WHITE PAPER THE ROI OF INDEPENDENT CONTRACTOR COMPLIANCE Building a Business Case for Introducing an Enterprise IC Engagement and Compliance Program AUGUST, 2012 MBO Enterprise Solutions is an MBO Partners company.
TABLE OF CONTENTS 1. Introduction... 1 Increase in Legal and Regulatory Activity... 2 Who Benefits from Using an ICES?... 3 Target Audience for this Paper... 3 Paper Structure... 3 2. Financial Impact of Using an ICES: Costs... 4 Services Fees... 4 Program Funding Options... 5 Client-Funded Model... 5 IC-Funded Model... 5 Hybrid Model... 5 Implementation... 6 3. Financial Impact of Using an ICES: Advantages... 7 Cost Avoidance... 7 Risk Mitigation...7 Improved Time-to-Productivity... 9 Improved Talent Retention... 9 Cost Savings... 10 Disintermediation and Tax Payment Reduction...10 Reduction of IC Administration Overhead... 11 Elimination of Subtier Markups... 11 IC Rate Reduction Through Eliminating Need for Business Insurances... 12 Reduction of Sales Tax Requirement... 12 Cost Control... 12 Spend Visibility... 13 Reduced Maverick Spend... 13 Rate Rationalization and Normalization... 13 4. ROI Summary Example and Worksheet... 15 ROI Example... 15 Cost Avoidance... 15 Cost Savings... 16 Cost Control... 18 Cumulative Example ROI Summary... 19 ICES ROI Worksheet... 20 Try It Yourself... 20 5. Best Practices to Ensure Program Success... 21 Executive Sponsorship... 21 Engagement Services Designed to Appeal to Workers... 21 Differentiating Professional ICs from Payrollees... 21 Identifying and Grouping IC Populations... 22 Different Program Funding Model for New vs Incumbent ICs... 22 No Requirement for Manager Questionnaire... 23 Manual IC Assessment Review... 23 Use of Statements of Work (SOWs)... 23 Indemnification... 23 6. About MBO Enterprise Solutions... 25 7. Disclaimer...26 August, 2012
1. INTRODUCTION Businesses of all sizes and industries rely on the services of independent workers to supplement their full-time staff. While businesses commonly source independent contractors ( ICs ) through recruiting or staffing companies, they also identify many ICs internally; that is, the client finds ICs without outside sourcing assistance. WHAT S AN INDEPENDENT CONTRACTOR, ANYWAY? Independent workers go by a wide variety of names. For the purposes of this paper, ICs include internally sourced professional independent consultants, freelancers, Statement of Work (SOW) consultants, and small businesses of five or fewer people. These types of individuals fit the IRS s definition of independent contractors as people who are in an independent trade, business, or profession in which they offer their services to the general public. Internally identified ICs represent a flexible Workers such as temps and staffing agency contractors are not included in the definition of an IC and are therefore not represented in this paper. means of completing critical non-core functions without the added cost of a recruiting intermediary. Their use, however, introduces unique risks should actually be classified as an IC is a complex endeavor. Please note that determining whether someone working as an IC According to the IRS, the general rule is that an individual is and challenges; most notably, the risk of IC reclassification. If the IRS, state tax authorities, or or direct only the result of the work and not what will be done an independent contractor if the payer has the right to control labor-related regulatory bodies determine that a and how it will be done. However, each case must be assessed on its own merits. business uses ICs who are non-compliant with guidelines for working independently, they can reclassify these workers as W-2 employees. The result can be penalties and back tax payments than can be as embarrassing as they are costly. Businesses that use ICs must therefore implement engagement policies and programs that attempt to mitigate this and other IC-related risks. In many cases, these businesses are tapping into the expertise of a new breed of service providers: Independent Contractor Engagement Specialists ( ICES ). "Frequently, an MSP will introduce an ICES to its customers who may know independent contractors they want to engage, but prefer to do so through an ICES, who not only acts as the W-2 Employer of Record or 1099 Agent of Record but who may also provide support services to the contractor so that they can focus on their client engagements rather than the administrative work involved in running their business." Human Capital Institute, "The ROI in Enterprise Contract Talent Management," September 2009 ICES providers are third party intermediaries that specialize in the compliant and efficient engagement of independent contractors. 1 This paper explores the costs and value associated with using an ICES to establish and maintain an effective IC compliance and engagement program. It includes a detailed ROI analysis and highlights several emerging best practices that leading ICES providers employ to ensure successful programs. 1 Human Capital Institute, What Influences Contract Talent Usage, 2011 August, 2012 Page 1
INCREASE IN LEGAL AND REGULATORY ACTIVITY Worker misclassification has long been a high-stakes issue, but new legislation, recent high-profile cases, pressure from organized labor, and heightened scrutiny from government agencies have increased the risks of misclassifying workers as ICs. State and federal government budget crises have driven scrutiny on IC classification which was already high to a new and even higher level. Misclassification, intentional or unintentional, can lead to fines and penalties, litigation expenses, and worker settlements. Other costs, such as increased insurance premiums, also hang in the balance. On state and federal levels, the enforcement trend is toward moving workers from IC status into employee status. Since 2009, there has been a steady increase in regulatory activity and enforcement regarding IC misclassification. Members of the U.S. House of Representatives and Senate have introduced classification-related bills repeatedly, while at least 15 states have passed laws that either strengthen the definition of an independent contractor or increase misclassification penalties. The IRS is in the process of auditing 6,000 randomly selected businesses from across the country and the federal budgets for 2012 and 2013 include millions of dollars in funding for a Misclassification Initiative designed to stem the tide. This regulatory activity flies in the face of societal and business trends that are driving increased IC usage. According to a 2011 study 2, there are currently 16 million independent workers in the U.S., and that number is expected to rise to 20 million by 2013. By 2020, a separate study anticipates that more than half of the U.S. workforce will be independent 3. Meanwhile, more and more businesses are moving toward a more flexible, contingent model that includes independent workers. Internally identified ICs represent a flexible means of completing critical non-core functions without the added cost of a recruiting intermediary. Businesses seeking to increase their flexibility for relatively low cost are increasing their reliance on independent experts. Taken together, all of these factors create a perfect storm of government compliance efforts moving directly against a strong societal trend with businesses caught in the middle. 