What Causes Independent Contractor Engagement Risk and How to Avoid It (Guide)
9 MIN
Independent talent are playing a vital role in the workforce strategies of modern organizations. In order for this talent pool to give your company a competitive advantage and help accelerate innovation, it is first important to understand and mitigate the risks of independent contractor engagement. Worker misclassification is one of the biggest risks of integrating independent talent into your workforce.
GATE
Independent Contractor Engagement: trends, risks and benefits
Total Number of Independents (in millions)
Reference: MBO Partners State of Independence Report 2022
The independent workforce is a growing and increasingly valuable source of talent for businesses today as “the traditional employer-employee relationship is being replaced by the emergence of a diverse workforce ecosystem.” Our research finds that in 2022, 64% of independent workers said that working independently was their choice completely, up from 59% in 2020. 76% say they are very satisfied with their decision.
Independent professionals give companies the ability to outsource work on a project basis, providing staffing flexibility and offering in-demand expertise and skills. It’s no wonder that so many organizations are embracing this valuable workforce—61 percent say they expect to hire more contracting freelance or consulting workers in the next three years. Yet, due to the risks of misclassifying independent professionals, some companies are becoming anxious and are pulling back from using this talent pool altogether. Deloitte research finds that most companies are not fully ready to engage independent professionals or outsource work. Without proper management of independent talent, businesses run the risk of misclassification, which can lead to serious consequences including audits, fines, penalties, lawsuits, and negative press.
To complicate matters, enterprise misclassification risk can be easy to overlook given the rise of online marketplaces. Such marketplaces are becoming a common way for managers within an organization to find and engage independent talent by simply creating a username, and password, and connecting a credit card, and people within your company are likely using this technology to some extent. While marketplaces give managers direct access to talent, allowing them to self-source and reduce time spent on recruiting activities like contract administration and onboarding, this technology also poses a risk because most marketplaces lack the level of compliance vetting that enterprises need to compliantly engage highly-skilled independent talent. Company managers can easily engage with independent professionals who aren’t properly vetted, which unwittingly exposes the company to misclassification claims and the risk of lawsuits. However, while independent professional compliance can be intimidating, the decision to avoid using independent talent altogether only puts businesses at risk of falling behind their competition.
The good news is, that by understanding how to properly work with independent talent, your company can remain both legally compliant and competitive among peers by joining the likes of leading companies such as PwC, KPMG and UnitedLex. In partnership with MBO Partners, these companies strategically embrace the independent workforce and successfully manage their legal risk while doubling down on strategies to leverage high-end independent talent, accelerating their innovation and organizational agility.
In order to remain both legally compliant and competitive among peers, businesses must understand how to properly work with independent professionals.
Assessing Compliance and Avoiding Risk: 5 Key Questions
Is your organization in a position to compliantly attract, engage, and retain top independent talent for your business? Review the following questions to assess your company’s risk level when scaling your independent professional engagement program.
1. Does my organization understand the inherent risk of independent contractor engagement?
The simple nature of using independent talent poses a risk to all organizations, no matter what practices they follow. Laws and regulations surrounding worker classification and use of independent contractors are ambiguous and change frequently, making legal compliance challenging. Perhaps your finance department has a handle on them, but true risk management is difficult to achieve.
Risk: There are no standard laws determining worker classification. Federal, state, and local government agencies each have different tests and guidance documents dictating whether business should classify their workers as employees or as independent contractors. In addition, the consequences of misclassification are serious: paying back-taxes with interest, getting pulled into class-action lawsuits, or suffering repercussions from bad press.
As the use of independent talent becomes more commonplace and disrupts the traditional workforce model, we are at a moment in time where there is a lot of changing legal precedent surrounding classification. For example, in April of 2018 the California Supreme Court issued a landmark decision in the matter of Dynamex Operations West, Inc. v. Superior Court of Los Angeles , adopting a new standard for determining if a worker is an employee or an independent contractor—the “ABC” test.
This new test makes it significantly more difficult for an entity to classify someone as an independent contractor, and more states may follow suit in the future. While businesses and industry organizations strongly support modifying the ruling, labor organizations are opposed to changes that reduce protections for lower wage earners (although there have been some reports that labor organizations will make exceptions for higher-paid professionals). The California legislature is not expected to adjust or clarify the ruling until later this year. Legal decisions like the one in California provide a tangible example of the type of disagreement, confusion, and frustration that is likely to occur as government agencies grapple with how to establish and enact independent workforce policies.
