize the risk of worker misclassification by getting proactive and using the following strategies:

Create thorough independent contractor agreements

Ensure your independent contractor agreements comply with all the relevant classification laws. They should align with the country’s definition of a freelancer and reinforce the worker’s rights and responsibilities. Should employees ever file a misclassification suit, these agreements can serve as legal evidence to support your case.

If you use Deel to manage contractors, we can handle all the paperwork for you. We generate compliant contracts with laws in over 150 countries to protect your company from misclassification risks.

Train hiring managers and team leads

Independent contractor agreements only work if you treat the worker as an employee. You must check that anyone dealing with your freelancers never breaches the terms and conditions in place.

Running mandatory training sessions can help you guarantee everyone understands the risks and never exerts too much control over how independent contractors perform their work. Make sure you organize any sessions by location. As classification laws vary across countries, what applies to one team might not be true for another.

Outsource to a trusted third-party

Use a Contractor of Record (CoR) service like Deel to hire independent contractors on your company’s behalf. We not only manage the administrative process but also assume all legal liability for tax compliance, classification, and more.

CoRs are ideal for small companies with limited resources or mid to large-sized companies looking to scale hiring fast. We offer you our resources for a fixed monthly fee, including our advanced payroll technology and team of global compliance experts, to enable you to focus on growth and strategy.

Run regular misclassification audits

If your company works with several independent contractors, run worker classification audits at least once a year. Reviewing your team’s status will help ensure nobody’s drifting toward employment status.

In the following section, we’ll explore five methods you can use to evaluate your company’s working relationship with team members.

5 ways to determine worker status

Each country sets its own criteria for employment. While these vary across jurisdictions, most systems assess similar factors.

Here are five common tests you’re likely to find relevant no matter where you hire:
Alternatively, download Deel’s three tests to determine worker classification for actionable guides.

Finding a reasonable basis

Consider whether there’s a reasonable basis or a precedent for considering workers to be independent contractors. In this method, you focus on how the government looks at workers in similar situations rather than the specific relationship between you and individual team members.

Note that the reasonable basis test is best used as a starting point. It’s only used as an official method by a few countries, namely the US, and even then, it’s rarely considered sufficient grounds to classify workers.

Analyzing the economic reality

Gauge your workers’ status based on the level of economic dependence they have on your company. If they source all their income from your business, they’re likely to be considered an employee.

You can consider whether:

• The worker’s services are a core business activity
• The relationship between you and the worker is permanent
• The worker needs to invest in facilities and equipment to perform the job
• The worker has opportunities for profit and loss based on company success

Economic reality tests usually form part of larger official assessments. For example, South Africa and Australia have made it one of the core criteria of their worker classification systems. However, they tend to carry a lot of weight — South Africa even states that a lack of multiple clients is “near conclusive”.

Only the US Department of Labor (DOL) uses an economic reality test as a standalone assessment. They use it to determine whether workers should receive benefits such as minimum wage and time off under the Fair Labor Standards Act (FLSA). Likewise, this test forms the basis of many state wage and hour laws across the United States.

Comparing multiple factors

Complete an official questionnaire that examines the nature of the working relationship based on different criteria. Many countries have a version of this method, including the UK, Canada, and Japan, although the most well-known is the 20-factor or common law test in the US.

These tests are typically very thorough and cover many aspects of your agreement, such as:

• Whether the employer controls where, when, and how the worker completes their work
• Whether the employer provides the worker with training, tools, and equipment
• Whether the worker has multiple clients or works for a single employer
• Whether the employer reimburses the worker’s business expenses

Meeting multiple criteria

Check that the working relationship meets most, if not all, the criteria for independent contractor status. Generally, that means:

• Being free to organize their own working hours and methods of work
• Doing the same type of work for other client companies
• Accepting work outside of the client’s regular business activities

This type of assessment is popular across many US states, including New Jersey, California, and Connecticut. They typically call it an ‘ABC test’.

Requesting an official audit

Ask the relevant authorities to classify your workers. Many countries allow individuals and companies to request an official audit when their teams fall into a legal gray area. For example, you can file Form SS-8 in the US to formally ask the IRS to come and determine a worker’s status.