2 MBO Partners, Independent Workforce Index, September, 2011. 3 MBO Partners, 2012 Independent Work Preview, December, 2011. August, 2012 Page 2
WHO BENEFITS FROM USING AN ICES? The value an ICES can bring to an organization is directly proportional to the number of ICs the organization engages. While small and medium-sized companies can effectively leverage an ICES to reduce risks and cut costs, the analysis presented in this paper represents the financial impact an ICES can have on a large, IC-heavy company that deploys the ICES solution throughout its enterprise. The larger the company and the heavier its reliance on ICs the greater the role an ICES can play in reducing costs, minimizing risks, improving talent retention, and increasing visibility. TARGET AUDIENCE FOR THIS PAPER A wide variety of stakeholders within an organization can leverage the analysis in this paper. As IC engagement and usage touches a wide variety of functions most notably Procurement, Human Resources, Legal, and any stakeholder involved in managing nonemployee talent executives from multiple departments may benefit from the introduction of an IC compliance and engagement program. This paper may also be valuable to managers of complex spend categories, whose responsibilities cover large and small providers of professional services. These managers may find the subject of this paper particularly valuable, as ICs are commonly used in situations where project spend is relatively small. Such spend may fall below the threshold that requires the application of standard procurement practices normally associated with bigger ticket items. PAPER STRUCTURE Four sections follow: Section 2 looks at the universe of possible costs associated with using an ICES. Section 3 details the potential financial advantages a business can derive. Section 4 compares the costs with the advantages to derive an ROI estimation. Section 5 explains several best practices business should consider when establishing an enterprise IC engagement program. August, 2012 Page 3
2. FINANCIAL IMPACT OF USING AN ICES: COSTS SERVICES FEES Services fees commonly associated with an ICES program include: Compliance Evaluation Services Fees. Most ICES providers charge a fee to conduct evaluations that determine whether ICs are compliant with regulatory guidelines for independent contracting. These fees can vary from $150 to $500 per IC. ( Follow-on evaluations of previously qualified ICs may be less.) Component services may include manual review of assessment responses (to ensure accuracy), the collection and warehousing of supporting documentation, client audit support, and indemnification. In some cases, an ICES may waive the Compliance Evaluation Services Fees if the evaluated IC goes on to engage through the ICES s engagement services. On-Boarding Services Fees. Clients that require their ICs to undergo pre-engagement screenings (such as background checks and drug screens) incur fees that vary depending on the scope and type of screenings required. These costs may be passed on to ICs as a cost of doing business with the client. Engagement Services Fees. These fees reflect the ongoing costs associated with engaging, managing, and paying ICs. They represent the brunt of an ICES program s overall cost burden. For ICs found to be non-qualified through an assessment, many ICES use a traditional payrolling/staffing pricing model that bundles the burden of Employer Payroll Taxes including FICA, unemployment, and Workers Comp into their services fess. This creates a total mark-up of approximately 15% to 25% (depending on the worker s state and total anticipated billings). Other ICES providers, typically those catering to professional consultants, recognize that ICs rates may already accommodate for these taxes and therefore charge a much lower mark-up, typically 4% to 10%. For ICs found to be qualified, the Employer Payroll Tax burden is not necessary. Most ICES providers therefore charge a mark-up of only 3% to 8%. MSP/VMS Services Fees. The presence of an MSP and/or VMS typically adds approximately 1.5% to 3.0% to the overall services fee. This additional charge is commonly bundled into and collected as part of the ICES services fee and later distributed to the MSP/VMS. August, 2012 Page 4
Please note that many MSPs perform some ICES-like functions as part of their standard service offering. In most cases, however, MSPs do not offer a comprehensive engagement and risk mitigation solution for ICs that is embraced by both the client and workers. Many prominent MSPs therefore seek out partnerships with ICES providers to expand and enhance their overall service footprint. PROGRAM FUNDING OPTIONS Businesses enlisting an ICES are faced with a critical financial decision from day one: whether to cover the Services Fees associated with the engagement program or pass them on to their ICs. The sections below explore common funding methods clients may incorporate into their programs. CLIENT-FUNDED MODEL In the client-funded model, clients cover the program s Engagement Services Fees and, usually, the Compliance Evaluation and On-Boarding Services Fees as well. This practice results in the lowest cost for the workers and, consequently, drives higher program adoption and acceptance. In a client-funded model, ICES providers commonly uplift each IC s original negotiated rate to accommodate for the Engagement Services Fee. The ICES collects the fee from the ICs billings each pay period and the ICs receive the rate they negotiated. IC-FUNDED MODEL In the IC-funded model, the ICES does not uplift the IC s negotiated bill rate before collecting its Engagement Services Fee. The IC therefore shoulders the full financial impact of this fee. This represents a virtually cost-neutral program for the client, but is more likely to cause disruption and dissention among the ICs. Clients concerned about aggravating or even losing their valuable consulting talent should consider all the ramifications before deciding on an IC-funded model. HYBRID MODEL ICES programs do not necessarily have to adhere exclusively to one model or the other. Because program funding is simply a matter of adjusting the ICs rates prior to fee collection, clients may decide on a case-by-case or group-by-group basis which workers to fund (or even to partially fund through a smaller rate uplift). August, 2012 Page 5
