Managing Independent Contractors

By Andrew E. Schult, PrO Unlimited

On your morning commute, buzzwords race through your mind: “reengineering, rightsizing, headcount.” It’s no surprise. After all, your employer just reduced staff by 30%, rightsizing several close colleagues out of their jobs. Will you be next, you wonder, consoling yourself with the thought that now, at least, it should be easier to find a parking spot.

Guess again. As you pull into the, lot, you strain to find a space. There, entering the building, are recently downsized colleagues, briefcases in tow. Are they back with the company? As it turns out, their former employer is now their client, and they’re getting paid as contractors, instead of payrolled employees.

As downsizings and corporate mergers continue, this scenario is becoming far more common in the chemical process industries. Senior managers, particularly in publicly owned companies, are under increasing pressure to limit the number of full-time employees on their divisions’ payrolls, since Wall Street generally views low headcounts in a favorable light.

A growing number of technology-oriented companies view a workforce made up of full-time staff and independent contractors as the way to operate more efficiently. A balanced, flexible workforce allows them to protect themselves against layoffs in an economic recession, and to respond more effectively to moves by the competition. Leading CPI companies, led by such pharmaceutical companies as Merck, Abbott Labs, and Warner Lambert, are now making significant use of contingent workers.

As a result, a growing number of downsized engineers and technical managers soon find themselves back at their old desks, doing their old jobs and parking in their old spots. Within five years, the U.S.’s biggest employer will be “self,” according to the U.S. Dept. of Labor (Washington, D.C.).

The implications for such technology-intensive businesses as the CPI, are profound. More companies realize that technical contingent workers are often among the most talented in their fields. Accordingly, they’re willing to pay top dollar for this talent - in some cases, over $100/h - while saving on payroll taxes and benefits. In turn, more of the CPI’s most talented chemical engineers realize that they can earn more as independent contractors than they could as employees.

It sounds like a win-win situation, for both the workers and their new clients. Unfortunately, it’s not quite that simple. There are some complex problems inherent in managing a contingent workforce made up of significant numbers of free agents.

In addition, as shortages of skilled technical professionals grow, independent contractors in these fields will soon be setting many of the rules. At CPI companies, technical decision-makers who don’t have a plan for adapting to these new realities may soon be in trouble. This article outlines some suggestions for dealing effectively with contingent workers.

Watch out for the IRS
In the U.S., unpaid taxes from the self-employed account for $20 billion/yr in lost tax revenues, according to the U.S. General Accounting Office. Not surprisingly, the U.S. Internal Revenue Service (Washington, D.C.) and local taxation agencies have allocated significant resources to recover this money.

In addition, the IRS believes that further revenues are missing, due to misclassification of contractors by companies. According to the Agency, nearly half of the nine million individuals now working as independent contractors are misclassified, because they may be functioning more as employees than as independents.

The IRS and local tax authorities use “twenty questions” criteria to determine whether a worker is an independent contractor or an employee. Generally, the more control one has over an individual, the more likely that person is to be classified as an employee. If a company is the worker’s primary source of income, and that worker is a former em-ployee, it is extremely difficult to prove that the individual is an independent contractor.

And companies are well advised to avoid getting into legal tangles with the IRS. In 90% of the companies it looks at, the Agency finds misclassified contractors. Fines, penalties, and interest charges from both the IRS and state tax authorities have been staggering; a number of recent U.S. assessments cost more than $10 million per company, and CPI firms have not been immune from audits.

If you’re a technical decision-maker who’s interested in using independent contractors, there are other considerations as well. For instance, it’s tougher to control intellectual property when using contractors in critical roles. Team building also becomes trickier when a significant number of workers are not employees.

Communicate with full-timers
In establishing a contingent worker policy, communication with full-time staff is critical. “Outsourcing” has always been a dirty word to many employees, connoting lost or threatened jobs. If efficiency and morale are to be maintained, employees need to understand that independent contractors do not represent a threat. They should be made to see that a balance of permanent staff and contractors are essential to the company’s success.

