Compliance with state and federal 1099 classification criteria is critical when engaging freelancers. If not done properly, the costs of misclassifying just one freelancer could easily outweigh the benefits that led you to the freelance talent population in the first place. Knowing the 1099 risk landscape and understanding how it will impact your business model is the new compliance imperative for the gig economy.
Michael: Michael hello thanks for joining us.
Tyler: Hey Tyler thanks for having me. Pleasure to be here.
Michael: Early on in your process which you’ll do is you’ll try to define the type of freelancer model if you could explain a little bit about the different working models and what makes them different in terms of the length of engagement or the structure of the work itself.
Michael: Yeah there are a lot of different criteria a lot of different elements to look at but generally we try to make a distinction between is it a traditional compliance model or is it more of a gig platform or on demand type of model for work that requires a slightly different solution. Traditional is really like it sounds it’s it’s what we’ve known in our industry for years.
Tyler: The gig platform the on demand as you can imagine is with the you know the growth and the popularity and the you know it’s just the new innovation in our space around creating platforms for marketplaces for buyers and sellers of micro services or project based services to come together and that creates a unique compliance issue that has to be dealt with.
Michael: And I don’t think our industry as a whole has really figured it out completely and we’ve certainly got the regulators weighing in and sort of trying to drive to the discussion or the conversation. But yeah that’s how we segmented at the top is between traditional and gig.
Michael: It sounds like this distinction can be difficult to make. Would you recommend that companies trying to tackle this themselves.
Michael: I think it all you have to measure your risk and that includes a lot of factors. You know what size company are you or you publicly traded. Do you know how many freelancers or independents do you engage on a regular basis. What kind of work are you having them do all of that sort of weighs into that kind of conversation or to that decision. Tyler what we recommend is that you you have a a qualified group do an icy compliance assessment so that you can have an outside third party someone who specializes in classification screening and and providing compliant services do that kind of assessment and give you that feedback. There are a lot of options on managing your your I see compliance risk internally and with third party providers and it really just depends on each companies unique situation and on these components of risk.
Michael: Where do they come from. And I want to speak specifically on the traditional freelance mileage because that’s that’s sort of more familiar I think to most companies.
Michael: Yeah well the the origins of risk are the easy answer as I say from anywhere. You know one of the things that we see in defending the propriety of icy classifications is that the facts matter.
Tyler: Right. Just like any law a lawsuit or court case or anything that’s pending in front of an agency what the specific facts matter.
Michael: And while that makes sense it also creates a bit of a challenge for companies and for service providers like ourselves because we have to anticipate what those potential facts are that might go into an inquiry or to a claim against the propriety of an icy classification. So for instance you know you might set up a contract that says this person Tyler is a independent contractor but if you engage Tyler and then treat him like an employee during the engagement then the contract really doesn’t matter. What really matters is the facts that the client invited you to staff meetings you went to the company Christmas party you you did all sorts of things like an employee would do at their employer. So that’s kind of my bigger scope. Caution is I don’t think that there is one aspect that you can zero in on and actually solve all your problems. But to answer your question more scientifically if you will we have done studies on where do I see misclassification inquiries or claims come from. Meaning if if an agency. And again just to be clear for the audience it could be the IRS. It could be the Department of Labor. It could be any one of the different states. It could be the. The wage and hours division it could be the unemployment division. It could be the workers compensation commission. Those are all areas that look at and care about the classification of workers.
Tyler: So that’s that’s one aspect. They you know those regulatory bodies are nothing to overlook.
Michael: I mean there’s a lot of them and there’s a lot of moving parts but surprisingly we found in our study that they were the number three trigger of of groups that drive I misclassification claims or increase the number one group that actually was responsible for it were the contractors themselves which again is why we focus a lot on managing the contractor in every contractor that comes into our into our programs whether it’s through our collaboration with short list or when we go directly to clients they have to participate in some level of icy compliance and best practices training.
Michael: I’ll give you an example why when we say that the the the the biggest driver of misclassification claims is the contractor we looked at and said well you know what are they doing that is causing the obvious question. Yeah.