One common manifestation of the hybrid model includes using a client-funded model for existing ( incumbent ) ICs and an IC-funded model for ICs who engage after the program is in place. This practice is designed to keep current talent happy while minimizing program costs associated with new ICs. IMPLEMENTATION A typical enterprise ICES program implementation can last several weeks and typically includes discovery activities, program decisions, customized solution design, a variety of program-tailored communications, process details, and sometimes technology interface development. Most ICES providers do not charge for implementations that fall within the parameters of a standard implementation. However, an ICES may charge for extensive system design and customization. August, 2012 Page 6
3. FINANCIAL IMPACT OF USING AN ICES: ADVANTAGES The use of an ICES invites a wide variety of cost avoidance and cost savings advantages. While the costs associated with using an ICES are highly variable due to the program funding options, large businesses may find that the advantages of using an ICES outweigh the costs even if the program is entirely client-funded. COST AVOIDANCE A critical means by which ICES-using clients recognize value is through the avoidance of costs to which businesses may be subject if they do not have a formal IC engagement program in place. By far the most dramatic example of cost avoidance and often the primary motivator for businesses opting to engage an [U]sers of ICES solutions have achieved a 56% higher ICES is the avoidance of fines and penalties rate of independent contractor compliance than companies not currently utilizing this enabler. associated with independent contractor misclassification. This factor and other examples of cost Aberdeen Group, "Contingent Labor Management: The Evolution of the Contemporary Contingent Workforce," May, 2011 avoidance are below. RISK MITIGATION ICES clients gain an immediate cost benefit from avoiding fines and penalties associated with IC reclassification. Most ICES providers evaluate clientreferred ICs for compliance with regulatory guidelines for working independently. They then engage noncompliant workers as W-2 employees thus eliminating the threat of reclassification while engaging compliant ICs as sub-contractors. ESTIMATED IRS* MISCLASSIFICATION PENALTIES (100 ICs, $125,000/YEAR) UNINTENTIONAL INTENTIONAL TOTAL SPEND (ANNUAL) $12,500,000 $12,500,000 FICA $1,012,092 $1,686,820 INCOME TAX $187,500 $3,125,000 FUTA $43,400 $43,400 UNDERPAYMENT INTEREST $42,220 $194,209 FAILURE TO FILE $421,705 ACCURACY-RELATED PENALTY $962,364 FAILURE TO DEPOSIT TAXES $721,773 FAILURE TO FILE W-2s WITH GOVERNMENT $1,250,000 FAILURE TO FILE W-2s WITH WORKERS $1,250,000 ESTIMATED ANNUAL LIABILITY $1,285,200 $9,655,300 THREE-YEAR LIABILITY** $3,966,300 $29,929,800 * Does not include potential penalties from state tax authorities, the Department of Labor, and other authorities. When selecting an ICES, be sure that it ** Includes interest related to previous years. indemnifies your business for taxrelated penalties you would incur if tax authorities reclassify previously qualified ICs. Between this indemnification of compliant ICs and a W-2 employment vehicle for those found to be non-compliant, an ICES can eliminate a client s reclassification risk entirely. August, 2012 Page 7
IRS penalties alone can amount to 80% or more of a business s original IC payments if the business is found to have misclassified its ICs knowingly or intentionally. The example above shows the potential penalties associated with misclassifying 100 ICs with $125,000 in average annual billings for three years. IRS penalties, however, are only a small part of the potential risks associated with IC misclassification. Other potentially damaging risk factors include: State Penalties. Most states have their own laws dealing with CALIFORNIA IC classification, with some levying potentially devastating penalties. These penalties can approach or even exceed penalties TRANSGRESSORS FACE $5,000 TO $15,000 PENALTY FOR EACH CLASSIFICATION VIOLATION PENALTY INCREASED TO $10,000 TO $25,000 IF imposed by the IRS. The table at left depicts just a few of the THERE IS A PATTERN OR PRACTICE OF VIOLATIONS more damaging state misclassification laws. BUSINESSES MUST PUBLICIZE TRANSGRESSIONS ON WEBSITE Class-Action Lawsuits. Some ICES providers enable clients to mitigate the risk of class-action suits that may be filed once a CONNECTICUT reclassification finding becomes part of the public record. Some TRANSGRESSORS FACE CIVIL PENALTIES OF $300 may also review a client s defined benefit plans, highlighting PER VIOLATION PER DAY red flags that may prompt ICs to believe they are entitled to VERMONT employment benefits. More importantly, though, an ICES s offering should include benefits and services that help promote a TRANSGRESSORS FACE FINES OF $100 PER DAY FOR THE FIRST SEVEN DAYS; $150 PER DAY more satisfied IC workforce. Though co-employment risk can THEREAFTER IF ISSUE CONTINUES, LABOR COMMISSIONER CAN never be removed completely, an ICES can reduce ICs inclination to initiate and foundation to win a co-employment law- ISSUE STOP WORK ORDER; FINES INCREASE TO $250 PER EMPLOYEE PER DAY suit. Penalties accurate as of August, 2012. Business Risk. Because an ICES ensures that all ICs are covered under the required business insurances (either on their own or under the umbrella of the ICES s policies), it dramatically reduces a client s exposure to lawsuits relating to typical business risks. Worker s Comp Risk. A business that engages ICs who do not carry Worker s Compensation insurance exposes itself to significantly higher potential claims than ones using workers who do carry the insurance. An ICES can ensure that all ICs either carry their own Worker s Comp insurance or are covered by the ICES. Other Risks. Businesses found to have misclassified ICs may face additional ramifications: August, 2012 Page 8
