March, 17 2010
1099 Risk Profiling: Three Types of Independent Contractors
Posted by Dave PuttWho are independent contractors, and what are some of the risk profiles for 1099s? Good question. It’s one I get all the time. I find that there are generally three prototypical people that become independent contractors.
The Real Independent Contractor (IC)
The first person truly wants to be an entrepreneur. She invests in her business and knows it is important to buy the proper business insurances (E&O, General Liability), develop marketing strategies, and in general think of her client as a client and not an employer. She understands the 1099 laws and wants – at all cost – to preserve her independent status as a consultant.
The Temporary Employee Working On A Contract Basis
The second person is an employee-minded person who becomes an independent contractor on a 1099 contract when a single engagement requires it. She thinks of the client as her employer, she thinks of the work as a temporary job (or temp to perm), and has no long term entrepreneurial aspirations. Running a business is the furthest thing from her mind, and she may not be entirely clear about the meaning of being paid on a 1099 agreement.
The Game Player
The third person is an opportunist; she becomes an independent contractor for perceived financial or tax advantages, but she would abandon this status if it became more financially beneficial.
This last category of person is the most dangerous type. She is more than likely playing games with her income and applying illegitimate expenses to reduce her taxes beyond allowable levels. She would be the first to claim unemployment benefits against the client if that client cut her contract. She would file a Workers Compensation claim against the client if injured on client business and she didn't have coverage. Finally, she would happily enroll in a class action suit (a la Vizcaino vs. Microsoft) if there was a compelling financial benefit.
Unfortunately, this last category of 1099 worker is more common than procurement departments allow themselves to believe.
Safe 1099 Engagement & Independent Contractor Compliance
Sure, there is risk associated when you engage with any consultant or independent contractor. But IC's are valuable and usually highly skilled, and are a fact of the way work is now performed in our "project economy." Fortunately, our independent contractor compliance program has an answer for each category. True entrepreneurs pass compliance tests easily, and simple 1099 vetting, with a readily available audit file to maintain compliance, should do.
Those who should be employees can be payrolled as W-2 employees, case closed. There is no reason to have them working on a 1099 contract, and that independent contractor agreement is just a worthless piece of paper. Contractor payroll companies abound that can handle this more traditional situation of contract talent.
And finally, those who are independent consultants for the financial advantages will fail our compliance assessment, but generally embrace our MBO Exec model and can be converted into safe, compliant consultants on a W-2, still able to take advantage of the sole-proprietor tax breaks, still able to work as de facto independent consultants with multiple clients, and covered with the correct insurances like Worker’s Comp. By setting them up with the appropriate coverages like Errors & Ommissions, General Liability, a Crime Bond, Unemployment Insurance, Worker's Compensation, Disability, Life insurance, a rich benefits package with a 401(k), medical, and so forth, you can strongly mitigate the risks that would otherwise be associated with engaging this kind of consultant.
In that process, abusers are exposed. Our program offers non-compliant independent consultants the same tax advantages afforded to legitimate small business, but requires full tax compliance. If we see pushback in this regard, it usually indicates some untoward business practices.
Round Up Maverick Spend Through High Program Adoption
Albeit overused, the Shakespearian quote applies to the last group: “The lady doth protest too much, methinks.” Those that wish to use independent contractor status as an illicit tool for tax evasion are the most likely to fight a compliance assessment. In reality, these are the ones a compliance process should expose.
The conclusion here is this: if your independent contractor assessment program produces no noise, chances are it is not finding the risks. Look for a program that will be able to correctly sort and engage the various types of workers -- including Statement of Work (SOW) Consultants -- with a high adoption rate and eliminate maverick spend. If you can provide contractor engagement models that meet all the legal needs of an independent consultant while still delivering compliance, then the squeaky wheels who refuse to abide by the process can be labeled for what they are.
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Liz Greene at 03/28/2010 18:10:57
Dear anonymous, thanks for your comment about misclassified employees. I think if you re-read Dave's blog post you'll see that his second type is actually an employee, who thinks of the paying party as their employer and may not understand their tax status.
Dave's response to discovering that situation -- that someone being paid on a 1099 is really an employee -- is that the person should immediately be transferred to W-2 status.
Misclassification of employees as independent contractors is a problem. In some businesses it is an intentional shirking of the law as you state, and we agree this is unfair both to the worker and to companies that play by the rules. In other companies, especially larger and more complex enterprises, or sometimes in very small companies that don't have sophisticated HR practices, misclassification is not always intentional. In fact, since there is no straightforward test that determines proper classification, in many cases it is more of an art than a science.
Our position is that no person who is an employee, and believes they are an employee, should have independent contractor status forced upon them. We also believe arrangements should be transparent and a worker should not be surprised by their status at tax time. Various pending legislation around the country, including the current bill in Congress, would require clearer notification when workers are being treated as independent contractors, in part to reduce misclassification abuses.
Thanks again for commenting and reading our blog. Perhaps it is time to write a post about intentional misclassification and abuses because, as you say, this is a serious issue.