Nearly 20 years ago, a famous legal case changed the stakes for self-employed professionals, corporations, and staffing agencies. In Vizcaino v. Microsoft, a group of independent contractors filed a class-action lawsuit against the software giant for failing to give them certain employee benefits like overtime pay and stock options.
These workers, ostensibly hired as independent contractors, worked in positions of indefinite duration side by side with full-time Microsoft employees and were supervised by the same managers. Some were paid by Microsoft and others by third-party agencies. In both arrangements, the workers were not eligible for paid personal time off, participation in stock-purchase programs, or participation in Microsoft’s 401(k) program. Most of them were paid on a 1099 tax basis, with no money withheld for taxes or Medicare; some were paid on a W-2 basis by a third party. The workers typically signed contracts waiving their claim to the perks and benefits due regular Microsoft employees.
After audits, judgments, and appeals based on Internal Revenue Service rules as well as state and federal labor law, Microsoft settled the case for nearly $97 million. Even for a titan like Microsoft, that’s a boatload of money. Those wronged workers, deemed “common law employees,” won the battle, but two decades later legitimate independent, self-employed professionals like us are still dealing with the fallout.
Since Vizcaino v. Microsoft, companies have become gun-shy about hiring independent consultants, contractors, and freelancers as independent workers. They have developed labor procurement policies and vendor compliance processes that shoehorn independent workers into W-2 work arrangements through third-party intermediaries.
In response to fluctuating business needs, companies want to shrink and expand their headcount quickly and with minimal administrative burden or compliance risk. They also want access to specialized expertise and high-level talent they can’t afford to keep on the payroll long-term. Staffing agencies promise to minimize the administrative burdens that go along with sourcing, recruiting, and onboarding. They also claim to relieve companies of many of their legal and financial responsibilities for the workers.
Self-employed professionals want flexibility to attain better life-work balance and maximize their income, savings, and tax deductions. Like a wolf in sheep’s clothing, staffing agencies promise to relieve independent consultants of arduous tasks like marketing, branding, prospecting, negotiating, and billing. However, this comes at a significant price.
Staffing agencies and contingent workforce management companies like Allegis Group, MBO Partners and PRO Unlimited have seen their market mushroom into a $120-billion industry since the Microsoft settlement. They shrewdly expanded their service offerings to corporations, playing upon the corporate fear of a lawsuit similar to the Microsoft case. Long associated with placing temp workers like administrative assistants and data-entry personnel, the staffing industry did a major rebranding to become a “contingent workforce partner” and “one-stop shop for the extended workforce.” Today, companies believe staffing agencies to be capable of finding highly skilled workers, and they rely on these companies to handle their employment compliance processes. (See Vendor Compliance for more information.)
The problem? The staffing agencies make a lot more money when they pay a worker on a W-2 tax basis than if the worker qualifies as an independent contractor, sometimes as much as 18% more. And, as explained in our companion article "1099 vs. W-2 Tax Status" the consultant ends up making less money and paying more income tax.
Client companies are overpaying like a bride-to-be hiring an expensive wedding planner. They’re paying a premium for the convenience of outsourcing everything to a staffing agency (generally 15-20% on top of the worker’s pay) and they aren’t even fully mitigating their employment compliance risk. (It gets complicated but joint-employer liability still remains, even if a worker is paid on a W-2 basis through a third party.) Furthermore, by forcing nearly all non-employee workers to bill through a staffing company, companies often miss out on the truly seasoned, expert talent who refuse to be paid on a W-2 tax basis. (See Friends Don't Let Friends W-2TM.) Many professional freelancers and consultants won’t take W-2 contracts because it’s not worth jeopardizing their tax deductions and better retirement savings plan.
And professional independent consultants? Without independent contractor status that allows us to be paid on a 1099 tax basis, we’re hamstrung from building truly successful independent consulting businesses in two ways.
First, once you’re paid on a W-2 basis it becomes a downward spiral. One of the criteria for qualifying as a legitimate independent business is having simultaneous clients. This means providing proof of other clients such as invoices and contracts. When you’re paid on a W-2 basis you don’t have these things, and you can’t supply W-2 statements as proof because they are evidence of an employee relationship, not an independent business.
Second, it’s especially difficult for us to get on a company’s preferred vendor list because the hurdles are too high. For example, many vendor compliance programs require that a business have five or more employees. (Why this is a requirement is unclear since it has nothing to do with being a legitimate business.) Actually, this hurdle is bad for the client too; they’re missing out on more reasonably priced consulting talent.
Professional independent consultants can enjoy a wonderful way of life. We use our talent and expertise to help companies solve problems and to make their employees’ jobs more productive and satisfying. We get to escape the commute, the cubicle, and the tyranny of the time clock. We often make more money than we did in staff roles, and we can save more for retirement. If we’re smart, our effective tax rate is lower too.
It’s independent contractor status that makes most of this possible. Don’t let the staffing agencies push you down the W-2 path or lure you into “corporate services” programs where you’re paid as a W-2 employee of your own company — and you pay them 5% for the privilege. Ask your tax professional if an S-Corp structure makes sense for you and, if so, set it up yourself instead of paying an agency 5%. That might not sound like much, but if you bill $150,000 a year that adds up to $7,500. Instead, do the research, get informed, be smart, and keep that money for yourself!
Several times a year, PICA offers a webinar called "Successfully Navigating Vendor Compliance." Keep an eye out for it on our calendar.