The Department of Labor may investigate whether the misclassifications also indicate Fair Labor Standards Act violations, such as overtime and minimum wage underpayments. The Department of Homeland Security may impose immigration penalties if improperly vetted ICs are actually working illegally in the U.S. Executives may face criminal prosecution under provisions of the Sarbanes-Oxley Act which requires full disclosure of all risk factors. Businesses reliant on federal contracts could face debarment. Legal defense costs could be damaging. Brand damage may occur, which could impede talent acquisition and retention. IMPROVED TIME-TO-PRODUCTIVITY Most ICES use an online enrollment and on-boarding process that enables new ICs to complete their pre-assignment administrative requirements quickly so that they may more expediently begin their work. A 2009 Aberdeen Group study found that businesses using an ICES reduced their average IC on-boarding time by 68%, from 4.1 days to 2.7 days 4. IMPROVED TALENT RETENTION In order for an ICES to effectively achieve its objectives throughout an enterprise, it must offer an enticing and attractive engagement solution for the ICs themselves. This attractiveness serves as the linchpin behind widespread IC adoption, which represents the foundation for all the other advantages an ICES program can deliver. The attractiveness of the ICES offering has an additional benefit as well. An ICES can help a client create a more appealing business and financial environment for its IC talent, thus improving the client s ability to attract and retain this critical component of its workforce. Some ICES providers can also help clients develop private talent pools of trusted workers who can be accessed and engaged easily and efficiently. This can streamline sourcing, improve service quality, make rates easier to manage, and reduce on-boarding time. 4 Aberdeen Group, " Contract Labor Management: Superior Workforce Strategies for a Demanding Environment," 2009. August, 2012 Page 9
COST SAVINGS A client opting for the IC-funded model can enjoy the benefits of an ICES relationship for virtually no cost, thus realizing dramatic financial advantages, process improvements, and risk mitigation. However, even those clients which choose to fund some or all of the program s costs realize significant cost savings. Different categories of savings are explained below. DISINTERMEDIATION AND TAX PAYMENT REDUCTION A primary cost benefit of using an ICES is disintermediation the ability for a client to safely engage internally sourced ICs without using high-overhead third-party intermediaries, thus reducing overall costs. Contemporary methods of locating ICs such as modern search technologies, social networks, and online marketplaces give clients unparalleled new talent access streams and enable them to establish talent channels outside of their staffing vendor networks. Without an ICES, however, the cost savings associated with direct engagement would likely be superseded by the risks. In an attempt to avoid direct engagements, some companies direct ICs to engage through approved consulting firms with existing contracts. This may sometimes minimize the risks of direct engagement, but it also results in higher costs because the consulting firm will likely have at least 15% to 25% in overhead built into their cost models. This additional cost can eliminate most of the savings offered by direct sourcing and it may not even eliminate the risk (see Elimination of Subtier Markups on page 11). Disintermediation is particularly valuable when you consider its impact on ICs rates. Some ICES providers use a pricing model designed for professional ICs who are accustomed to formulating a billing rate that already accommodates for statutory costs (payroll taxes), overhead, and profit. As a result, their Engagement Services Fees do not re-include statutory costs. August, 2012 Page 10
This type of pricing model can translate into significant savings for the client. Clients that instead channel professional ICs into a conventional payroll provider (which charges a mark-up that includes payroll taxes), are in fact being double-charged for these taxes: they are paying them as part of the IC s negotiated rate and then again as part of the payroll provider s markup. Potential savings: As indicated above, this characteristic enables clients to reduce ICrelated spend by approximately 15% compared to conventional payroll providers. REDUCTION OF IC ADMINISTRATION OVERHEAD Consolidated Invoicing. Rather than paying each independent service provider individually, clients can pay all of them through a single consolidated invoice. Potential savings: Clients typically realize a 50% to 80% reduction in administration time and costs (depending on IC volume). Alternatively, administrative resources could be reallocated to other tasks. Reduced Contract Negotiation. An ICES and its clients only need to negotiate contract terms once. Clients then initiate all future engagements through a relatively unobtrusive Work Order or Purchase Order. Potential savings: Client managers can reduce the administration time associated with bringing on an IC by 30% to 60%, depending on the complexity of the client s contract and IC volume. Reduced Errors. Reducing the amount of administration associated with each IC engagement naturally reduces the number of errors that can be made in processing them. Potential savings: Creating a savings estimate relative to error reduction is problematic due to the wide variety of legacy processes that different clients may use. However, a 40% to 50% reduction in errors is reasonable. ELIMINATION OF SUBTIER MARKUPS Clients wishing to avoid direct relationships with internally sourced independent workers commonly channel them through businesses with which they already have a services agreement (such as consulting companies or integrators). This practice can prove costly, as the subtier company typically adds a mark-up of 20% to 30% to the worker s original bill rate. Channeling ICs to an ICES instead of a subtier dramatically reduces this unnecessary mark-up in favor of the Engagement Services Fee. August, 2012 Page 11
