10 inequalities between independent contractors and employees: Why classification matters

In our last post, we covered one of remote work’s tricky “gotcha moments”: treating remote workers as independent contractors rather than employees can cause many problems. The fact that many distributed companies still do it doesn’t make it right. The repercussions of doing so can be grave and damaging in financial, reputational, strategic, and ethical ways. It’s just not worth it.

In this post, we are zooming in on the last point we made: the inequality it creates among people within the company. Working as independent contractors leaves people feeling like second-class citizens in comparison to their properly employed counterparts in a variety of ways. I know that feeling all too well as I have experienced it first-hand.

The ability to work and hire remotely is a gift for everyone. Still, it has to happen in a compliant and legal way, for the benefit of all.

Having independent contractors instead of employees can often be a cost-saving mechanism. Opting to work with independent contractors could be in order to keep headcount low, have an easier way to replace people if necessary or as a mechanism to work with remote workers in a different country without a registered entity. Whatever the reason, feeling like a cost-saving mechanism is very demoralising to any human.

Full-time employees benefit from legal protection, rules, and regulations that govern the way in which they are employed. In a lot of countries, this also comes with the benefit of a social system. Most regular employees probably take them for granted. But the moment an individual becomes an independent contractor and loses them, they will miss them dearly. I probably didn’t think about them as much in my early twenties, but as I start thinking about family, home, children and security, I have started to understand how important they are. Without these fundamental benefits and protections in place, I would feel unequal and not as worthwhile to a company.

Let’s look into the ten most common inequalities independent contractors experience.

Employment grants a lot of statutory rights to employees. Pension, health care, social welfare, maternity and unemployment benefits are some of the most fundamental ones that exist in many countries. They all act as social safety nets for employees in a variety of important scenarios.

None of them extends to contractors, however. If a contractor has not been paying into the social security net and is pregnant, she will not have maternity cover aid from the government, which in some countries extends to up to two years. If she gets sick, she will not be able to avail herself of public health services free of charge. And, worst of all, when an independent contractor is let go, they may not be able to claim from the country’s benefit scheme (legislation in some countries is changing to avoid such dire situations, such as in Ireland, but it is a slow legislative process to put these laws in place). Redundancy packages that exist for employees do not apply to contractors.

Had they been an employee, the story would have been entirely different. While many US companies operate under “fire at will” states, where an employer can tell an employee, “Don’t turn up tomorrow, you’re done,” in much of the world, like my home country, France for example, employees have rights to be taken through a very clear and fair process, before a decision on termination is made. Government employment agencies would also have a process for determining the redundancy and last payment amounts, based on the period of time the person has given to the company. To a contractor, none of that applies.

One of the mistakes I made when I first started working remotely was that I didn’t think about the public services’ mandatory contributions that would protect me. I didn’t factor them in when I negotiated my pay. Especially in European countries, the contributions for healthcare, pension and other services could be up to 40% of the salary. Determining the total cost of being an independent contractor can be very difficult and left to the contractor. Full-time employees need not worry about any of this, as all these payments are already accounted for in their salary.

Some of the most important points in a country’s employment laws are regulations around the rate of employee pay. This covers minimum wage, overtime pay and hours of operation. Because the relationship is structured around a commercial agreement, and not an employment contract, there are usually no protections for the contractor when it comes to minimum compensation or terms of payment. This means that independent contractors and employees can be doing the same job, yet be paid vastly different amounts. Contractors may be paid much more or much less than employees, especially after all the taxes and contributions they need to make to the government. Pay disparity can lead to negative feelings between co-workers.

There is no question that it is hard to determine how much to pay people who work remotely in other countries. Even fully distributed companies such as Buffer have taken years to figure this out. Buffer has been very transparent about the formulae they use to determine how much everyone should be paid. One of the things their method used to take into consideration was the cost of living where people were based, but not the market rate present there. In 2016, they changed the formula to include both cost of living and market rate and included an elastic correction based on the location, making sure that there was no massive gap in the salary between someone working in San Francisco and Cape Town. They called it the Good Life Curve.

Even if paid the same as full-time employees, independent contractors have to take care of their taxes and appropriate contributions. There is a reason payroll is done by professionals. Figuring out what taxes need to be filed is difficult. That complexity falls on contractors to take care of: registering entities, working with independent accountants, dealing with banks and tax authorities, not to mention the paperwork, etc. All these come with the fear that they may not be doing it correctly, as failure to do it exposes the individual to significant penalties.