Solution: In order to combat the inherent risk independent professionals pose, businesses must stay on top of these constantly changing regulations and standards. The best way to do this is to create a stable, centralized classification program. This allows enterprises to more confidently engage and manage independent talent.
Yet oftentimes, creating an effective program falls short. Not only is creating a centrally managed program a big investment of time and cross-functional resources, it’s also not likely to be an area of expertise for the enterprise. In order to mitigate the risk of using independent talent, it’s easier to partner with a firm that has this expertise, versus building your own center of excellence for engagement compliance. Partner companies that specialize in independent workforce engagement and compliance may indemnify the enterprise from misclassification and legal risk.
2. Is my organization equipped to manage the risks of handling independent professional engagement on its own?
In a world where managers have the ability to go rogue and find their own independent talent, one of the biggest risks of independent contractor engagement is trying to manage a program without the right organizational support and infrastructure in place. Without a complete program that solves for supporting enterprise managers easily finding, engage, managing, and paying independent talent, there’s a lot that can go wrong.
Risk: When enterprise managers, for instance, try and engage independent talent themselves, it may expose your organization to risk. Or, managers may not be required to properly categorize independent talent as a human resources spend. Improper management and spend tracking create risk for an organization, not just due to possible worker reclassification, but also because independent professionals may not get paid for the work they do if they are not properly accounted for, which can lead to dissatisfaction and lawsuits.
Solution: If your business has some type of independent talent program in place, conduct an audit on your existing engagement practices. This is a valuable exercise to identify gaps and areas for improvement, and can help you decide if external support is needed.
If your company does not have a program in place, consider partnering with an expert who can help you establish a program to properly engage, manage, and pay independent professionals. A lasting and successful program begins with the right leadership support and sponsorship. This support should be driven from the top down by a senior business leader who has influence over the managers who will be sourcing and utilizing independent talent
While a top-down approach is not the only method to successfully starting a program, trying to secure internal support from the bottom up is almost always a long and arduous path. Internal adoption will be a slower and more disjointed process if it relies on word-of-mouth and proof-of-concept in small groups. With the top-down approach, program leaders should establish specific metrics that can be easily tracked as the program rolls out. Set clear expectations from the beginning, and make sure that employees have visibility into the progress of goals.
3. Is the relationship between my organization and independent workers a true business-to-business relationship?
Independent contractors cannot be treated like traditional W-2 employees. Think of independent talent engagement as many small business-to business relationships.
Risk: One of the main causes of worker misclassification is when enterprises take too much control of the working arrangement. Independent professionals maintain a certain amount of autonomy that traditional employees don’t have. For example, independent contractors are allowed to determine when, where, and how they work. Oversight such as requiring independent professionals to perform their work onsite or engaging them to complete the same job as an employee can expose a company to misclassification risk.
Solution: Aside from being aware of the rights of independent professionals, it is also of utmost importance to get the contract right from the start. Contracts should be as clear and as simple as possible: define what the independent worker is responsible for, by when, and for how much.
Once the independent professional has signed the contract, the next step is to make sure that they are treated like an independent worker— and not company employee—throughout their engagement. Remember, independent contractors are their own business entity. They are experts in their industry, can openly market their services to other businesses, and are engaged for a specific period of time for a specific type of work.
When interacting with independent professionals, always refer back to their deliverables. Avoid asking for specific reporting that may inadvertently provide you the ability to influence how the work is performed, don’t make them attend corporate meetings that have to do with something that isn’t in their contract, and always emphasize that you are their client and not their employer.
Along these same lines, it is important to educate existing employees and managers about these practices as well. Anyone who may be interacting with independents during their engagement should know and abide by these practices
4. Do the independent professionals my organization leverages have the proper insurance in place to protect my business from risk?
Insurance requirements play a specific role in business partnerships, transitioning risk from the enterprise to the independent professional, based on the work being performed.
Risk: Companies need to ensure that they are not liable for any damages caused by the independent talent they engage. Providing independent professionals with insurance, however, is a slippery slope that can lead to misclassification.