If you’re unsure how to submit this form, a hiring company is permitted to do so on your behalf.

What steps to take when you misclassify a worker

If you unintentionally misclassify a worker and only realize later, there are steps you can take to correct your mistake. You may incur some extra costs, but acting quickly can significantly reduce the potential damage:

1. Assess the scope of the issue

Conduct a thorough internal review to see how many workers are affected and for how long. As the laws differ across jurisdictions, also note their locations.
Then check which of the following the misclassification is likely to have impacted:

• Tax withholdings
• Contributions
• Benefits
• Overtime
• Minimum wage

2. Calculate your total liabilities

Estimate all the back taxes, unpaid wages, and social contributions your company owes. If you don’t have the in-house expertise, you could outsource to professional accountancy services.

International companies should consider a global HR and payroll solution. When you partner with Deel, you get automatic access to hundreds of local accounting, payroll, and legal experts.

3. Voluntarily disclose your mistake

See if the country has a system to allow you to disclose your mistake and potentially receive reduced penalties. For example, the US has a Voluntary Classification Settlement Program (VCSP) and Canada has a Voluntary Disclosure Program for some businesses. Note that you’re unlikely to be eligible if concerns about your worker’s employment status have already triggered a government audit.

4. Inform the worker

Let the worker know about the issue and discuss the next steps to take. They may wish to amend their independent contractor agreement so they can continue working autonomously. However, they may be just as willing to accept an offer of employment with your company.

During this meeting, you can explain how misclassification has impacted them and when they’ll receive any compensation owed. You can use a global payroll solution like Deel to make instant, one-off payments anywhere in the world to resolve the issue promptly.

Are there any protections for contractors?

Freelance status doesn’t necessarily mean your workers have no entitlements. Many countries have given independent contractors benefits and protections to protect them from potential exploitation.

Here are some examples from different places to give you an idea of what to expect:

• Spain: Contractors who receive at least 75% of their income from a single client are entitled to employee benefits. They must register as a TRADE (Economically Dependent Self-Employed Worker)
• Italy: Some certain continuous collaborators (co.co.co.) are entitled to benefits like paid time off and termination notices under the Self-Employed Worker’s Act
• Australia: Contractors may require you to withhold and remit Pay As You Go Tax under certain circumstances in the country
• New York: The state introduced a set of protections for independent contractors known as the Freelance Isn’t Free Act, which includes the right to a written contract and timely pay

Struggling to keep up with local requirements for freelancers? Deel’s Continuous Compliance Hub can keep you updated about any current or future regulations that affect your business.

Additionally, Deel Global Payroll can help you manage contractor payments compliantly. We handle invoicing, currency conversions, and international transfers according to the relevant laws. All your freelancers need to do is complete a few steps to get onboarded onto the Deel platform and review their payments.

How do workers report a business for misclassification?

Local governments often give workers multiple ways to check their classification and report businesses. They often provide information on a dedicated webpage.

For example, in the UK, individuals can contact Acas or Citizens Advice for information and support. The government website encourages individuals to first speak with the hiring company to resolve the dispute. If both parties still disagree, the worker can make a claim to the Employment Tribunal.

In the US, individuals can use IRS Form 3949-A to report a business for misclassification. The form collects information about the individual and company you suspect has violated tax laws by misclassifying the worker.

Get classification right every time with Deel

Whether you’re a worker trying to determine your classification or a business owner looking to expand your global team, Deel is here to help.

Deel Contractor can assist with hires by classifying workers, generating compliant local agreements, and collecting all the necessary paperwork. You can onboard independent contractors from virtually anywhere within days instead of weeks.

If you need extra security, Deel CoR can hire independent contractors for your company and eliminate all compliance risks. Deel acts as the hiring entity to absorb all legal liability.

Where countries have strict requirements for freelancers, Deel Global Payroll can help you comply through our invoice management and payments. Our platform even supports benefits for independent contractors.

Ready to hire more independent contractors and scale your global team? Book a demo to see Deel in action.