Michael: So so saying what are they doing. Well some of it a lot of it. And we think most of it is inadvertent meaning they just didn’t understand they made a mistake. Some of it is intentional. But I’ll get to that in just a minute. But the contractor based inquiries triggered increase your claims are the top four were they made a mistake on their taxes meaning they reported the wrong number from their ten ninety nine.
Michael: When a company or a third party an intermediary let compliance solutions engage as a contractor we issue a Form ten ninety nine miscellaneous to each contractor whose work over six hundred dollars in an account or a year. We put the exact amount of pay on that form. The contractors job because they are technically their own small business they’re self-employed. They have to carry ten ninety nine no over exactly to their ten 65 partnership form or to their schedule C on their on their income taxes. Anytime there is a discrepancy you know the IRS has a you know as you can imagine they will receive an alert hey this is the wrong number. If it’s material if it’s going the wrong way then you know that that’s going to drive forward or trigger an inquiry. The other the other things that we found were they contractors were submitting or trying to claim unemployment insurance.
Michael: But the reality is they are their own employers or self-employed. So the con the client they work for really isn’t their employer but oftentimes the contractors don’t understand this. You know to a certain extent we understand this and there’s some sympathy there because you know they maybe they got terminated from the engagement early or maybe it just ended and they just can’t find new business. So what they do is they say well I’ve got to file for unemployment and they named the last company they quote unquote worked for. But if they worked for them as a ten ninety nine then that’s that wasn’t their last employer. The last thing I’ll mention is the same thing with worker’s compensation if they get injured whether it’s on the job or not. We find that that drives a lot of misclassification inquiries because there’s the tendency if they don’t have insurance or if they do have insurance and they mean the need to name a worker because every time you go into a hospital or to a doctor’s office with some kind of injury they’re asking you did this happen at work. Well you say yes and then and then you sort of have to name somebody. And without thinking they triggered an inquiry so that those are those are very trainable items to circle it back and we can train the contractors to be aware of that. We can help them understand why a misclassification actually works against them. We can help them understand that it protects their business as a small business or as an independent contractor when they avoid being misclassified. Now we want everybody to be properly classified but once you’re classified as a ten ninety nine you know you don’t want to mess things up and in an inadvertently trigger an inquiry and maybe you have a regulator come in and reclassify you that’s painful for everybody in it especially including the contractor because they have to redo their taxes they they can’t take all those business deductions that they like to take.
Tyler: And it really causes a challenge for everybody.
Michael: And that’s so interesting to hear that something as simple as an accounting year can trigger one of these claims or in unforeseen circumstances like a hospital visit does that necessarily thought that now why should a company care you know what does the penalty look like for a misclassification.
Michael: Wow. It it it’s all over the map but the two things that I can say one is if it’s an individual claim then it can be as high as eighty thousand dollars for the average contractor.
Michael: And generally what we’re what we’re looking at there is when when you have a reclassification meaning for whatever reason the IRS comes in and reclassified that 10 none and I work to a W-2 and says no they really were an employer employee and let’s just say it was for a full calendar year and they got paid you know the average amount seventy sixty five thousand dollars.
Michael: Well the company has to go back and in and repay those payroll taxes and then they have to pay those payroll taxes with a penalty because they didn’t pay him on time to begin with. They also have to pay a fine oftentimes and that fine can can can vary greatly.
Michael: So here’s why it’s really important to put an institutionalized process in place to manage your your icy compliance whether you go through compliance solutions and short list or whether you go through some other provider. The really important thing is that you institutionalize this this understanding that freelance workers need to be properly classified. If if you intentionally or or found to be intentionally avoiding the W-2 classification in order to save money in order to avoid paying the payroll taxes in order to avoid extending health care and other benefits to your employees or to your workers vague they can identify that and they can extend the look back period which is what the IRS or the department later look at when they go back and try to assess your penalty or your your back taxes payroll taxes you have to pay. If if it was a true mistake and just a wrong call but you’ve got good processes in place they they’ll go back you know that one year or two years maybe. But if they if you’re found to have intentionally avoided the proper classification they can go back for up to five years in that just is a huge multiple. When you’re talking about potentially you know somewhere between a 50 80 thousand dollars for an average contractor now. So that’s just if you’re looking at one contractor what we’ve seen and a lot of things that hit the news recently are the class action suits where I took a full class of contractors is being reclassified. Those are the ones where you really want to protect yourself by having the right contracts in place by having the right agent of record in place. And even though there’s a lot of activity around arbitration agreements these days you know the going thinking is from a legal and I’m not a lawyer but you know our counsel guides us is have an arbitration agreement in place with your contractors. That way the companies are limiting their exposure and having another remedy in the event that there’s an inquiry about improper classification and that’s great.