In addition, managers should be aware that they may need to use a different managerial style when working with contractors. Independent contractors, especially in technology-related positions, are often the cream of the crop from a creative and technical standpoint. Often experts in their fields, they will need to be treated as such. A “hands off’ approach, in which the contractor is responsible for meeting certain goals, will work better than micromanagement. Such an approach will also give you and your company a reputation for handling contractors well, and ensure referrals, should you need to hire more contractors in the future.

As a CPI manager, you will need to oversee management and control of your contingent workforce. Many managers who have left this to human resources departments have lived to regret it. A key component is managing compliance questions, If you’re classifying some professionals as independent contractors, it’s important to come up with a plan before the tax-authorities do it for you. A good compliance system includes the following:
• A method of analyzing the classification of all potential contractors
• A file documentation system for all contractors who are found to be truly “independent”
• A third-party payroll setup for contractors and returning retirees who would not meet the “twenty questions” criteria for classification as contractors.

Some technical managers believe that their companies are safe as long as they execute legal contracts claiming the contractor’s independence from the company. If tax authorities view the company’s relationship with the contractor as that of boss and employee, their contracts won’t be worth the paper that they’re written on.

Working with HR Departments
If you’re not sure about all the regulations surrounding independent contractors, you may find yourself going to your company’s human resources department for guidance. Be aware though, that, particularly in small to mid-sized firms, human resources departments typically lack the expertise to handle this issue. After all, the “twenty questions” are only a guideline and are subject to varying interpretation. In many cases, the U.S. Labor Dept. has viewed one worker as an independent contractor, while the IRS has found that person to be an employee. A corporate human resources staffer may have extreme difficulty determining what will work for different taxing agencies. Technical managers are best off working closely with human resources to answer these questions for each contractor. In some cases, you may want to work with an outside consultant.

If you believe that a worker is an independent contractor, you’ll need to ask for articles of incorporation, proof that the individual works for other clients, and insurance certificates. This evidence will not only help in an audit, but will also tell you, up front, if this person is a legitimate independent contractor. The promptness and ease with which the worker provides this information should also help you in making this determination. True independent contractors will have no trouble providing these documents.

If you find it necessary to use a third-party payroll, make sure it is set up properly, with contracts that protect intellectual property and with non-disclosure agreements. In addition, make sure the workers are offered benefits comparable to those of permanent employees, and that all coemployment concerns are addressed by your third-party employer.

Use your common sense
Common sense is also important. In many corporations today, indepenent contractors play on the company softball team, eat in the employee cafeteria, have their phones answered by company employees, and are included on the organizational chart. If your firm engages in such practices, watch out.

If you’re an independent contractor, you should be able to show a substantial amount of insurance coverage as well as a client list. And you’ll likely be asked to accept payment on a project basis, rather than hourly or daily. In addition, you should expect to sign a blanket contract that shifts responsibility for projects to you.

If you’re thinking of leaving your company to hang out your own shingle, consider the ramifications carefully. In many cases, engineers take more money home as employees than they do as free agents. There are also substantial risks to you as an independent contractor. If the IRS think you’re misclassified, they could question all of your income tax deductions, leading to a devastating audit. Regardless of the risks, contingency staffing is attracting more employers and engineers. Have a plan in place and - whether manager or worker -you’ll reap the rewards of flexibility.

Edited by Agnes Shanley

AUTHOR
Andrew E. Schultz is president of PrO Unlimited (301 Yamato Road, Suite 4160 Boca Raton, FL 33431, Phone: 561-994-9500; Fax: 561-994-3351; E-mail:info@prounlimited.corn), a consulting and outsourcing firm. PrO Unlimited specializes helping companies address compliance issues associated with the use of independent contractors. In addition, PrO Unlimited provides third-party payrolling services. Mr. Schultz has a B.S. in Economics from the University of Delaware, and began his career on Wall Street. He later worked as an office automation specialist and as national accounts manager for Uniforce Services Inc., where he subsequently started up the company’s IT consulting division.

Source: Chemical Engineering January 2000