Companies that work with independent contractors enjoy tremendous benefits—and take on sizable risks. When companies misclassify workers as independent contractors rather than employees, they open themselves up to devastating financial and operational consequences.
Compounding the problem is the fact that there is no one set of rules that determines whether a worker is an independent contractor or an employee. Contractor qualification laws vary tremendously between different U.S. states and from country to country. In Spain, for example, companies must provide benefits to an independent contractor that spends 75% or more of their time working with one client. Other countries have different standards separating independent contractors from employees.
HR teams must go through the lengthy and complicated process of researching worker classification laws in new markets—or risk severe fines, legal fees, and reputational damage that leads to lost business opportunities.
Companies Turn to Independent Contractors More Than Ever
Despite the risks, companies engage contingent workers more than ever. Contingent workers include freelancers, consultants, seasonal workers, and other temporary or on-demand professionals.
A study by McKinsey Global Institute reveals that 20 to 30 percent of the working-age population in the United States and the EU-15 (a selection of countries in Europe)—or up to 162 million individuals—engage in independent work. The study also confirms that the increase in contingent work is fueled by factors such as new digital freelance service platforms and rising demand from consumers and organizations.
Contingent work arrangements give companies the ability to hire the right talent at the right time, so they have the flexibility to get the skills and availability they need. At the same time, workers enjoy increased job mobility. One way companies take advantage of contingent work arrangements is by engaging independent contractors.
How Do Independent Contractors Differ From Employees?
Independent contractors generally have more autonomy than employees. They decide where and when to work, and they cannot be held to a schedule, use significant company resources, receive skills training, or work exclusively for one company. However, independent contractor rules are highly complex and constantly changing. HR teams have a hard time keeping up with evolving requirements, especially if they engage contractors in multiple markets.
While many countries have similar standards, in some cases classification will vary and the enforcement of these rules may be strict. In general, classification depends on the allocation of the worker’s time and methods to determine if they are contractors or employees.
Some HR teams mitigate risk by classifying their workers as employees rather than independent contractors. To better understand which choice is better for your business, let’s look at the pros and cons of hiring independent contractors, with a particular focus on HR teams that need to quickly hire workers internationally.
Pros of Using Independent Contractors
The following are some advantages of engaging independent contractors:
- Save Money: Companies typically pay higher wages to employees than they pay to contractors. Hiring an employee requires additional expenses like payroll taxes, health insurance premiums, employee benefits, office space, and more. In the U.S., additional employee expenses can add at least 20 to 30 percent in costs to a typical employee’s salary.
- Remain Competitive: Amidst a tight labor market, companies engage independent contractors to broaden their talent pool and find the workers they need to stay ahead of the competition.
- Increase Flexibility: Engaging independent contractors gives employers the ability to assemble teams on their schedules. Employers engage independent contractors for a specific project and offboard them when they complete their independent contractor agreements. There are usually no additional legal steps required to terminate employment, nor any need to consider unemployment payments, health insurance continuation, or other obligations that employers must pay attention to when terminating an employee. The easy offboarding of independent contractors is especially valuable in foreign markets, as many countries force companies to meet complex legal requirements before terminating employees.
- Boost Efficiency: Independent contractors have specialized skill sets and require little training to be productive immediately. Employers that engage contractors can seek out the unique skills they need to address their specific business needs.
- Reduce Liability: Employers must offer numerous benefits to employees, including sick leave rights, minimum wage, workers’ compensation for an on-the-job injury, protection from employment discrimination or wrongful termination, and more. Companies that do not offer these benefits risk legal repercussions and fines. Employers do not owe the same benefits to correctly classified independent contractors, thereby reducing their risk of related lawsuits.
When Using an Independent Contractor Is Better: Engaging independent contractors is advantageous for companies that have a temporary need for skilled workers and do not want to assign extra work to current employees. For companies building a global workforce, independent contractors also give employers the ability to test out markets with minimal commitment. Many countries require companies to establish a business entity before hiring employees. Companies avoid the lengthy, costly, and inflexible entity establishment process by engaging independent contractors or working with an Employer of Record (EOR) company to legally hire other workers.
Cons of Using Independent Contractors
Despite the many advantages, engaging independent contractors also presents the following challenges:
- Less Control Over Workers: Independent contractors work autonomously, deciding for themselves how best to accomplish tasks, with what tools, and in what timeframe. Employers that want significant control over their workers must classify those workers as employees.
- Workers Come and Go: Most employers use contractors as needed for specified projects. Once the project is complete, independent contractors take on additional assignments or move on to other work. Also, since contractors work for multiple employers, they may not be available for a company’s next project. Some employers find this uncertain availability disruptive. Companies that want to consistently rely on the same workers must hire employees.
- Increased Liability for On-the-job Injuries: Employers must use their insurance to cover employees’ on-the-job injuries. In the U.S., this practice is called workers’ compensation insurance. Under worker’s compensation insurance, employees waive their right to sue their employers. On the other hand, most independent contractors are not covered under their employer’s insurance, nor do they purchase their own. As a result, they can sue their employer for damages related to injuries suffered on the job.
- Loss of Copyright Ownership: Unless explicitly indicated in the independent contractor agreement, a contractor owns the copyright for the intellectual property (IP) he or she creates on the job. Conversely, employers usually own any IP that their employees make, giving them more ownership over sensitive information.
- Risk of Worker Misclassification: Government agencies in the U.S. and abroad are constantly on the lookout for companies that misclassify workers as independent contractors, whether intentionally or unintentionally. These companies must be aware of the extra scrutiny that comes with engaging independent contractors—and the heavy costs associated with worker misclassification:
- In the U.S., a business must pay the IRS back taxes, interest, and a penalty of up to 35% of the tax bill for each misclassified worker.
- The IRS also fines corporations up to $500,000 for intentionally misclassifying workers as independent contractors.
- U.S. employers also risk fines from the Department of Labor and state unemployment offices.
- Companies operating in foreign countries must contend with various local agencies, all of which impose their own fines, penalties, or outright business bans.
- If a contractor is reclassified as an employee, your company will need to find a way to run payroll and meet all of the employment regulations around benefits, leave, social contributions, and tax withholding.
Mitigate Risk With The World’s Leading Compliance Experts
Engaging independent contractors offers companies tremendous flexibility and cost savings, but employers must ensure their workers are accurately classified—or risk the high costs of noncompliance.
Because employment laws and regulations vary significantly between U.S. states and world markets, HR, legal, and finance teams must carefully focus on the nuances between markets. Employers reduce liability by relying on global employment partners to engage, manage, and pay workers. Finding and vetting service providers, however, is its own time-consuming HR burden. That’s where Velocity Global comes in.
Velocity Global ensures local independent contractor compliance in over 185 countries worldwide. By working with Velocity Global, companies use one partner to manage and pay every independent, remote, and contingent worker in the U.S. and around the globe. Reach out today to learn how Velocity Global helps you ensure workforce compliance wherever you do business.