Michael: And to get more into these best practices and it sounds like having a proactive process in place is really important in terms of training and education or communication. What else would you recommend to the average company to get ahead of some of these.
Michael: Yeah I think the in and we’re never surprised to find even Fortune 500 companies who who are engaging hundreds maybe over a thousand freelancers and they don’t have formal classification screening processes in place. They don’t leverage a program approach or use a third party provider like ourselves to help them manage that. So one is is just awareness you know recognize that you have a risk. And certainly if companies are engaging that many freelancers they generally their legal counsel somebody and regulatory compliance has raised the flag and said Hey we should probably think about this. But nonetheless it awareness is is is step number one step number two is getting that assessment that we talked about the assessment that we do takes a close look at what your current state is it matters if you have a solution in place to do the screening and to engage the contractors and to attempt to classify them properly. But it also matters if if that solution isn’t effective and we need to help tease that out a lot of companies will when they first start using freelancers they’ll lean on you know oftentimes their staffing firms or some other vendor that they have available to them to say hey can you payroll this person. And then it becomes Hey can you screen this person for I.S. classification. And and that’s fine for know very small volumes and kind of do very infrequently but it’s actually not fine if you if you kind of take that kind of approach into in your freelance population grows significantly because when you’re managing a large number of them then you know the burden is on you the company organization to actually put proper procedures in place to operationalize it so that all freelancers are properly screened and classified. And then certainly with the growth comes the risk. So those are the things that I would recommend that companies kind of think about. And then once you get that assessment and and kind of develop an awareness that hey yeah we need some kind of help then you can start looking at the different solutions that are available to you.
Michael: Yeah. To gets into some of these solutions because they do seem sort of involved especially as as you know a company might grow its external workforce and scale in that manner. Some of these things might seem a bit high touch. So how would you scale a solution like them. What is what is some of that those solutions look like.
Tyler: Yeah. So you know when we talk about traditional solutions where we’re taking each individual engagement and you know there’s a there’s a lack of technology or automation that is directly addressing the marketplace to for the client company to engage that that freelancer that contractor generally the the compliant support falls in line or layers on top of whatever the operational engagement or acquisition model is for the talent of that company.
Tyler: So that’s really what we recognized first. You can’t go in as the compliance provider and say hey you know you’re you’re engaging freelancers or you’re acquiring these contractors in a really bad way. And you know we can’t provide you compliant support for that. Well the the truth is that’s not true. I mean we can. But what we like to see and what we’re encouraging more and more so nowadays with the advent of the contract management systems freelance management systems the gig platforms companies like short list who are really creating a marketplace to make it efficient and effective and and you know address all the marketplace connections between a between a contractor and a client. What we really like to do is is infuse our our services are compliant screening our agent or record services into that platform or that technology that the companies using because if we can do that then we accomplish a few things. One we’re in line with what that company has already sort of decided is is acceptable to them to engage contingent workers to engage freelance workers. So that’s that’s job number one.
