SI Review: July 2012


Risky Business

Legal issues in staffing that one should pay attention to

By George Reardon

The contingent workforce has been very good for the economy of the United States, so much so that the model around it is now a growing phenomenon in numerous other economies around the world. But because it is relatively new, lawyers and other commentators have published many cautionary messages about the issues and risks that it presents. These may surface in sales and service interactions between staffing firms and their customers. Staffing firms can help their customers by putting such concerns into perspective.

The risks of employing people directly are far greater than the risks of using contingent workers. There is virtually a fixed amount of potential liability attached to any worker. When that worker is contingent, the staffing customer may be a co-employer with some responsibility, but its liability will always be less than it would be in a direct employment relationship, because the staffing firm is sharing some or most of that potential liability and is taking proactive efforts to avoid incurring it. With some outlying exceptions, staffing customers know or can confirm that their direct employees cause proportionately more litigation and governmental agency charges than their contingent workers.

Still, there are risks in contingent staffing that customers and staffing firms should recognize and deal with together. Here are some of the things to watch for.

Independent Contractors

Three main factors make the casual, unsystematic use of independent contractors especially risky for staffing firms and their customers:

  • there is great uncertainty and unpredictability about the practical meaning of the law;
  • highly motivated adversaries of independent contractor relationships (like state and federal governments and class action plaintiff ’s attorneys) are organizing enforce- ment against them; and
  • the contractors and the user firm personnel who retain them are highly and stubbornly motivated to continue that use regardless of legal compliance.

The damages and costs of contractors’ reclassification as employees can be very heavy, including back payroll taxes of the employer, back income and payroll taxes of the contractor/ employee that the employer failed to withhold, overtime premium pay, payroll administration penalties, waiting penal- ties, employee benefits, fringe benefits, refund of deductions, attorney’s fees, liquidated damages and civil penalties.

Customers often ask staffing firms to help them with independent contractor compliance. Staffing firms can help by:

  • hiring the contractors as W-2 employees,
  • selling administrative compliance services to operate under the guidance of the customer’s legal experts,
  • becoming an intermediate contracting firm for workers who the staffing firm concludes — solely for its own information and purposes — are qualified to be treated as contractors,
  • referring workers who do not qualify as contractors to other firms that are willing to take the risk, or
  • replacing the workers with new W-2 employees.

Staffing firms should carefully avoid giving customers legal advice on the past or ongoing legality of the customer’s independent contractor relationships. And certainly, it is very reckless for staffing firms to just take over an independent contractor population without applying a qualification screening process to it.

The first step in dealing with an independent contractor population is to find it. In large organizations, these relation- ships are often formed ad hoc on the front lines of operations, instead of through systematic HR and procurement processes.

When the contractor population has been identified, it should be systematically screened, qualified and resolved according to the various IRS and state law guidelines. There is no simple formula for compliance, least of all the popular “corp-to-corp” myth, by which firms expect personal corporations to automatically qualify their owners and to protect the users. Documentation of this process with relevant contracts, findings and filings is extremely important for avoiding “low- hanging fruit” status during enforcement drives. Another good idea is to test the population against criteria that are stricter than the law itself — building a hedge around the law.

The rewards of contractor compliance programs certainly include reduction of tax and litigation risk, but they also include practical benefits like better protection from liability for workplace injuries; rate savings from renegotiating deals made hurriedly by front-line managers; and better protection for confidential information, computer systems and intellectual property rights. Customers’ need for such programs is widespread, and meeting that need can be good business when properly executed.

Wage & Hour Law

Wage and hour law presents the same aggravating factors as the independent contractor issue — vague law; motivated and increasingly organized enforcers of the law; and equally motivated managers who ignore, rationalize and violate the law.

When workers are misclassified as independent contractors, enforcement actions will likely include many wage and hour issues in addition to the tax issues. These can include issues of minimum wages, overtime, timely wage payments, pay stub deficiencies and improper deductions from pay.

Temporary employees present all of these wage and hour risks, too, but the avenue to their enforcement is often through the misclassification of the employees as exempt. Wage and hour exemptions are frequently misunderstood, because the labels of the exemptions (e.g., executive, professional, administrative, computer and outside sales) have exacting legal definitions that may not conform to their broad, everyday meanings.

