Jul 1, 2011
Authored By Jay Lash, Vice President of Market Strategies, MBO Enterprise Solutions
Two months ago, we published a Top Ten article titled “Top Ten Ways to Determine if You Have an Independent Contractor Compliance Issue: Understanding and Recognizing Misclassification Risk.” This prompted some readers to ask for the next logical step: once you know you have independent contractor (IC) risk, what should you do about it?
This Top Ten list does just that. As businesses move into the Project Economy, proper use of ICs is critical. If you suspect that your business may be using independent contractor engagement practices that heighten your risk profile, you need to arm yourself with an understanding of what today’s most forward-looking companies are doing to reduce their risk. The following ten best practices can mitigating or even eliminate risks associated with engaging independent talent.
1. Establish a consistent, centralized process to evaluate and on-board any IC.
The attention that regulatory authorities are giving nowadays to proper classification of ICs should be driving all businesses to revisit their IC compliance policies and procedures. A good place to start is to get a general understanding of your organization’s current IC classification and engagement procedures. What are you doing? Who’s doing it? How consistently is it being done?
It is important to understand the extent to which your current IC engagement/classification procedures are being followed. Where it is not being followed, attempt to determine if there are any common problems with or complaints about the current procedure that are motivating people to work around it. Once you know this, you can avoid creating the same problems when you institute a new procedure (as outlined in the remaining Top 10 items), thus increasing adoption and overall program success.
Any new process should not only include compliance and on-boarding mechanisms, but also the overall governance to ensure consistent execution of the policy (see below).
2. Disgruntled Independent Contractors
Your managers need to know your business’s policies and procedures for engaging ICs. But before writing your policy, you should evaluate the adequacy of your current program. Is it business-friendly and seamless to hiring managers? Is the talent you are engaging clear on what they need to do to be engaged properly? Has it been adopted adequately, or is it being avoided? How accurate are your classification determinations?
Your policy needs to clearly state what is to be expected in the IC evaluation process. Outline the baseline requirements for a qualified IC, such as insurance coverages and limits, contract language, billing instructions/payment terms, and more. If you are treating ICs similar to how your treat larger vendors (i.e., subject to the same qualification determination and insurance requirements), the policy should reflect that.
The policy should also specify that all IC assignments be governed by a guiding “Statement of Work” (SoW). It should empower hiring managers to initiate IC engagements by producing a SOW that follows a consistent format (including defined beginning and end dates, expected results or deliverables, and associated payment schedules).
3. Review vendor procurement practices to properly vet any small business including independent contractors.
Companies often pay independent contractors and small business providers through invoices and categorize them as “1099s” (after the tax form the company must file to reflect the payment). These small services providers are typically low in volume and are often not required to maintain the levels of insurance or contract terms of other larger vendors. This can cause problems when suddenly you’re faced with potential damages or lawsuits that would otherwise have been protected under the vendors’ General Liability of Errors & Omissions insurances.
It is important to review the practices associated with these vendors and try to create standardized requirements for all contracted vendors. It is a good idea to set some standard minimum levels of business insurance coverage. All of these important procedural changes should be reflected in your standard contracts, as discussed below.
4. Assess your IC contract template.
It’s easy for managers to get into the rut of simply digging up a standard IC contract template and sending it over to any new IC who comes along. This can be problematic for two reasons: 1) the contract language may not include the adequate protections, and 2) different managers may be working from differing versions of a contract template that has morphed slowly over time.
As corporate counsel, it is critical that you carefully review your company’s IC contract or contracts. First, be sure that the template requests their business’s name rather than their actual names. Also, ensure that they stipulate that the contractor should be charging a fixed price for his/her services rather than an hourly rate. Also, be sure to include a clause in the contract specifically identifying their status as an independent contractor and have each IC attest to this understanding through their signature. (While the existence of such a clause doesn’t make an IC compliant by default, it’s important to make sure they understand the expectations and limitations of your relationship.) Further, make sure you have a clause in your services contract that limits or prohibits sub-contracting where possible and be clear that your vendors are subject to periodic unannounced audits.
You should also implement a process that ensures the consistency of IC contracts enterprise-wide. Make sure that ICs’ payment terms and business insurance requirements are consistent for everyone – and never waived! Also ensure that non-disclosures, rights to inventions/intellectual property, and non-compete clauses are consistent and applicable. Finally, research existing contracts to make sure that certain vendors (often small local providers) aren’t “grandfathered” under outdated contracts that may include substantial exceptions from your new standard.