Tyler: If you if you go in and you say why can’t support that and they don’t have the the political will within the organization to change the underlying engagement or acquisition of their talent then you know it doesn’t make any sense to say you can’t add compliance layer on top of that. If if you haven’t hired a high volume organization and they’ve recognized the value and efficiencies of going to a platform to support engagement of freelancers we think that’s the best way to scale. And here’s an example of why. If you have the compliance screening and the monitoring that we do infused into the platform so that neither the contractor nor the client manager has to go outside the platform to do some compliance related stuff you’re your adoption and your participation in your adherence to policy is much greater. So just the ease of use for that user is really important. Secondly when you have a platform like that you still have to make that determination between is it traditional or is it gig and in and we started talking about that earlier. Let me let me add a little bit to sort of make this point. You can have a platform like short list that that could be either gig or traditional. It really matters on the underlying engagement that the client perceives with their with their talent with their contractors. And what we look at are those parameters that help us say OK well here’s how you’re using the platform. Here’s how we can support it. Here’s how we can help you maintain your almost immediate on demand real time classification of your gig workers. And we can do that. But the reality is most business models or talent acquisition models that are using contract management and freelance management solutions tend to fall into the to the traditional space. And here’s why. So Locke took a long time to get to this point but here’s why the the commonality of the work that you’re sending to those putting out there on the platform for the contractors to engage with and the lack of a pre vetted contractor population causes us to take the traditional approach to doing that screening. We have to do the interviews we have to get the forms fill it out. We have to on both the contractor side as well as the client side and that can be time consuming and laborious and it’s not exactly in sync with today’s modern technologies that support the talent acquisition model. So what we’re really excited about is this ability to take a shortlist platform because we’ve proved it. We’ve got some some great cases already underway in our partnership with shortlist and we’ve done a lot of pre vetting of the contractors and the the engagements if you will that allow us to not maybe not do real time classification although there is a narrow path where we can do it. But if we have to pop it out in our queue usually we can do it in a matter of one or two business days versus the traditional non platform based solution that takes anywhere from 8 to 15 days. No kidding.
Tyler: Eight to 15 days because you have to address each contractor in each engagement structure work description individually what we like about the platform and I think the thing the glue that kind of creates that ability that foundation to do it is there’s there’s a commonality there’s I won’t call it complete standardization but there’s a there’s a move towards standardization that we’re able to leverage in our compliance screening and delivery of our compliance support services that we’re able to take advantage of and we couldn’t do that if we weren’t infused with the with the platform itself and working with you and the rest of the shortlist team so that when you’re implementing your platform we’re also implementing our compliant solution so that it’s almost seamless to both the client and to the contractors when they’re coming in and that’s our goal. It’s a secondary goal because our first goal is to make sure we’re making proper classifications but the secondary goal is to support the platforms business model of providing creating and supporting that efficient fully transparent well oiled marketplace between buyers and sellers.
Michael: And that single source of information I think via the platform model with freelancer management systems or contractor routers systems is important and I can see how that free vetting would be challenging you mentioned 8 to 15 days and I would imagine a lot of that would be going back through email records and and really non scalable methods. So I can see how that platform would help you do your job better in terms of spotting these misclassification risks while also putting the safeguards in place to protect you from from these pitfalls.
Tyler: Absolutely and what we’ve got going on the back end is we’re developed we have developed and we’re continually adding to our compliance rules engine and what that allows us to do is to take the information that both from the contractor side as well as the client engagement side take those inputs and run them up against our rules and and get early quick easy decisions. So for instance we would never give an automated classification decision for any ICI coming out of California right. So we’re checking the states. That’s an easy one to say that’s a rule we have to lay our eyes our hands on that one and really take a second look. Just because of all the the fluidity in their regulatory environment. But if it’s in a state like Oklahoma or it’s a we’ve already predetermined that a client engagement is very unique and it’s truly structured as a project base and it’s it’s not part of what the client organization does on our in their normal course of business. If we’ve kind of been able to check all the boxes then we can look at the profile of that contractor as long as there I PRICHEP certifying we’ve done the preventing on them. Then when those two things get matched in the platform then we can say either automate the classification because we’ve done all our homework for these two for this very scenario or we look at it and we say you know what. This is close but let’s just lay our eyes on it just to get that second look at it make sure that we got maybe an extra piece of documentation from the contractor or maybe if there was a slight alteration or amendment to the work description that we had originally prevented. Those are the kind of things that pop out in our queue and we make quick work off and when we can work it within you know usually a day but we allow ourselves from our with our s always two days to do it that that near real time classification you know is still far superior to the eight plus days well that’s fantastic.
Michael: Michael I want to thank you so much for stopping by today.
Tyler: Yeah. Thank you so much for having me. Really enjoy our partnership and relationship or shortlists. Thanks Tyler.