Outsourcing and using independent contractors can be a legal minefield

Courtesy: http://kpbj.com/

Employers have shed a record number of jobs in the last few months. All of our businesses are running leaner and struggling to get the work done with fewer hands on deck. Creative staffing solutions are in high demand as businesses look for ways to take care of the demands of their customers and their business needs.

In this economy, flexibility and cost containment are the keys to success. There are several ways to incorporate these elements into your company’s staffing plan.

First of all, as you juggle your internal workforce, maintain those employees who are cross-trained and willing to handle a variety of job functions. In this climate, employees are being required to wear a variety of hats. For example, if it’s necessary to eliminate the receptionist’s job, the employees who remain need to be willing to answer the phone, or your customer service will suffer.

Many businesses are turning to outsourcing as a way to hold the line on labor expenses. Outsourcing is when you hire an outside vendor to perform work that was previously performed by an in-house employee. Oftentimes we think of outsourcing as a call center in India, but many times companies outsource functions to providers in their own community.

There are advantages and disadvantages to outsourcing a business function. The advantages include cost savings, flexibility, access to new processes and technology, ability to focus on core competencies, and the ability to tap into a more skilled workforce. The disadvantages include a loss of control over the process and product, and challenges incorporating an outsourced function and personality into the company’s culture and environment.

There are specific business functions that are typically outsourced. They include IT support, web design, technical writing, engineering, bookkeeping, data entry, customer service, human resources, translating, marketing and public relations services to name a few. When looking at which functions to outsource, companies need to consider what defines their company. For instance, if the company is known for its superior customer service, then outsourcing that function to a call center may very well diminish the company’s position in the marketplace.

If you choose to outsource one or more business functions, take the steps necessary to create success. Consider the management costs associated with selecting the outsourcing firm or contractor, training them regarding your needs, and overseeing their work. Spend time selecting the right contractor for your business. Assess the competencies and check the references of the contractor or firm, just as you would for an employee, before you engage with them. Create a written agreement that specifies the work to be done, the terms of the agreement, and that the arrangement is for an independent contractor versus an employee. Assign coordination to a specific employee so someone on staff always knows what’s going on.

As regulatory and tax issues become more burdensome and complicated, some small businesses are tempted to convert employees into independent contractors, or to only utilize the services of independent contractors. This is dangerous territory for businesses to tread on. The IRS and the Department of Labor are increasing their scrutiny of the misclassification of employees as independent contractors. In 2007 the GAO estimated there were 10.3 million independent contractors in the US. It is unknown how many were misclassified, but in 2000 the Department of Labor estimated it to be 30 percent of businesses. In 2007 testimony before a House committee estimated that employer misclassification costs the federal government in the range of $3.3 billion annually.

Employers do not pay social security, Medicare, unemployment, workers comp or any benefits for independent contractors. The workers are responsible for taking care of all of their own taxes and benefits for themselves. In addition, employers do not have to comply with minimum wage laws, overtime laws, or federal and state employment laws when dealing with independent contractors. Understandably, this raises red flags for federal and state governments.

The IRS has set forth criteria on the proper classification of independent contractors. If your business currently works with an independent contractor, or is thinking about it, visit the IRS website and apply the criteria. It includes principles relating to the degree of control over the contractor and their independence. These are broken down in three areas, which are behavior, financial and type of relationship.

Behavior has to do with whether the company has the right to direct or control how the worker does the work. It involves controlling when and where the work is done, what equipment is used, controlling which workers are hired to do the actual work, the amount of instruction and training, and the evaluation of the performance.

Financial control relates to whether the business has the right to control the economic aspects of the worker’s job. For instance, does the worker have the opportunity for a profit or a loss? Will they have unreimbursed expenses? Does the worker have a significant investment in their own equipment? Are they being paid for the project or job, rather than by the hour?

When looking at the type of relationship, the IRS considers such things as whether there is a written contract between the business and the worker, the permanency of the relationship, if any benefits are being provided, and whether the services being performed are a key activity of the business.

If the IRS finds that a company has misclassified someone as an independent contractor, the business may be liable for overtime wages, benefits, taxes, and penalties. As our federal and state governments grapple with reduced revenue streams, we can expect that they will continue to increase their emphasis on enforcement of these regulations. In addition, the misclassified workers also have the right to bring a claim. Typically this happens when they are injured and find they don’t have workers compensation coverage, are laid off and don’t receive unemployment benefits, or go to file their tax return and learn they are responsible for their entire social security and Medicare obligations.

Despite these pitfalls, accessing a contingent workforce is a smart move for businesses coping with the fluctuations in today’s marketplace. Utilizing the services of a staffing company is another avenue to accomplishing this. The difference in this case is that the worker is an employee of the staffing company, who is paying all of the payroll taxes, providing benefits, and covering obligations for unemployment and workers compensation. Companies still have the ability to staff up for projects or access a specialized talent, without the concerns of misclassification of workers.

One more solution worth mentioning is payroll services, which are typically provided by staffing companies. This is a great solution for a company that wants to select the employee or service provider, but not handle payroll, taxes, liabilities or benefits. In this instance, the business selects the worker, sets their schedule and pay, and directs their work. The difference is, they are an employee of the staffing company, who handles the payroll, pays the taxes and benefits, and incurs all of the liabilities such as unemployment and workers compensation. Some companies are utilizing payroll services to temporarily “re-employ” laid off workers to handle projects or peak work periods. It’s also a good way to temporarily bring back a retired worker.