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The Ethical Side of Contractor Classification: Why It Matters

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Atlas Team

Atlas is a global tech company that spans over 160 countries, offering expertise and software built for the future of work.

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Published: 16 Jan 2024

Gig workers and contractors have become a massive part of today’s business landscape. With just a few clicks, companies can access specialized experts from around the globe without the hassle of hiring full-time employees. But in the rush to assemble on-demand talent, companies can unknowingly misclassify their employees as "independent contractors" and gloss over the ethical and legal mess this creates. 

While organizations may take calculated steps to classify employees, they could still stumble into this pitfall unintentionally. Regardless of whether or not it’s an accident, wrongly categorizing workers is unethical. Beyond eroding worker rights, employee misclassification can ravage corporate reputations, risk heavy lawsuits, and contradict the values modern companies claim to stand for. 

The Widespread Impact of Misclassification 

Despite an organization’s best intentions, mislabeling employees can ruin their reputation. It can signal that corporate interests outweigh fair worker treatment, even if the misclassification was unintentional. For big companies like Uber, for example, that rely on contract labor, news of questionable classification hits public trust hard. 

Beyond public image, misclassification also financially harms various groups. Contractors themselves can lose out on earned wages, overtime, insurance, and other worker protections they’d receive as official employees.  

Similarly, governments can also lose out on some tax revenue when companies misclassify employees as contractors. While contractors do pay income taxes, companies may avoid contributing payroll taxes for programs like unemployment insurance and workers compensation for misclassified workers. This deprives these government programs of the funding they would have received otherwise. 

 

Why Do Companies Risk Misclassification? 

For many, it comes down to pure economics. Payroll taxes, insurance premiums, HR administration, and other costs make employees radically more expensive than freelance talent. When an unethical company weighs potential fines against the huge savings from misclassification, risking legal issues makes financial sense in their minds.  

Meanwhile, other businesses can blunder into this issue unintentionally, failing to fully grasp the nuances in labor regulations across multiple countries. Global businesses working with international contractors typically struggle to classify talent appropriately as they try to navigate a maze of disjointed international compliance rules on their own. It’s an easy trap to fall into. 

Here are just a few of the common ways this accidental misclassification can happen: 

  1. Allowing contractors to use company email addresses, business cards, office space, or other facilities designated for employees. This can give the impression of an employment relationship. 

  2. Setting rigid schedules or imposing rules that limit the contractor's flexibility and independence in how work is performed.

  3. Renewing independent contractor agreements over and over for years, rather than project-limited bases. Long durations imply regular employment. 

  4. Failing to correctly withhold taxes or provide tax documents like 1099s to independent contractors in the U.S., for example. The different payroll tax treatment is a major legal indicator government agencies use to determine whether a worker is correctly classified. 

  5. Assuming global talent has the same contractor rules abroad as domestically without verifying local laws. Employment regulations differ greatly across countries, and employers need to have an adequate understanding of these laws before pursuing global expansion. 

 

A Better Path Forward 

Facing public pressure and regulatory crackdowns, businesses must address classification practices before their damage becomes irreversible. But this shouldn’t discourage companies from accessing the global talent pool. The key is adopting an ethical approach from the start. 

With guidance from an Employer of Record (EOR) specializing in global workforce management, businesses can expand their people operations abroad seamlessly without allowing the complexity of international HR to hinder their growth efforts. This is because an EOR acts as the legal employer, taking on risk and compliance duties so companies can ethically employ international teams. 

Not only does working with an Employer of Record make it easier to expand into international markets, but it also demonstrates an organization’s commitment to ethically hiring overseas talent. While subpar classification practices may offer short-term savings, the long-term advantages of integrity in contractor relationships inspire far more public and employee goodwill. It also attracts socially conscious talent and customers to your organization who will typically be loyal to your brand in the long run. 

  

Learning From Past Mistakes 

To give you a better understanding of how quickly a company can get penalized for misclassifying employees, let’s take a look at a few notable examples. 

Uber's classification of drivers as contractors rather than employees led to extended legal battles and negative publicity. Only after losing a multi-year UK Supreme Court battle in 2021 and vowing to classify 70,000 UK drivers as employees did the rideshare company change its UK driver policies to meet minimum wage and benefit requirements.  

And Uber isn’t the only company guilty of misclassifying workers. In 2016, FedEx agreed to pay drivers in 20 states $240m to settle lawsuits claiming the parcel delivery company misclassified them as independent contractors.  

Even more recently, Nike is facing potential fines of over $530 million for allegedly misclassifying thousands of temporary office workers as independent contractors instead of employees. Independent reviews found that Nike improperly classified about 25% of its over 3,670 contractors in the US, paying them over $1.2 billion over 3 years. This could result in $293.2 million in US tax fines. Similar issues were also found in the UK, Netherlands, and Belgium, bringing the total liability to over $530 million. 

Flirting With Disaster 

Many companies tread into questionable territory without realizing it—situations involving hiring former employees back as contractors merit extra scrutiny. While sometimes legitimate, converting employees to contractors primarily to avoid paying benefits will land most businesses in legal trouble. 

 

While prudent business leaders recognize that mislabeling contractors may generate immediate cost reduction, they also understand that it’s a ticking reputational time bomb certain to detonate eventually. And contrary to expectations, the financial payoff rarely justifies the risk once penalties and lawsuits hit. 

 

True Progress Begins With Ethics 

At its core, workforce classification symbolizes what an organization values most. In a climate where consumers, investors, and employees demand transparency and fair worker treatment, ethics can no longer take a back seat to efficiency and cost-cutting in contractor relationships. 
 
Want to ensure your classifying your employees correctly? Check out our recent whitepaper, “Are Your Independent Contractors Independent?” Here are some of the key insights you’ll gain: 

  • Understanding the criteria for contractor classification 

  • Navigating the risks of misclassification 

  • Taking control of your employee classification 

  • How Atlas can help you take the next step towards protecting your business and classifying your workforce correctly 

You can download the complete White Paper here.