One common way in which customers create wage and hour risk for their staffing firms is to insist that certain temporary employees assigned to them be treated as exempt by the staffing firms. Under federal law, most exempt employees must be paid on a salary basis, another legal term that means a lot more than its common meaning. Salary basis requires that exempt employees be paid for entire pay periods, regard- less of most kinds of absences. Most clients are not willing to pay for time that is not actually worked, and most staffing firm payroll systems are set up to pay only for time actually worked. Consequently, it is easy for wage and hour laws to be violated with these forced exemptions, even in situations where the kind of work would qualify as exempt.

Customers can also create wage and hour risk for staffing firms by taking control of key aspects of wage payment processes, like the placement of time clocks, the management of meal and rest breaks and the unilateral reporting of time worked to suppliers.

And laws vary by state. California is an especially difficult jurisdiction for this area of the law. It has statutory rules not seen elsewhere, coupled with extremely aggressive enforcement provisions and the most aggressive plaintiff’s class action bar in the United States. Although staunch zero tolerance policies for wage and hour violations are a good idea everywhere, they are especially appropriate in California.

Increased costs

Staffing firms will continue to see their costs rise in the coming years, specifically due to unemployment insurance and healthcare legislation.

Unemployment insurance. The unemployment insurance systems operated by the states (with a federal subsidy) are supposed to be self-financing. Unemployment has remained persistently high for several years, so the states have borrowed from the federal government to pay benefits. Now, the federal government must be repaid.

The states must raise unemployment taxes significantly to repay the loans, and they are doing this by raising the wage bases on which the taxes are paid and by raising the tax rates on the covered wages. Staffing firms will likely need to pass these costs on to their customers, either through higher quoted bill rates or through contract provisions allowing adjustments due to rate increases. This will usually require discussion and interaction with the affected customers, because most staffing business is priced at particular dollar rates or percentage markups from pay rate to bill rate, and neither of those systems automatically adjusts for increases in burdens.

Healthcare reform. Unless struck down by the U.S. Supreme Court, the Affordable Care Act will impose penal- ties on employers that don’t offer comprehensive and afford- able coverage to their full-time employees beginning Jan. 1, 2014. Suppliers of lower-wage temporary employees are likely to opt for paying the penalties instead of providing the insurance. The pre-tax equivalent cost of these penalties would range from $2,000 to $4,500 per year per full-time employee, depending on the tax status of the staffing firm and the type of penalty being imposed.

If the penalty provisions of the Affordable Care Act stay in place, staffing firms will have to decide whether to ask their customers to absorb some or all of their cost. If customers agree to absorb them, changes to your staffing agreements and procedures will be required, since the penalties may accrue long after the associated work is done and billed, and the true cost to the staffing firm is a grossed-up, before-tax cost that will be hard to account for.

Healthcare Reform’s Opportunities

Some contingent workforce issues are opportunities for staffing firms. Large customer companies may face two serious challenges under the Affordable Care Act. Discrimination in self-insured and non-grandfathered insured healthcare plans will be penalized in different ways, and failure to offer qualifying and affordable coverage to all full-time employees will result in significant financial penalties.

These are problems for which staffing firms may provide some solutions. Regulations permitting, positions for which customers do not want to offer and subsidize healthcare coverage could be payrolled with staffing firm employees, in order to:

  • reduce the customer’s directly employed full-time staff to a level below 50 full-time employees, which would make the customer exempt from all “play or pay” penalties;
  • relieve a large customer of a group of uninsured positions, thereby making its penalty regimen the less expensive individual penalty for unaffordable coverage instead of the very expensive penalty on all full-time employees;
  • relieve the customer of positions that would otherwise render its health insurance program discriminatory; or
  • relieve the customer of its independent contractor positions, thus avoiding the risk of their reclassification as the customer’s employees, which could trigger the more expensive penalty regimen and/or the discrimination penalties.

People are bad at quantifying risks, and they tend to take legal risks when the laws seem foolish, unfair, unreason- able or obscure. Even apart from firms’ overriding desire to be law-abiding, few of the independent contractor and wage and hour employment law risks produce actual rewards that would justify taking them. It’s better to take care, to take action, and to focus on opportunity than to take these risks.

George Reardon is special counsel and a member of the Contingent Workforce Practice Group at Littler Mendelson P.C., the largest employment and labor law firm exclusively representing management in the U.S. He was formerly general counsel of Kelly Services Inc. and Adecco Group NA. He can be reached at


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