What Is Co-Employment: Definition, Risks, and Workforce Management Tips

When two companies share responsibility for the same worker, that’s called co-employment. One company oversees the worker’s day-to-day tasks, while the other handles personnel matters like payroll and compliance.

Co-employment most commonly occurs when staffing agencies or talent solutions providers bring independent contractors on board for their clients. Because they share responsibilities, both the staffing agency and the client are considered employers of the contractor.

This arrangement might seem straightforward, but it operates within a complex legal landscape where mistakes can be costly.

What Are Regulatory Guidelines Associated With Co-Employment?

Co-employment operates within a complex legal environment. Making mistakes here can lead to audits, fines, or even lawsuits. Here are the major guidelines to understand:

• IRS test: Determines whether someone is an employee or contractor based on behavioral control, financial arrangements, and how permanent the relationship is.
• Fair Labor Standards Act (FLSA): Ensures proper wage and hour compliance. If workers are misclassified, they may claim unpaid overtime or benefits they should have received.
• State-Specific Tests:
  • California’s ABC Test: Contractors must (A) work independently, (B) perform tasks outside the hiring company’s main business, and (C) operate their own independent trade.
  • New York and New Jersey enforce stricter worker classification rules than many other states.
• Penalties: Misclassification can result in back taxes, fines, repayment of benefits, and legal fees.

What Are the Risks of Co-Employment?

Some businesses use co-employment to work with independent contractors without managing personnel tasks like payment and taxes. However, this arrangement doesn’t eliminate all risks—it can actually create new ones.

If an independent contractor claims they should be treated as an employee—or if an audit uncovers worker misclassification—both your company and the staffing agency could face penalties. This is particularly likely if contractors are working alongside full-time employees, reporting to the same supervisors, and using company equipment, which can make the relationship look more like employment than independent contracting.

It’s also worth considering that independent contractors come from various backgrounds and have different perspectives. Some fully embrace their independent status, while others may have reluctantly taken contractor roles due to market conditions. If a contractor feels their situation is unfair under a co-employment arrangement, your company could face significant compliance risks.

What Are Some Frequently Asked Questions About Co-Employment?

Q: Can co-employment be intentional?

A: Yes, and it often is. Some companies deliberately structure co-employment (such as staffing agencies) to share compliance responsibilities. Success depends on having clear contracts and well-defined roles.

Q: How does co-employment affect tax filings?

A: Typically, the primary employer (often the staffing agency or talent solutions provider) handles payroll taxes. However, if misclassification occurs, your company could be held responsible for back taxes or penalties.

Q: What industries face the highest risks?

A: Technology, healthcare, and professional consulting—sectors where contractor use is widespread—face heightened scrutiny from regulators.

Q: How can I tell if my company is in a co-employment situation?

A: Look for red flags such as contractors receiving training, following employer schedules, or being managed like full-time employees. Regularly auditing your contractor relationships can help you identify and address potential issues before they become problems.

Q: Do written contracts eliminate co-employment risk?

A: Not entirely, though they’re an important protective measure. Contracts must align with actual working conditions. If day-to-day practices contradict what’s in the agreement (like micromanaging contractors), courts may disregard the contract entirely.

How Does Co-Employment Impact Global Hiring?

Co-employment risks become more complex when working with contractors across borders:

Stricter Definitions

In the EU, workers are often presumed to be “employees” unless proven otherwise. Countries like Germany and France heavily favor worker protections.

Permanent Establishment (PE) Risks

Exercising too much control over foreign contractors could trigger PE status, which subjects your business to local taxes and penalties.

Regional Compliance

• Canada: Courts assess the “total relationship” between worker and employer.
• Australia: The Fair Work Act imposes harsh penalties for sham contracting.
• UK: IR35 rules determine tax status for contractors.

Always consult local labor experts before engaging international contractors to avoid unexpected consequences.

What Are Some Ways to Avoid Co-Employment Risk?

While co-employment arrangements can offer flexibility, proactive risk management is essential. Here’s how to minimize exposure to classification risks:

1. Properly Classify All Members of Your Workforce

Make sure you’re following federal, state, and local rules when classifying independent contractors. Tools like the IRS’s SS-8 form can help, and it’s smart to team up with compliance pros like MBO Partners for regular check-ins.

2. Ensure Proper Interactions With Independent Contractors

Let contractors decide when and how they work. Try to avoid requiring them to be on-site—unless there’s a solid reason, like security needs.

3. Educate Your Team on Compliance

Train your managers and staff on how to work with contractors the right way. They should know contractors aren’t employees, and shouldn’t be managed like they are.

4. Document Everything

Use contracts that clearly lay out what the project involves and how payment works. Keep good records, like invoices and communications, to protect your business and the contractors who work with you.

5. Partner With a Contingent Workforce Expert

Talent solutions providers like MBO Partners specialize in compliant contractor management. They offer end-to-end workforce solutions, including classification audits, contract drafting, and ongoing risk monitoring, to ensure your business stays protected.

When working with independent contractors, compliance should always be a priority. For more tips, check out our article, “How to Reduce Your Risk of Employee Misclassification.”

More Workforce Support and Resources From MBO Partners

If you’re looking for additional workforce guidance, MBO Partners offers a variety of tools and resources to help you build an effective program. We cover a wide range of topics, including workforce compliance and how to successfully incorporate independent contractors into your organization.

The information provided in the MBO Blog does not constitute legal, tax or financial advice. It does not take into account your particular circumstances, objectives, legal and financial situation or needs. Before acting on any information in the MBO Blog you should consider the appropriateness of the information for your situation in consultation with a professional advisor of your choosing.