Managing Workforce Risk – Part I

by Harold Mills on September 10th, 2010

There is almost no reward without risk. They always say talent is the key to the success of any business. But hiring people is also risky business, and seems to be increasingly so as the IRS ramps up additional resources, legislators are considering bills to increase penalties and lay the burden of proof of worker status on companies, and government entities look for ways to recover missing revenues.

Misclassification risk

Misclassification risk is on everyone’s mind lately as the IRS continues to escalate enforcement and class-action lawsuits with household-name companies continue to make the news. Almost a quarter of the states have enacted or are considering legislation increasing penalties for misclassification and moving the burden of proof to companies in case of audits. Additional federal legislation is also pending.

Interestingly enough, the latest tax revenue seeker appears to be State Unemployment commissions. As you can imagine, all of the so called “independents” aren’t obliged to pay state unemployment insurance taxes, which means less revenue for these agencies. Of course, this is really making them angry!

Typically, misclassification suits start with the individual independent contractor not paying the “employer” portion of taxes. As a legitimate independent contractor you’re obligated to pay both the “employer” portion and the “employee” portion of federal Social Security, Medicare, and unemployment taxes. Independents, on the other hand, tend to take tax deductions for business expenses that may not necessarily follow the letter of the law. Even more than most people, they try to minimize their tax burden, particularly because of their high earning power.

The government agencies, on the other hand, spend much of their time trying to maximize their tax revenues, so there is an inherent conflict. So instead of fighting each of these battles independently (no pun intended), the agencies target the receivers of the services, namely the large corporations. Their claim is that the companies benefited from this talent and their services, so they should be on the hook for ensuring the government receives its due. In reality, it’s just easier to pursue companies. One, as a consolidation of effort; two, because they know companies don’t like to spend money on lawyers fighting these things; and three, they know the companies actually have the money to pay (unlike the individuals, where the money is mostly spent already).

So the strategy is to assume the company treated the independent contractors like the rest of their employees and therefore should have paid the employer statutory taxes. As you can imagine, with all of these factors, even a small group of misclassified employees can cost big money!

There are a variety of risk mitigation tactics. If an independent contractor is willing to be payrolled as the W-2 employee through another company, that mitigates the independent contractor risk, placing it on the shoulders of the payrolling company. If they are a true independent, however, they may not wish to be payrolled. In that case, you must perform some due diligence or use a service like our validation and risk management (VRM), which helps determine if, for that one assignment, the worker is an independent contractor. This risk can be further mitigated by adding the worker to a Supplier Network like ZeroChaos, which means they’ve been validated as having the necessary business insurances and structure to reduce business risk, and makes them an independent contractor to that company, adding a layer of indemnity.

In the next segment, we’ll talk about how these risks lead to even more risks for companies. Misclassification risk has caused many companies to shy away from using independent contractors at all, but eliminating what may be the most talented available resources isn’t the answer. Don’t fret, however, there are solutions as well, and we’ll make sure we highlight those in the coming weeks.

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