It is also important to note that the practice of channeling workers through subtiers to reduce reclassification risk may in fact have the opposite effect. If the subtier engages a worker as a 1099 independent contractor and that worker goes on to be reclassified, both your business and the subtier carry the potential liability. In these cases, reclassification risk is not eliminated; it is simply being distributed among a wider group of entities and it becomes more difficult to monitor and track. Potential savings: Clients that channel internally sourced ICs to subtiers can expect to reduce their overall spend by 10% to 30% on each IC channeled to an ICES instead. IC RATE REDUCTION THROUGH ELIMINATING NEED FOR BUSINESS INSURANCES When an ICES engages an IC as a W-2 employee, it covers the worker under its business insurances (including Errors & Omissions, General Liability, Commercial Auto, and sometimes others). In doing so, it relieves ICs of the requirement to pay for these insurances on their own a cost that would then get passed on to the client in the form of increased rates. Potential savings: The aggregate cost of business insurances varies significantly based on the client s actual insurance requirements and the levels to which the IC must be covered. If ICs must pay $2,500 to $5,000 each year in premiums a reasonable estimation clients could recover much, if not all, of these costs through reduced bill rates. Clients that require no or low levels of insurance assume significant business risk. REDUCTION OF SALES TAX REQUIREMENT While sales tax may only be applicable to a small percentage of a typical client s IC workforce, and only in certain states, an ICES can reduce this cost as well. For some labor categories, workers channeled to a payrolling provider would be subject to sales tax, while the same workers engaged through an ICES would not be. Potential savings: Specific potential sales tax savings vary by state. In general, clients can expect an average of 3.5% savings in situations where sales tax would apply. COST CONTROL In addition to reducing and avoiding costs, ICES clients can also leverage their programs to gain better control over their enterprise IC spend. Most consulting spend falls under complex spend categories where sourcing and bidding work competitively and consistently can be a challenge. Because consulting engagements August, 2012 Page 12
affect a wide range of enterprise functions and departments, many businesses experience spotty adherence to corporate standards and erratic rate and quality comparisons. Further, ensuring adherence to corporate vetting and auditing practices is arduous and often unattainable. The presence of an ICES, however, can better ensure that corporate policies related to IC and small vendor engagements are followed throughout the enterprise. Three important cost control factors are below. SPEND VISIBILITY Widespread program adoption enables clients to realize significant improvements in its visibility into contractor-related spend. An ICES therefore gives clients a platform upon which they can more easily review enterprise-wide expenditures and control costs by managing rates (see below), supervising budget adherence, and eliminating providers whose rates exceed corporate limitations. REDUCED MAVERICK SPEND Client managers are sometimes faced with the choice between project expediency and adherence to corporate engagement policies. Maverick spend occurs when managers engage ICs using processes that are inconsistent with corporate guidelines, oversight, and visibility mechanisms. Leveraging an ICES reduces the likelihood of maverick spend by installing consistent and easy-to-use engagement processes and improving IC engagement speed. Further, most ICES implementations are embraced and sponsored by C-level executives; this affiliation often drives ramifications for non-compliance with corporate policies. RATE RATIONALIZATION AND NORMALIZATION ICs weigh many factors and account for a variety of dynamics when developing the bill rate they present to their clients and not all ICs follow the same guidelines. Consequently, ICs can charge wildly disparate rates for fundamentally the same work. An ICES program can help clients rationalize and normalize the rates they pay ICs throughout their enterprise. An ICES can integrate a client s existing IC rate data, data from its own experience, and information from publicly available rate sources to create parameters within which IC rates must fall. Once a client can readily identify ICs whose rates fall outside this margin, it can apply its own discretion as to whether and how it should address the discrepancies. August, 2012 Page 13
In addition, clients leveraging an ICES may be able to control rates further through the establishment of private IC networks. These go-to talent pools of proven ICs, introduced above, are not only a convenient sourcing vehicle but promote rate control through competitive assignment bidding. August, 2012 Page 14
4. ROI SUMMARY EXAMPLE AND WORKSHEET The following vignettes summarize the potential savings an ICES client can realize based on the topics outlined in the previous section. This section also includes a worksheet (page 20) that readers can use in conjunction with an ICES ROI Estimator. Each vignette in the example below includes a comparison of a three fictitious companies: one that does not have an IC compliance and engagement program, one that relies exclusively on a conventional payrolling service for its IC engagement, and one that uses an ICES 5. These examples are based upon the following general assumptions. Each company engages 100 ICs. The average annual bill rate of each IC is $125,000. Seventy of the workers see themselves and operate as self-employable independent consultants (i.e., they consider themselves and operate as true independent consulting practices), the other 30 do not. See Differentiating Professional ICs from Payrollees on page 21 for more information about this categorization.) The program is client-funded. The ICES Engagement Services Fee is 5.0% while the payrolling services fee is 20.0%. Additional specific assumptions accompany some of the vignettes. ROI EXAMPLE COST AVOIDANCE Eliminating IRS reclassification risk. Estimates reflect potential single-year penalties based on published IRS regulations. Please note that the IRS can levy penalties at its discretion and businesses found to have intentionally misclassified workers as ICs may not be liable for all the components that sum up to the aggregate risk potential. 5 ROI estimates presented in this section are based on MBO Partners research of its enterprise clientele as of August, 2012. August, 2012 Page 15
