Most large corporations have a compliance process to screen their extended workforce to determine if the workers are contractors or legitimate micro-businesses. This makes sense — most “on-demand” or “gig workers” are not self-employed professionals running their own businesses and directing their own work. The big problem is that treating independent consultants as part of this extended workforce and paying them as temporary employees on a W-2 basis through a third party is a costly mistake. Here’s why:
1. Paying a consultant like a temp employee does not fully mitigate the risk of joint employment!
Paying someone through a third party mitigates the client company’s tax risk but not the risk of being sued as a joint employer. “Joint employer liability” exists when a worker is paid by one company like a staffing firm, but their work is directed by another company. The largest joint employment lawsuit was settled in 2000 when Microsoft agreed to pay $97 million after thousands of workers accused the company of improperly denying them benefits.
The best way to ensure that the client corporation will not be found to be the individual’s employer or “joint employer” is to clearly document the type of relationship that exists between the client corporation and the individual. In other words, to have a written contract between the two parties, not between a staffing agency and the consultant.
Usually, when a staffing agency pays a consultant on a W-2 tax basis they have a contract but it’s with the staffing agency, not the client corporation. The bigger problem with this, however, is that these contracts are usually full of fuzzy language, like calling the consultant a “self-employable associate” or a “special employee.” Undoubtedly this nebulous language would raise a lot of questions with the National Labor Relations Board or a judge if a co-employment lawsuit were filed.
How a person is paid has nothing to do with who controls or directs the work, or the real relationship between the parties. In other words, paying a consultant through a staffing agency does very little to mitigate the client corporation’s vertical co-employment risk.
The client corporation can still be sued as the joint employer because the relationship between the parties is so unclear. The consultant is being paid like an employee on a W-2 basis but are not being called an employee in their contract. So what type of worker are they and who is the real employer?
2. Paying a consultant like a temporary employee is expensive!
Most staffing agencies charge 15% to 18% on top of the consultant’s billing rate in order to pay the consultant on a W-2 basis through their agency. For example: On a $100,000 contract the client corporation will pay an additional $15,000 to $18,000 for the W-2 service, which still does not fully mitigate the client corporation’s risk of joint employment! (See item 1 above)
A less expensive alternative is to hire the consultant using a professional services contract based on a clear statement of work. Client corporations can do this through their own indirect procurement function or through a professional services company. If just 10 independent consultants are paid on a 1099 tax basis with a contract in place, the corporation would likely save over $100,000 per year and be better protected against joint employer liability.
3. Paying self-employed consultants on a W-2 tax basis is bad for the consultant.
Being paid on a W-2 tax basis reduces a self-employed professional’s tax deductions, costing them thousands of dollars. It’s for this reason that most professional consultants won’t do projects that pay on a W-2 basis. (Be sure to watch our two-minute video.)
4. Paying consultants on a W-2 tax basis limits access to truly professional, highly experienced talent.
Many self-employed professionals will only work on a 1099 tax basis so they can preserve their valuable tax deductions. (See #3 in this list.) Many companies use compliance processes so restrictive that they make 1099-based contracts impossible, so consultants turn down the work. (See Our Cause to understand how compliance processes work against self-employed professionals.)
It doesn’t have to be this way. Client corporations shouldn’t be over-paying to partially mitigate risk. Professional consultants shouldn’t be penalized for being self-employed. There is a better way to hire independent consultants, a way that’s a win-win for all parties involved.
A professional services contract with a clear statement of work does a better job of mitigating co-employment risk for less money, and it’s also better for the professional consultant.