Although there are clear benefits for companies to work with independent contractors (ICs), there are also large risks. If workers are classified as ICs when they should be classified as employees, the consequences, both financial and operational, can be devastating for a company.
In today’s competitive business climate, more companies than ever are engaging contingent workers, such as freelancers, consultants, seasonal workers, and other forms of temporary or on-demand professionals, instead of hiring regular employees, and this trend is only growing. A large study by McKinsey Global Institute reveals that 20 to 30 percent of the working age population in the United States and the EU-15 (a selection of countries in Europe), or up to 162 million individuals, engage in independent work. The study also confirms that such work is rapidly evolving, its growth fueled by such factors as expanding digital platforms for freelance services and an increased demand for independent services from both consumers and organizations.
These type of work arrangements give firms the flexibility to accommodate fluctuations in their businesses as well as offer workers greater job mobility. One way companies take advantage of the flexibility offered through a contingent workforce is by engaging independent contractors.
Independent Contractor Compliance Risk
Compounding this risk related to independent contractor compliance (1099 compliance in the U.S.) is the fact that there is no one set of rules that clearly determines whether a worker is an IC or an employee. Furthermore, IC qualification laws vary tremendously between different states, and between different countries. In Spain, for example, an IC who spends 75% or more of his time working with one client must be provided with benefits, like an employee.
Which Is Better: IC or Employee?
In general, for workers to be classified as ICs, they must be operating with a lot of autonomy. ICs decide where and when to work, and they cannot be held to a schedule, use significant company resources, receive skills training, or work for one company exclusively. However, these requirements are extremely complex and always changing. It can be difficult for companies to keep up on requirements, especially if they engage ICs in multiple geographic locations.
Depending on local employment laws and the nature of the work an employer has planned, it may be advantageous to hire workers as employees instead. To better understand which choice is better, let’s look at the pros and cons of hiring ICs, particularly if an employer needs workers quickly or internationally.
Pros of Using ICs
Here are some advantages of engaging independent contractors.
- Saving Money
Although ICs can be paid more than employees for the same work, employees typically cost employers more. Hiring an employee requires additional expenses, such as payroll taxes, health insurance premiums, employee benefits, office space, and more. In the U.S., such additional expenses, many of which may not be required for ICs, can cost an employer an additional 20 to 30 percent of an employee’s salary or more.
- Remaining Competitive
With current trends in the marketplace, companies may need to engage ICs to take advantage of a larger talent pool and help keep their companies competitive.
- Greater Flexibility
With ICs, employers have greater flexibility in bringing workers onboard, and letting them go. Employers can engage ICs for a specific project, and once the work is completed, employers can offboard those ICs in accordance with their IC agreements. Most often, there is no additional legal process to terminate employment or any need to consider unemployment payments, health insurance continuation, or other obligations, as would be the case when terminating an employee.
- It’s also important to note that many countries don’t have at-will employment arrangements as they do in the U.S., which would further complicate terminating an employee.
- More Efficiency
By definition, ICs bring in specialized skills and require no training, so they can be productive immediately. ICs also enable employers to seek out qualified workers to better address specific business needs.
- Reduced Liability
Employees are protected by numerous rights, which, if violated, can bring about legal claims against the employer. These include rights to sick leave, a minimum wage, workers’ compensation for an on-the-job injury, protection from employment discrimination or wrongful termination, and more. Correctly classified ICs are not protected by the same rights, thereby reducing an employer’s exposure to related lawsuits. However, an employer is still bound to stipulations in IC agreements, such as the conditions under which employment can be terminated.
- When Using an IC Is Better
Engaging ICs may work better for a company that has a temporary need for skilled workers and does not want to use any in-house resources. When engaging workers globally, engaging ICs also makes better sense if an employer wants a less committed footprint in a country or wants to test out a market before establishing a business entity there. In many countries, if a company wants to hire an employee, it must first establish a business entity in that country. Engaging an IC or working with an employer of record company to engage other types of workers can help a company avoid this requirement.
Cons of Using ICs
Here are some disadvantages of engaging independent contractors.
- Less Control Over Workers
By definition, ICs work autonomously, deciding for themselves how best to accomplish tasks and with what tools and in what timeframe. If an employer wants to have significant control over what their workers do and how they do it, they need to classify those workers as employees.
- Workers Come and Go
Most employers use ICs as needed for specified projects. Once the project is complete, ICs can work on additional projects or may move on to other work. Also, given that an IC can work for multiple employers, an IC may not be available for a company’s next project. Some employers may find this disruptive. If a company wants to rely on the same workers on an ongoing basis, it is usually better to hire those workers as employees.
- Increased Liability for On-the-job Injuries
Employees’ on-the-job injuries are covered by their employer’s insurance. In the U.S., this is called workers’ compensation insurance. Such insurance provides injured employees with compensation in exchange for their right to sue their employers. Unless an IC purchases his/her own insurance, which can be cost-prohibitive for individuals, an IC may be able to sue the employer for damages if injured on the job.
- Loss of Copyright Ownership
Unless explicitly indicated in the IC agreement, an IC may own the copyright for certain types of intellectual property created on the job, such as an article or photo. In most cases, if an employee creates such work, the employer is automatically the copyright owner.
- Risk of Worker Misclassification
Government and local agencies both in the U.S. and abroad are always looking for companies that are using ICs to avoid tax payments and other legal responsibilities, either intentionally or unintentionally.
As previously mentioned, classifying workers as ICs when they should be classified as employees can have financially devastating consequences. In the U.S., among a host of fees and penalties, a business must pay the IRS all back taxes owed, with interest, plus a penalty of 12% to 35% of the tax bill for each misclassified worker.
In the U.S. employers may attract audits by the IRS, Department of Labor, state unemployment offices and others. Similar agencies perform audits in other countries.
In order to avoid compliance issues, companies need to check specific tax requirements and employment laws in the countries and/or U.S. states in which their workers reside.
Engaging ICs offers companies tremendous flexibility and cost savings, but employers must be sure that workers are accurately classified as ICs, as this is critical to ensuring IC/1099 compliance.
Because employment laws and regulations are complicated and vary greatly from one state or country to another, employers can reduce liability by engaging, managing, and paying workers through local vendors. Finding and vetting local vendors, however, can be an additional, time-consuming HR burden. Companies like iWorkGlobal can help. In over 160 countries, iWorkGlobal can ensure local IC compliance and act as an employer of record or agent of record to engage and pay an employer’s independent, remote and contingent workforce, in the U.S. and around the globe.
Learn why organizations should be focusing on independent contractor classification in 2021 and beyond, here.