In general, employees are told when to work, get benefits, and are provided with all of the resources required to complete their work. Contractors work their own hours (with the exception of meetings), do not receive benefits, and use their own resources (with the exception of access to company systems required to complete tasks). In both the US and the Philippines, the government has certain classification “tests” to determine whether someone is an employee or a contractor.

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Classification Tests in the US

1. Behavioral Control Test - the extent to which you tell the person how, when, and where to do the job. Close control of work (e.g. micromanaging) will always result in the US classifying the person as an employee. How to ensure the person is a contractor:
   • Avoid dictating how work is performed
   • Don't mandate specific work hours or location
   • Minimize supervision requirements
   • Allow the contractor to choose their own tools and methods
2. Financial Control Test - contractors invest in their own tools, advertise their services, and have other expenses related to running their business. Employees are paid based on hours worked or a salary, while contractors are paid for deliverables/completed projects. How to ensure the person is a contractor:
   • The contractor should invest in their business
   • Use project-based payment structures
   • Contractors manage their own expenses
   • They have the freedom to seek other clients
3. Relationship Test - employees often receive paid leave, retirement plans, or health insurance (but not always). Contractors do not receive these benefits. Contractors only work for a set period of time (e.g. until a project is completed). Contractors, by definition, also have a clear contract defining the relationship with the company. How to ensure the person is a contractor:
   • Both parties sign a written contract defining independent status
   • Clear project scope and deliverables
   • No employee-type benefits provided
   • Distinct business separation
   • Complete all “contractor” paperwork and processes (W-8 BEN, contract, track paid invoices, submit 1099 NEC if paid $600+/year)

Classification Tests in the Philippines

1. Selection and Engagement - Contractors are hired to deliver a specific deliverable or to work on a specific project. It is time-bound (not open-ended). Contractors may also work for multiple clients. Employees are hired for an indefinite period of time. However, this classification test seems to suggest that directly hiring a contractor (vs. using an agency) can complicate the relationship. How to ensure the person is a contractor:
   • Define and agree on the scope of work and specific deliverables
   • Specify an end date on the contract/work agreement
   • Document how the selected contractor was the best option due to specific competencies (knowledge, skills, attitude, abilities, experiences) directly related to the project/deliverables
   • Clarify “independent contractor” status in the contract
2. Payment of Wages - Payment to contractors is defined in their contract and is typically tied to delivery of work or completion of project milestones. Contractors submit invoices before payment. Employees receive regularly-scheduled payments, which are typically managed through a payroll system. How to ensure the person is a contractor:
   • Do not pay the contractor until after they submit a written invoice
   • Only pay the contractor based on the payment terms agreed upon in the contract
3. Power of Dismissal - Contractors are “terminated” when the contract is complete or if the contractor breaches the terms of the contract. Employees must go through due process (investigations must result in two documented warnings prior to termination) to comply with “security of tenure.” How to ensure the person is a contractor:
   • Include a termination clause in the contract
   • Only terminate based on failure to reach project milestones, breach of contract, or end of contract period
4. Power of Control - Contractors have a business that is distinct from the company and performs their tasks autonomously (without supervision) from the company. Even if there is a contract, if the job entails working specific hours or doing work a very specific way (especially if micro-managed), then that person is an employee.How to ensure the person is a contractor:
   • Do not tell them when, where, or how to do the work
   • Ensure that the contract specifies the deliverables in enough detail that you get what you are paying for - without micromanaging how they got there
   • Respect their autonomy and maintain professional distance (e.g. no daily scheduled meetings or check-ins)
5. Economic Reality Test - The worker is an employee if they are economically dependent on the company, meaning the company has been paying Government-mandated benefits (SSS, PhilHealth, Pag-IBIG) and has the employee listed on the company’s payroll (e.g. the company issues a payslip). Contractors own their own equipment, while employees are provided with tools (e.g. a computer). How to ensure the person is a contractor:
   • Allow and encourage them to solicit other clients, so that they are not exclusively dependent on you
   • Encourage them to register with the BIR, issue official receipts for services rendered, and pay their business taxes (by highlighting that they are their responsibilities in the work agreement/contract)

Consequences for Misclassification

In the US, when you classify an employee as a contractor, you will probably have to:

• Pay back wages and benefits that an employee would have received
• Pay tax penalties and withholding violation fines
• Pay legal fees and court costs
• Pay liquidated damages
• Deal with potential injunctions
• Actively manage reputational damage

In the Philippines, when you classify an employee as a contractor, you will probably have to:

• Pay court-ordered damages up to PHP 500,000
• Pay additional fines
• Serve a prison sentence for non-compliance with social security programs
• Pay back pay and benefits
• Pay interest feels and penalties until settlement

And

1. You should realize that Philippine courts tend to favor workers in classification disputes.
2. The burden of proving valid independent contractor status falls on you.
3. Classification regulations are subject to change, so you should consider consulting legal experts in both jurisdictions.

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By following these guidelines and maintaining proper documentation, you can minimize the risk of misclassification while successfully engaging Filipino independent contractors. Regular review of your arrangement against both countries' requirements will help maintain compliance over time. It is really not that hard, but if you are a micro-manager or you have a history of frustrating your employees, you might not want to hire contractors - in the US or the Philippines.

• Hire the right contractor
• Carefully outline expectations in a detailed contract/work agreement
• Trust, but verify deliverables
• End the contract when the contract ends

We hope that you found this newsletter informative. While we are not lawyers or accountants (nor do we play them on TV), we strive to provide information that is as accurate as possible at the time of writing. We also don’t have a preferred expert in either country, but some online resources are worth sharing. You should always seek out professional legal and financial advice from experts - not us!

Have a great week,

Coleen & Darin