Another benefit that extends to full-time employees but not to independent contractors is proper public holidays and paid time off. They are usually not entitled to any, and it will be at the discretion of the company to offer contractors paid time off. If they do not, contractors may opt out of taking it as they will not be paid for it. That takes away from much-needed downtime. As employees go on holidays, contractors will either have to do so at their cost or work hard to negotiate a higher day rate.

Coverage for sick days off is another benefit that is available to employees in most countries. This varies from country to country, but for example, Dutch employees are entitled to 70% of their salary during the first two years of illness. In recent years, companies have been pressured to offer some sort of paid sick leave for contractors. However, if the illness is more severe and they have to be out of work for a prolonged period, the company may be unlikely to cover for that. Depending on the country, the contractor may not be entitled to any governmental illness or unemployment benefits either, putting them in an incredibly precarious situation.

Independent contractors get paid a certain amount each month, which is usually in the currency of where the company they contract with is based. At a former job, my contract was in US dollars. As the exchange rate went up and down, so did my “salary.” I never knew how much money I was going to get at the end of each month in the bank.

Even though I had a promotion, just because of the exchange rate, I didn’t always get to see the increase in my bank balance. It was particularly disheartening when that happened with expenses that I had incurred, such as a computer, flight, or accommodation. Exchange rates change, and it often happened that I wasn’t reimbursed for the correct amount.

In many countries, the definition of an independent contractor states that the individual must have several clients and sources of income. The reason for that is straightforward: it mitigates the risk for the self-employed.

In the Netherlands, for example, registered freelancers are expected to have a minimum of three clients per year. Yet often, companies will work with independent contractors on a full-time basis, making it virtually impossible for the contractor to comply with even fundamental regulations. Surpassing more than 70% of a contractor’s income from one client may result in the Dutch tax authorities viewing it as a traditional form of employment, which would subject the company to employer-paid tax and social security, as well as penalties.

This is an example of when an individual may be an independent contractor on paper, but is treated as an employee in practice by the company. This is called a worker misclassification, and it has significant repercussions for the employer. However, in some jurisdictions, contractors do not get out of that unscathed either. In the US, if misclassified, independent contractors might be required to pay certain taxes and will become ineligible for unemployment and workers’ compensation benefits.

Many independent contractors work from their homes or cafes, as they would have to bear the cost of using a co-working space or renting an office. As we mentioned in our guide to becoming a compliant remote company, workplaces have been regulated for decades to provide a compliant working environment from a health and safety perspective. Working from home does not take any of these into consideration and instead brings back to people a range of chiropractic, muscular, degenerative, visual, and auditory problems.

Thus, contractors are not only unprotected by healthcare benefit mechanisms, but they are also more exposed to a variety of issues. With the likelihood of them working more and not taking enough time off, this can quickly spiral out of proportion and impact their health directly.

Bike-to-work schemes, private healthcare insurances, private pension schemes, and many other benefits extended to employees are not given to independent contractors. Even if there is a willingness on the part of the company, there are no mechanisms to implement them if the person isn’t on the payroll officially. This is particularly problematic when it comes to individuals applying for a mortgage. While not technically a benefit, a mortgage is a tool for people to be able to buy a roof over their heads.

However, in many countries, it can be challenging for independent contractors to qualify for a mortgage. I would know, I tried last year. I had saved up a significant down payment and started looking for a house. I still needed to borrow money, so I applied for mortgages at a few different banks. All of them rejected me because I wasn’t an employee.

All these inequalities leave contractors feeling like second-class citizens with inferior rights. Understandably, it makes them feel pretty bad. That two-tiered system can quickly escalate into resentment and disgruntlement and can impact the entire dynamic of the company and its culture.

Well-resourced companies often establish a legal entity to directly employ people in different countries. However, this can be incredibly difficult, time-consuming and expensive.

Yet keeping the status quo and operating a mentality of business-as-usual in light of these inequalities is not good for business.

Changing that starts by openly acknowledging why you are working with independent contractors. Open a conversation, be honest and say you wish you could have them as employees, but cannot due to financial reasons. Offer an extra amount each month to contractors that would cover their healthcare and other benefits, would allow them to work with an accountant and would make sure they can save for unemployment.

None of this, however, fixes the problem long-term. For that, consider working with an Employer of Record, such as Boundless, so you can co-employ people legally and compliantly without having to open entities and take care of tax registrations in each country.