Total Payments (100 ICs) $12,500,000 $12,500,000 $12,500,000 Estimated Annual Liability (if Unintentional) $1,285,200 $0 $0 Estimated Annual Liability (if Intentional) $9,655,300 $0 $0 Other cost avoidance categories. Other cost avoidance categories all vary significantly depending on several factors. These include the categories introduced earlier state reclassification risk mitigation, co-employment risk mitigation, and business risk mitigation plus other less conspicuous dangers introduced above: FLSA action, immigration penalties, Sarbanes-Oxley Act violations, legal defense costs, debarment from government contracts, brand damage, and more. COST SAVINGS Eliminating double tax payments: Estimates below reflect a savings of 15% compared to payroll providers on 70 professional independent consultants. Total Payments (70 ICs) $8,750,000 $8,750,000 $8,750,000 Services Fee Addition $0 $1,750,000 $437,000 Eliminating subtier mark-ups: Estimates below reflect the subtier charging a 25% services fee. Assumes that 10 of the 70 professional consultants are channeled to subtiers. Total Payments (10 ICs) $1,250,000 N/A $1,250,000 Services Fee Addition $312,500 N/A $62,500 Eliminating rate increases due to business insurance requirements: Estimates below reflect an overall cost for required business insurances of $4,375 per year. Assumes that all 100 ICs must be covered under business and Worker s Comp insurances, either through their own polices or those of the engagement provider. Total Payments (100 ICs) $12,500,000 $12,500,000 $12,500,000 Aggregate Rate Increase $437,500 $0 $0 Eliminating payment of state sales taxes: Estimates below reflect an average sales tax rate of 3.5% and assume that sales tax applies to 10 ICs. August, 2012 Page 16
Total Payments (10 ICs) $1,250,000 $1,250,000 $1,250,000 Aggregate Rate Increase $43,750 $43,750 $0 Reducing on-boarding administration: Estimates below reflect an overall cost to the company of $40 per hour for administration time. Operational efficiencies gained through using an ICES include streamlined payments, contracts, invoicing, expenses, and problem resolution. On-Boarding Admin Time Estimate Per IC 6 hours 3 hours 2.5 hours Overhead Cost for 100 ICs $24,000 $12,000 $10,000 Reducing ongoing payment administration: Again, estimates below reflect an overall cost to the company of $40 per hour for administration time. For clients with no program, the estimate assumes an average of ½ hour of monthly administration time per worker for processing payments. Annual Payment Admin Time Estimate Per IC 6 hours 1 hour 1 hour Overhead Cost for 100 ICs $24,000 $4,000 $4,000 Reducing administration time related to error correction: Estimates below reflect a 50% reduction in errors compared to clients with no program. Assumes a baseline 2% monthly error rate and four hours of administration time needed for error resolution. Admin Time Spent on Error Resolution 24 errors * 4 hours 12 errors * 4 hours 12 errors * 4 hours Cumulative Cost for 100 ICs $3,840 $1,920 $1,920 Increasing productivity through decreased on-boarding time. Estimates below reflect a delay impact of $500 per day. Assumes the on-boarding time for payrolling is equivalent to that of an ICES. Average On-boarding Time Delay 1.4 days 0 days 0 days Cumulative Impact for 100 ICs $70,000 $0 $0 August, 2012 Page 17
COST CONTROL Controlling costs through improved spend visibility. Figures below reflect a conservative estimate of 1% overall cost reduction for the Payrolling client and a 1.5% savings for the ICES client. (This difference is a function of a wider segment of the IC population that would be engaged through an ICES.) Please note that clients vary widely in terms of how they execute on the improvements in their enterprise spend data. Total Payments (100 ICs) $12,500,000 $12,500,000 $12,500,000 Cost Reduction Due to Improved Visibility $0 ($125,000) ($187,500) The estimates above do not include the previously addressed benefits that improved visibility supports, including reclassification risk mitigation and the elimination of subtier vendor reliance. Controlling costs through reining in maverick spend. Figures below reflect a conservative estimate of 1% overall cost reduction. Total Payments (100 ICs) $12,500,000 $12,500,000 $12,500,000 Cost Reduction Due to Improved Visibility $0 $0 ($125,000) Controlling costs through rate rationalization. Figures below reflect a conservative estimate of 2% overall cost reduction. A client s cost reduction percentage will likely increase over time as they assemble more data, their talent pools increase, and their competitive bid processes mature. Total Payments (100 ICs) $12,500,000 $12,500,000 $12,500,000 Cost Reduction Due to Improved Visibility $0 $0 ($250,000) August, 2012 Page 18
CUMULATIVE EXAMPLE ROI SUMMARY The following ROI summary consolidates all of the vignettes above. Please note that state reclassification penalties, which can be significant, are not accommodated for in this example due to the diversity of state regulations. Total IC Billings $12,500,000 $12,500,000 $12,500,000 Estimated Annual IRS Liability (if Unintentional; assumes 10.2816% penalty percentage) Estimated Annual IRS Liability (if Intentional; assumes 77.2424% penalty percentage) $1,285,200 $0 $0 $9,655,300 $0 $0 Engagement Services Fees $0 $2,500,000 $625,000 Of this, annual costs of paying payroll taxes on self-employable ICs converted to W-2 status $0 $1,750,000 $437,500 Additional annual costs associated with ICs channeled through subtiers $250,000 $0 $0 Aggregate annual rate increase impact due to business insurance requirements for 1099 ICs $437,500 $0 $0 Aggregate annual cost increase due to state sales tax requirements $43,750 $43,750 $0 Aggregate overhead cost associated with on-boarding administration $24,000 $12,000 $10,000 Aggregate annual overhead cost associated with payment administration $24,000 $4,000 $4,000 Aggregate annual overhead cost associated with error correction $3,840 $1,920 $1,920 Aggregate annual impact of productivity delays due to slower on-boarding time $70,000 $0 $0 Aggregate annual cost reduction due to improved visibility $0 ($125,000) ($187,500) Aggregate annual cost reduction due to reduced maverick spend $0 $0 ($125,000) Aggregate annual cost reduction due to improved rate rationalization $0 $0 ($250,000) Total Outlay Considering All Factors and No IRS Penalties $13,353,090 $14,936,670 $12,578,420 Percentage Increase Compared to Client-Funded ICES 6.16% 18.75% Total Outlay Considering All Factors and IRS "Unintentional" Penalties $14,638,290 $14,936,670 $12,578,420 Percentage Increase Compared to Client-Funded ICES 16.38% 18.75% Total Outlay Considering All Factors and IRS "Intentional" Penalties $23,008,390 $14,936,670 $12,578,420 Percentage Increase Compared to Client-Funded ICES 82.92% 18.75% August, 2012 Page 19
