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Potential Worker Misclassification Risks with SOW Vendors

Engaging with a corporation does not automatically protect your company from worker misclassification risks. In our role as independent contractor compliance and engagement specialists, we are frequently asked by clients to help them manage the risks surrounding professional services vendors who perform work on a SOW basis for the benefit of the client company.

These are most often small service provider companies or individuals presenting themselves as a company. In addition to the ever-present delivery risk, these companies can pose significant worker misclassification risks. In this, and subsequent articles we’ll talk about a few of these risks:

  • Incorporation risk: (Common client statement: “They’re incorporated, so we’re safe, right?!”)
  • Contract risk: (Common client statement: “We have a signed IC agreement, so they’re an IC, right?”)
  • Misclassified subcontractor risk: (Common client statement: “We don’t know if our supplier is paying taxes, or how their workers are being paid. That’s their problem, why should we care?”)
  • Audited consultant risk: (Common client statement: “Our consultant was just audited. Do we have any exposure?”)

Worker misclassification risks with SOW vendors is a large, and growing, problem for enterprises across all industries and geographies who use contract labor. It is estimated that the combined SOW spend in the US is $250 Billion per year. To put this number in context, it is equivalent to the combined annual contingent staffing spend in the US.

Most SOW spend is not managed centrally by companies. It is managed at a department or workgroup level, not by corporate Human Resources or Procurement. This lack of oversight and controls can introduce a significant level of risk to the organization since it is very common to find misclassified independent contractors performing services defined within SOW contracts. In our discovery projects for new enterprise clients this is often where we find the most hidden independents. The most common functional area is within IT groups.

Vendors that are deemed to be in-scope for our programs are generally not large or public consulting firms, but rather small service providers who often fall “under the radar” of over-burdened corporate Procurement or HR groups due to their small size or relatively low spend. These companies sometimes present themselves as niche staffing firms, consultancies, professional services, offshore/onshore, independent contractors, or even as sole proprietors. Regardless of which bucket we put them in, they are all deploying workers to perform professional services that benefit a client company.

And therein lies the risk.

To set the stage for some of the worker misclassification risks created by these service providers, here are a few important principles to keep in mind:

  • Contract law does not supersede employment law. In other words, a regulatory agency who is looking at worker misclassification will first examine the work and the working relationship between parties before they look at any contractual agreements that may be in place.
  • The US Department of Labor (and other Federal and State agencies) have made their bias very clear: most workers are considered to be non-exempt employees unless proven otherwise. The lesson for companies: The burden of proof (and most of the risk) is on the buyer of the services, not the seller!
  • Absent any proof to the contrary, the beneficiary of the work product is generally considered to be the employer.

A very common misunderstanding we encounter with client program sponsors involves the belief that “engaging a company protects us from worker misclassification risks.” In practice this sometimes takes the form of an individual who wants to engage on a “corp-to-corp” basis with our client, or a small service provider who is providing a worker or group of workers to provide services.

Forming a Corporation is not a Worker Misclassification “Magic Pill”

Simply forming a corporation does not automatically qualify the worker for independent contractor status. If it were really that easy, then every independent worker would create a corporate entity and demand to be paid as an IC. All the worker classification tests, such as common law factors, IRS 20 Questions, the Three Elements of Law, Economic Realities Test, etc. would go out the window and the whole employee versus independent contractor issue would disappear overnight.

Obviously, that is not the reality of today’s employee-centric regulatory environment. In order to make a defensible worker classification decision, the work, and the worker, must be evaluated together.

Does the Type of Incorporation Matter?

We are also often asked if the type of incorporation makes a difference. The fact a worker is incorporated is just one factor to consider when determining a worker’s status. In reality, incorporating (as an S Corp, C Corp or LLC) only indicates the individual intended to create his/her own business.

A word of caution: It is a Red Flag if the contractor tells you they are an independent contractor of their own corporation, where they are also an officer. Why? Because corporate officers are specifically included within the definition of an employee at both state and federal levels. Therefore, an individual who is incorporated and who isn’t reporting their wages properly, is not in compliance and may be putting your company at risk.

Why You Need to Care

What you need to examine very carefully is if the entity providing workers (who are performing professional services that benefit your company) is really acting like a business. Why? Because this is what the various federal and state agencies are looking for. They want to make sure that all employer taxes are being paid and that all workers who should be employees are classified as such, and are receiving the benefits and protections to which they are entitled. If not, the workers in question could end up being reclassified as your employees.

At some level it doesn’t really matter to the government who is responsible for the worker. They just want to make sure that somebody is paying payroll taxes (income tax withholding, unemployment tax, Social Security and Medicare taxes), adhering to wage & hour laws, providing workman’s compensation coverage, properly classifying workers, etc. The problem for buyers of services happens when these things are not being done.

If the third party you engaged is not performing its duties as an employer, then it is not properly protecting you. A government agency can, and most likely will, hold your company responsible for any errors or liabilities. This is why you want to work with an experienced independent contractor compliance and engagement specialist, like TalentWave, who can help you evaluate your vendors and identify any lurking worker misclassification risks.

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