Compliance is not conducted for the sole purpose of being compliant. Compliance is, and always should be, a component part to the overall business objective. We should think about compliance, IC classification included, in the broader context of the business challenge or opportunity that is driving the need for freelance talent in the first place.

As we shift our thinking towards strategies for enterprises to avoid and mitigate IC compliance risk, we start with what many think is the ultimate, the perfect risk elimination solution: just don’t hire any freelancers as independent contractors.

Do No-1099 Policies Work? 

The most effective risk management strategy to guard against employee misclassification is a “no 1099 policy” (or “no IC policy” outside the US). This policy simply avoids the risk of governmental inquiry and judgement by not engaging any freelancers as 1099 independent contractors. Rather, all freelancers are engaged as W-2 contractors (also known as contract employees or EOR (employer of record) contractors).

Why is this a sure thing for managing misclassification risk? Because there is near zero percent chance that any state or federal agency is going to pursue an employee misclassification claim challenging the employer-employee relationship. There is simply no need for these agencies to do so; in a no-1099 environment the agencies’ objectives - to ensure the existence of employer-employee relationships - have already been met. When an employer-employee relationship exists, then worker’s rights are fully protected and the full complement of employer and employee taxes are being filed and paid. It is the one full-proof, government-approved solution that guarantees 100% classification compliance.

But… 

Despite the non-existent employee misclassification risk inherent in a no-1099 approach, this is not an excellent outcome for the business. Consider these two critical impacts of such a policy:

1. Missing out on talent - many freelancers, and the number is growing, prefer to only be engaged as ICs and not as contract employees; and

2. Paying more for talent - when engaged as contract employees, freelance talent costs more.

Finding and engaging talent to get work done is the biggest challenge companies face in a mixed labor market where some sectors are tightening, some geographies are cooling, and US and global unemployment remains steadily below 5% for 3 years and counting. So it does not help when a company further constrains that access to talent with a self-imposed restriction on up to 50% of the fastest growing segment of the global workforce, freelancers. Freelancers currently account for about 36% of the total workforce.1

In addition to restricted access to skilled talent, no-IC policies effectively lock companies into paying about 250% more for the engagement of their freelance talent than is necessary.  Assuming the freelancer pay is near equal, here’s the math.

The Cost of No-1099 Policies

• 25% EOR markup (generous average of country statutory costs + EOR fee)  

• 5% AOR fee (average global cost to engage freelancers as ICs) 

• Equates to a 500% EOR premium over AOR

• Multiply by 50%, assuming a 50/50 ratio of EOR/AOR -engaged talent

• Equals 250% more cost for freelance talent under a no-1099 policy.

Having worked in the financial services sector for a number of years, including in support of the regulatory compliance function in my strategic sourcing role, I know that some companies, particularly in the heavily regulated sectors, have legitimate reasons to institute no-1099 policies. The risk of reputational damage that even inadvertent misclassifications could impart is just too great to take the chance. It is truly an understandable business decision to make. But the question remains, is it always necessary?

We present the no-1099 policy to make the point that it can be a costly approach and because it actually is an option companies consider; and not just those in heavily regulated sectors. 

However, there are other reasons why companies find themselves in a no-1099 environment. Sometimes it is not intentional. There are generally two classes of these companies that we see on a regular basis: 

1. Baseless Risk Avoiders Companies that assume the risk of employee misclassification is too great to undertake and manage because they do not have the experience or functional expertise to navigate the risk effectively. So they don’t entertain independent contractors because they never have done so before; and often they don’t have the experienced leadership to help transform them into an organization that does.

2. Defacto Payroll Operations Companies that started using freelancers and asked a friendly staffing firm to payroll the first few freelance workers, potentially not realizing that the staffing firm did not have the classification screening competency either and wasn’t even considering an IC engagement. Not a real issue when the company only has a small population of freelancers, but left unchecked for a larger or growing organization, this default talent engagement model becomes a material issue that limits access to freelance talent and incurs significant excess costs, unnecessarily.

What Does IC Compliance Excellence Look Like?

Zero misclassification risk is an unrealistic expectation for any company, especially one seeking the competitive advantage of unfettered access to and leverage of the global freelance talent market. As we showed above, even a no-1099 policy acknowledges acceptance of a certain level of risk - limited talent access and higher costs. The risk event and impact is different from misclassification, but trading one risk for another more tenable risk is not the same as eliminating risk. 

For an organization that simply cannot or chooses not to institute a no-1099 policy, but instead needs to incorporate IC freelance talent into their contingent labor strategy, then what does IC compliance excellence look like? For these organizations there is tacit acceptance of at least a minimal level of risk exposure because the increased access to talent makes it worthwhile. What should companies strive for when it comes to guarding the organization against employee misclassification risk? 

Risk thresholds will differ from organization to organization and industry to industry, but as a baseline let’s define what we mean by IC compliance process excellence relative to the broader business objective of freelance talent acquisition: 

Key Compliance Metrics

Regardless of a company’s risk tolerance, these key performance indicators should be the goal. As we will explore in a later issue, to not target these process KPIs is to knowingly accept risk in the organization.

• Screenings: 100% of known, at-risk engagements 

• Determinations: 100% of IC engagement classifications are defensible

• Policy Compliance: 100% adherence to company freelance engagement policy

• Risk Events: 0 misclassification claims, lawsuits, or other formal inquiries

Important note: Achieving these KPIs will not eliminate misclassification risk. There is a level of residual risk that will always be present. More on this phenomenon later.

The IC Compliance Framework

The journey to IC compliance excellence will vary from organization to organization based on a number of variables: size, geographies, freelance population, freelance services, current processes, current policies, contingent workforce strategy, contingent workforce program governance (or lack thereof), and many other factors. But while the journey may be different, the destination - what we refer to as the Governing Framework for Compliant Freelance Management (IC compliance framework for easier reference) - is effectively the same for all companies, regardless of the starting point. 

Even with a robust IC compliance framework in place, a certain level of risk is unavoidable for any organization. This remaining risk, known as "residual risk," is the inherent uncertainty that persists after all reasonable process controls and risk mitigation strategies have been implemented. It is a fundamental concept in risk management, acknowledging that no system is entirely foolproof and that a zero-risk environment is an unattainable ideal. 

Conclusion

The following elements are necessary to establish an effective and sustainable IC compliance framework and the only way (other than no-1099) to achieve IC compliance excellence:

1. Audit - Current State Audit of Freelance Contractor Engagement Processes and IC Compliance Effectiveness 

2. Policy - Freelance Contractor Engagement Policy 

3. Training - IC Engagement Management Training

4. Process - Centralized Freelance Contractor Engagement Process 

5. Function - IC Compliance Function 

Next Issue

In our next issue we will begin to work through the IC compliance framework elements in detail, providing examples, templates, tools and advice on how to achieve IC compliance excellence.

Until next Wednesday, stay compliant and be happy.