ICES ROI WORKSHEET Complete the yellow cells below with data appropriate for your business s situation. If you do not know how to complete a category, use the value from the Estimation column. Population Your Data Estimation How many independent workers do you engage at any given time? What are the average annual billings of these workers? What percentage of workers are "self-employable"? 70% What percentage of self-employable workers are engaged through subtiers? 10% What percentage of all workers is subject to state sales tax? 10% Fees and Other Costs What is the ICES services fee? 5% What is the average payrolling services fee? 20% What is the average markup charged by a subtier? 25% What is the average annual cost to ICs for required business insurances? $4,375 What is the average savings due to state sales tax reduction? 3.5% What is the overall payroll tax percentage? (Used to calculate savings from avoiding double payments) 15% IC On-Boarding How many days longer does it take to engage an IC without a program? 1.4 What is the daily cost impact of on-boarding delays? $500 Administrative Expectation What is the loaded hourly cost of administrative time? $40 On what percentage of payment transactions are there errors? 2% By what percentage will an engagement program reduce errors? (Compared to no program) 50% How many hours does it take to correct each error? 4 Program-Variable Components How many hours does it take to on-board a new IC? How many hours per month does it take to administer one IC's payments? What is the overall program cost reduction due to improved visibility? (Compared to no program) What is the overall program cost reduction due to reduced maverick spend? (Compared to no program) What is the overall program cost reduction due to improved rate rationalization? (Compared to no program) 6 3 2.5 0.5 0.8333 0.8333 N/A N/A N/A N/A N/A N/A TRY IT YOURSELF To see an ROI estimation based on your business s data, download the MBO_ROI_Estimation_Worksheet.xlsx from MBO Enterprise Solutions. Enter your data on the ICES ROI Worksheet tab and view results on the ICES ROI Results tab. August, 2012 Page 20
5. BEST PRACTICES TO ENSURE PROGRAM SUCCESS Accomplished ICES providers will bring many industry best practices to all enterprise IC compliance and engagement programs. The sections below highlight some of the more critical ones. EXECUTIVE SPONSORSHIP Executive sponsorship is critical to the success of any enterprise ICES initiative. A visible and engaged sponsor helps ensure that clients devote adequate implementation resources up front, establish and enforce a comprehensive IC engagement policy, effectively manage change and communications, and help drive program adoption and sustainability. An ICES should attempt to communicate the importance of executive sponsorship as early as possible in its client relationship. ENGAGEMENT SERVICES DESIGNED TO APPEAL TO WORKERS All effective compliance and engagement programs have one thing in common: they offer engagement services that ICs are willing, or even eager, to accept. A client-centric program that ignores the needs of the ICs is not positioned for long-term success, as they will either alienate the talent or drive managers to engage their desired ICs outside of the program. Conversely, a holistic program that effectively serves the needs of both the client and the ICs is more likely to gain traction and drive long-term adoption. Today s best ICES providers offer engagement services that are designed with the specific needs of professional independent workers in mind. DIFFERENTIATING PROFESSIONAL ICS FROM PAYROLLEES An experienced ICES should recognize that not all ICs are created equal and design its offerings accordingly. Many ICs, even though they work on a contract basis, do not see themselves or operate as true independent consulting entities. Such individuals typically do not want to be encumbered with the complexities and risks associated with an independent career. Instead, they often seek the security and consistency of a regular paycheck as they work their assignments. Such workers are commonly associated with non-professional roles (such as administrative, light industrial, and other traditionally blue collar positions). August, 2012 Page 21
Differentiating between these payrollees and professional consultants is a critical best practice. Engagement services that would be embraced by professional consultants would be shunned or rejected by payrollees, and vice versa. A compliance and engagement program that wedges both categories of ICs into the same program is likely destined for failure. This differentiation also helps expedite on-boarding, as only professional consultants are appropriate for compliance evaluation. This can dramatically reduce the number of evaluations that are required without impacting the accuracy of the compliance categorization. IDENTIFYING AND GROUPING IC POPULATIONS Many large clients engage considerable numbers of ICs representing a wide variety of occupations, rate levels, and locations. This variety is often so extreme that client leaders including HR, Legal, and Procurement executives have little insight into the quantity and compliance status of their companies ICs. This can create a significant challenge when attempting to launch and operate a consistent compliance and engagement program across the enterprise. One evolving best practice is for the ICES to send an automated survey questionnaire directly to the client s ICs. The ICES can then assess the data in aggregate and divide the entire IC population into manageable homogeneous categories. The ICES and the client can then work together to determine the best compliance and engagement solutions for each category, thus expediting program implementation time and IC on-boarding. Note, however, that knowledge of possible IC compliance issues can be a liability that may influence the severity of the penalties levied by the IRS and other authorities. Reviews of this kind can only be considered a best practice if businesses perform them as part of a committed effort to remove the problem not simply to gather information about the problem s scope. DIFFERENT PROGRAM FUNDING MODEL FOR NEW VS INCUMBENT ICS As introduced earlier in this document, clients must determine whether they will fund the program s Engagement Services Fees themselves or if they will require their ICs to pay for it. To best balance program cost with IC acceptance and adoption, an industry best practice is for clients to fund the program costs as they relate to incumbent ICs, while requiring newly engaged ICs to fund the program themselves. August, 2012 Page 22