5. Evaluate your insurance and/or employee benefit plans.
Take a close look at your benefit plan documents. Do they expressly exclude groups that may be construed as contact-based workers? If not, you should modify them immediately. Only your W-2 employees may have rights to employer-sponsored benefits such as medical insurance, retirement programs, or stock plans.
It’s also wise to conduct an investigation to determine whether any of your existing ICs and small services providers are receiving any “employee-like” benefits. If so, get involved and make sure such benefits are no longer offered to these individuals.
6. Audit your 1099 population and review against your new policy for compliance.
Assuming it’s followed, your new IC engagement policy will help your business make giant strides toward gaining compliance – for incoming ICs. But what about your existing providers? Be prepared to conduct an audit of your 1099 population over a sample period (say six or 12 months). Don’t worry just yet about whether ICs are correctly classified – we’ll cover that in a moment. For now, simply determine roughly how many ICs you have engaged through your sample period, what are their common duty sets and business areas, and who (if anyone) made classification determinations.
Unfortunately, there’s no magic formula for conducting this population study. But a solid start includes looking at 1099s issued for the prior year and cross referencing your sample with the names of those issued badges for building access or computer systems access. You may also look at those who are filing their W-9 with a Social Security number vs. a Tax ID number.
7. Determine if you need an enterprise IC compliance program.
Without an external IC compliance specialist helping you out, it is very likely that your company is currently engaging misclassified contract talent. Obviously, you need to step in before the IRS, DOL, or state tax authorities do it for you.
First, determine if you can implement a consistent and effective IC compliance and engagement program internally (with or without additional staff, training or support), or if you should outsource this function. Procurement departments (which often own vendor compliance) are commonly short of resources and align the most talented and effective staffs with the highest spend dollars. That usually relegates vendors with under $500K or even $1 million in spend to less qualified staff members. You have to ask, “Does this group have the time, support, and training to make the determinations it is charged with?”
If not, assess the feasibility of augmenting these personnel with more staff, training, or support and closely monitor their decisions through peer review or a legal consultant.
A relatively new category of businesses – Independent Contractor Engagement Specialists – may be able to fill this need if you choose to look outside. They can take over the entire IC compliance and engagement process (adherent to your policy) and can serve as the employer of record for any ICs who are found not to be compliant.
8. Understand your risk profile.
Pick a randomized group of ICs from your sample period and conduct assessments to determine whether they are indeed compliant with regulatory guidelines. Be sure to be fluent in the criteria used by auditors to establish compliance status – not every IC will be clearly compliant or non-compliant and different authorities use differing criteria for determining compliance. (Again, an Independent Contractor Engagement Specialist may be helpful here.)
After evaluating your first sample group, you may need to assess another sample (or multiple samples) with the underlying goal of forming an opinion regarding the accuracy of your determinations. Remember that you must assess not just the individual, but also elements of his/her specific engagement before reaching a determination. In some cases, the same IC may be found to be compliant for one assignment and non-compliant for another.
9. Obtain executive sponsorship to drive program adoption and sustainability.
Driving any new IC compliance program from the legal in-house counsel is an effective approach. With sound legal judgment and support, it is usually easier to modify procurement/sourcing processes so new providers are engaged accordingly.
But that may not be enough. To achieve highest internal compliance with your new policy, insist upon the highest possible level of executive sponsorship. A business case can be made to get the “C-suite” involved. CFOs and CEOs find that the level of compliance driven by their involvement has huge value – especially if a financial event like an IPO or acquisition is planned.
10. Plan for change management issues and internal communication hurdles before launch.
The best plans can be easily derailed when the staff feels they were not included or consulted before major process changes. This change sometimes brings serious push-back and managers can feel they will be unable to complete their critical projects if their IC use is restricted or jeopardized.
It is best to over-communicate and allow time for the new policy and processes to be explained and built into the workflow. When referencing the reason for a change, it’s generally better not to mention the correction of a non-compliant process or even risk mitigation. You don’t want to suggest that something is wrong and that you are now correcting it. It is better to mention efficiency or process improvements as the drivers.
Although establishing a compliant IC engagement program may be challenging, the rewards are many: improved access to this critical talent, better visibility into your complete workforce, and, of course, dramatically less IC-related risk. Companies that find a way to embrace independent consulting talent without putting their organization at risk will have a distinct competitive advantage in the emerging Project Economy.