Solution: Requiring the right insurance in a contract can help mitigate business risks. Take the steps to build necessary insurance requirements for the project into written contracts before independent professionals start work and require proof those insurances are actively in place.
Insurance to consider:
General Liability: If an independent professional damages property or harms another worker on the job, that is a risk for your organization. General liability insurance provides coverage for bodily injury, property damage, and the cost of defending lawsuits.
Auto: If an independent professional drive as part of their contract with you, or if they are driving their own vehicle to your place of work, that can be a risk for your organization. Auto insurance will protect against these risks.
Errors and Omissions: Errors and omissions insurance, also known as professional liability insurance, provides protection in the instance your company incurs an economic or financial loss due to a professional error that an independent professional makes.
Workers’ Compensation: If an independent professional is working at your facility and is injured on the job, that can pose a risk to your company. Workers’ compensation insurance provides medical expenses, lost wages, and rehabilitation costs for injuries or illnesses that are incurred on the job.
Network Security: If an independent professional does something to interfere with the network security of your company such as introducing a malicious code or virus, or exposing data, that can be a big risk, both financially and reputationally. Network security insurance can help to cover a range of incidents including data and security breaches, and damaged or lost data and software.
5. Are the independent professionals my organization engages happy?
Sentiment among independent professionals not only impacts productivity and retention, but it can also have a legal impact on your business.
Risk: Dissatisfaction among independent professionals can lead to unnecessary risk. If independent talent for any reason feels they have been improperly classified—perhaps they have been forced to work on a 1099 or think they should be classified as an employee because they perform similar work as current employees—they may take action that raises classification questions or triggers an audit. These red-flag actions include filing an SS-8 form with the IRS to request classification determination, filing for unemployment benefits after a contract ends, or even filing a lawsuit against a company.
Independent professionals increasingly have a choice in the clients they work for—82 percent of independents say they have some or a lot of choice in picking their clients. That means that in order to attract and retain top talent, businesses must actively meet the needs of independent talent across every touchpoint within their engagement lifecycle. Common sources of dissatisfaction include: long payment terms, lack of a diverse range of engagement options, requiring an excessively high level of liability insurance, administrative burdens (extra tasks imposed on independent contractors like entering data into multiple client systems), and cumbersome invoicing processes.
Solution: To keep independent professionals satisfied, businesses must provide a superior experience specifically designed to meet the needs of independent professionals. Ideally, this should include a broad range of options for engagement that allow independent professionals to work the way they want while mitigating misclassification risk for the enterprise.
For example, a worker should not be forced into W-2 employment if they are missing one or two provisions that prohibit them from being legally classified as an independent contractor. Instead, a firm like MBO Partners can offer independent professionals multiple engagement solutions, which provide them with the flexibility they want in a work arrangement while maintaining total compliance for enterprises. MBO’s research has found that the vast majority of independent professionals want to work with clients who value their work and allow them control over their schedules.
With organization-wide enthusiasm for making independent talent engagement simple and a corresponding program that prioritizes talent-friendly policies, enterprises can become a Client of Choice, realizing a competitive advantage by becoming independent professionals’ top choice in client partnership.
One of the main causes of worker misclassification is when enterprises take too much control of the working arrangement.
How MBO Can Help
We know that independent worker engagement can be a complex course to navigate. Our holistic methodology empowers enterprises to build relationships with independent professionals that accelerate business success; we are there to guide you through each step in the engagement lifecycle— from finding, attracting, and engaging independent talent, to managing and re-engaging these resources.
Although risk in inherent when engaging independent contractors, with the right help to establish a properly structured program that mitigates risk and increases your confidence in making these valuable resources part of your talent strategy. When done right, engaging independent talent is not cumbersome, in fact, the right program can help bring top talent to your doorstep organically, giving your business a competitive advantage in today’s project-based economy.
In this guide
Subscribe to the Insights blog to get weekly insights on the next way of working
Learn more about MBO
Learn how to start, run and grow your business with expert insights from MBO Partners
Learn how to find, manage and retain top-tier independent talent for your independent workforce.
MBO Partners publishes influential reports, cited by government and other major media outlets.
Research and tools designed to uncover insights and develop groundbreaking solutions.