The Cost of Misclassifying Freelancers: What’s Really at Stake

By Cristin Monnich, Head of Global Compliance Strategy & GM of AOR at Worksuite

Why This Matters Now

There’s a common myth I run into often: that worker classification is just about filling in the right tax form or checking a box at onboarding.

One of the most common missteps I see companies make is fixating on a single factor—like a contractor’s TIN type or business structure—as their guiding compass for worker classification. When working with new clients, I often hear that they rely on whether the contractor  has an employer identification number (EIN) or has submitted a W-9 as justification for treating them as an independent contractor. While simple and convenient,  this approach is unfortunately deeply flawed and inaccurate.

Across countries and jurisdictions, the classification test isn’t about checking a box or relying on surface-level paperwork. It’s about evaluating the totality of the relationship—both what’s written in the contract and what happens in practice. To properly balance the scales, you must consider the full scope of the working relationship: who controls the work, how it’s delivered, and whether the contractor operates with true independence. Anything less is a shortcut that can lead to dire consequences.

The Risk: What Happens When You Get Classification Wrong

1. Back Taxes, Penalties, and Interest

If a contractor is reclassified as an employee, your company retroactively becomes the employer, and can be held liable for a variety of situations. This includes, but is not limited to unpaid:

• Payroll taxes (Social Security, Medicare, unemployment insurance). 
  
  Hot Tip: Did you know that when an independent contractor is reclassified to employee status, the employer is now responsible for both the employer contributions, and any unpaid taxes that should have been deducted from the employee?

• Employer contributions to benefits or pension plans
• Fines and interest, often calculated retroactively

In the U.S., this can mean up to $25,000 per misclassified worker in fines, or staggering legal settlements in Class Action lawsuits. In markets like Germany or France, where social contributions are mandatory, the totals can be even higher.

2. Audit Exposure Across Agencies

Misclassification doesn’t stay siloed. In the U.S. alone, a reclassification by the Department of Labor can trigger a ripple of audits across:

• IRS
• State labor departments
• State tax agencies
• Workers' compensation boards

And outside of the U.S., cross-agency collaboration is growing. If your contractor classification model fails under one country test (like the Netherlands false-self employment regulations), this information could be shared with other EU member states where similar engagements exist.

3. Lawsuits and Class Action Risk

Misclassified freelancers may be entitled to:

• Overtime pay
• Minimum wage
• Health or leave benefits
• Reimbursement for business expenses

If one contractor sues, others may follow. A class-action lawsuit is potentially the worst-case scenario when considering the financial liabilities associated with worker misclassification. In these scenarios, companies most often settle quietly outside of the courtroom to avoid additional headlines and scrutiny. I’ve worked with clients who narrowly avoided six- and seven-figure litigation because they corrected course—before being forced to.

4. Loss of IP or Confidential Data

If your contract doesn’t include valid IP assignment—and the individual turns out to be an employee under the law—your company may not legally own what they’ve created.

This is a massive issue in M&A due diligence, where clean IP ownership is non-negotiable. I’ve seen deals delayed (or discounted) over it.

5. Reputation Damage and Public Disclosure

Several U.S. states (California, Massachusetts, New Jersey) now publish lists of companies fined for misclassification. That’s not just legal exposure—it’s reputational damage.

And if your organization positions itself as worker-centric, this kind of exposure can erode trust inside and out, tarnishing your brand as an employer.

Why It’s So Easy to Get Wrong

Most teams don’t set out to misclassify anyone. The problem is that the rules are fragmented—and evolving.

You may be dealing with:

• The ABC test in California (or another modified version of it in other states)
• The Economic Realities Test at the federal level (poised for a change any moment now)
• IR35 in the UK
• Platform Work Directive in the EU

And those rules don’t just look at the “right of control’ or what the contract says. They focus on how the working relationship actually functions or the “de facto relationship.” Here are a few examples of commonly analyzed factors :

Even one or two misaligned factors could tip you into “employee” territory.