NO REQUIREMENT FOR MANAGER QUESTIONNAIRE As part of the IC compliance determination process, some ICES providers and providers that only deliver IC compliance determinations require both the IC and his/her manager to complete questionnaires. This practice represents an overly cumbersome experience for managers, as they are sometimes saddled with a large number of timeconsuming questionnaires. This burden can motivate managers to choose expediency over compliance with corporate engagement policies, thus engaging their ICs outside the program and increasing maverick spend. Contemporary best practices demonstrate a relatively recent shift to the recognition that an IC s compliance status can be effectively determined from the IC s questionnaire alone, with little or no managerial disruption. MANUAL IC ASSESSMENT REVIEW Many IC compliance providers rely exclusively on automated systems to produce IC compliance determinations. However, compliance determination is a subjective exercise that relies on experienced judgment for accuracy and there is some skepticism as to the accuracy of these systems. Today s compliance best practices combine an easy-to-use automated data collection mechanism with careful human review. Manual review by trained Compliance Officers may delay the delivery of results by a few hours compared to automated systems, but is generally considered more accurate. USE OF STATEMENTS OF WORK (SOWS) It is generally in a client s best interest to mandate that all ICs work under a Statement of Work (SOW). SOWs favor milestone/deliverable-based assignments over hourly ones and can clearly identify the lack of behavioral control and the financial risk of the project. INDEMNIFICATION It is critical that a client select an ICES that indemnifies the client 100% for tax penalties assessed if any worker whom it finds to be compliant is reclassified. An ICES should assume responsibility for items under its control, but it should expect clients to assume responsibility for items unrelated to the ICES. For example, if contract workers issue a class-action lawsuit to gain access to pension benefits and the pension plan does not specifically exclude contract workers, the ICES August, 2012 Page 23
would not be liable in that claim. However, the ICES should be able to provide supporting documentation to help the client defend itself against legal action. It is important to note that an ICES typically will not indemnify its client if it only conducts the assessment and does not go on to execute the IC engagement because it has no mechanism in place to ensure compliance through the engagement. August, 2012 Page 24
6. ABOUT MBO ENTERPRISE SOLUTIONS MBO Enterprise Solutions, an MBO Partners company, believes there is a better way for organizations and independent contractors to work together in the emerging Project Economy. We believe every organization should be empowered to use independent contractors within the framework of the law, and we feel every independent worker should be able to build thriving practices serving clients of their choosing. We take the traditional image of engaging contractors and turn it on its head. Our clients, which include dozens of Fortune 500 businesses, create workforce strategies that get the most from their independent talent without the risks commonly associated with 1099s. Since 1986, MBO Enterprise has been on the forefront of the ever-growing trend toward a more flexible workforce. Our innovations are now best practices that are being deployed in businesses of nearly every size, location, and industry. August, 2012 Page 25
7. DISCLAIMER The ROI Estimation Worksheet and related materials ( Worksheet ) is a tool to help the prospective client conduct an analysis of potential cost savings and benefits and to determine if the prospective client desires to engage in detailed discussions with MBO Enterprise Solutions regarding flexible workforce solutions. The Worksheet only provides estimates, is based on assumptions which may or may not be accurate, and should not be relied upon in any way by the client. Every effort was made to provide accurate, relevant and complete information on the Worksheet. However, laws, regulations and information change continually and the Worksheet is based on general Federal law and is not customized for state-specific law. Every business situation is unique. Examples of potential cost savings and benefits are not to be interpreted as a promise or guarantee of actual cost savings and benefits. Use of the worksheet by the prospective client is provided as is and with all faults, and MBO Enterprise Solutions expressly disclaims all warranties, representations and conditions, either express, implied, or statutory, including but not limited to any implied warranties or conditions of merchantability, fitness for a particular purpose, title, quiet enjoyment, or non-infringement. IN NO EVENT SHALL MBO ENTERPRISE SOLUTIONS BE LIABLE FOR ANY DAMAGES, INCLUDING CONSEQUENTIAL, INCIDENTAL, DIRECT, INDIRECT, SPECIAL, PUNITIVE, OR EXEMPLARY DAMAGES ARISING OUT OF OR IN ANY WAY RELATED TO THE USE OF THE WORKSHEET, WHETHER BASED ON CONTRACT, TORT, NEGLIGENCE, STRICT LIABILITY OR OTHERWISE, EVEN IF MBO ENTERPRISE SOLUTIONS HAS BEEN ADVISED OF THE POSSIBILITY OF SUCH DAMAGES. The Worksheet is provided to the prospective client at no charge. MBO Enterprise Solutions has included in this Disclaimer terms that disclaim all warranties and liability for the Worksheet. To the fullest extent allowed by law, the prospective client HEREBY RELEASES MBO ENTERPRISE SOLUTIONS FROM ANY AND ALL LIABILITY ARISING FROM OR RELATED TO THE WORKSHEET. The prospective client assumes all risk of use and is responsible for all actions resulting from the use of the worksheet. The prospective client agrees and acknowledges that the use of the Worksheet and the information related to the Worksheet are based on the prospective client s own due diligence and analysis. The prospective client must conduct its own due diligence analysis of August, 2012 Page 26