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How to choose a contractor payroll model

May 18, 2020

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Independent Contractor Payroll refers to the tasks an organization must execute to ensure Independent Contractors are paid correctly and on time in accordance with their contract or Statement of Work (SOW). Independent Contractors are not employees; therefore, employers are not responsible for the withholding, collecting or paying of the Independent Contractor’s taxes nor any other payments required for full-time employees.

Engaging Independent Contractors is practiced as a strategic outsourcing tactic around the world, so much so that 40 per cent of the U.S. workforce alone is currently made up of contingent workers, with the number expected to rise to 50 per cent by 2050.

Yet, contractor payroll is a complex, time consuming process, and staying on top of the frequent changes to legislation can be problematic. Any oversights will result in non-compliance, which could lead to serious fines and negative employer branding.

Fortunately, however, there are methods to help mitigate these risks, and organizations don’t have to face the threats that come with a contingent workforce and complicated payroll models alone.  

The role of a trusted contractor payroll vendor

One of these methods is outsourcing employer responsibilities like contractor payroll to a trusted vendor who will manage workers’ wages, bonuses, and deductions, as well as provide support during the length of a worker’s assignment(s).

The client partner will also identify and implement internal measures to protect organization from serious risks associated with a contingent workforce like severe fines, penalties and negative employer branding. 
However, it’s common for many organizations to think it’s better to let their own HR and accounting departments handle contractor payroll. After all, they do so for traditional employees, right? Payroll stats disagree, stating companies that outsource payroll save 18 per cent on costs over organizations that tackle it themselves.  Outsourcing contractor payroll not only gains access to the types of technologies and expertise that reduces overall cost and risks associated with operating a contingent workforce, it also frees up time for employers to focus on their organization’s core business objectives.

What's the difference between paying employees and paying contractors?

Independent contractors are not on staff and receive pay only in accordance with the terms of their contract. They are self-employed, and as such, are responsible for reporting income on a 1099 tax return. Independent Contractors are not entitled to benefits afforded traditional employees like paid vacation, holiday or sick days, overtime pay or termination pay.

A W2 employee is a traditional employee on staff. They receive a regular wage and employee benefits. The employer withholds income taxes from the W2 employee’s paycheck and has a significant degree of control over the employee’s work.

How to Determine Whether Your Employees Are 1099 Independent Contractors vs. W2 Employees

The determination of whether a worker is an employee or an Independent Contractor depends upon whether or not a "employer-employee" relationship exists between the payer and the payee.

The ABC test is a guide for employers to use in the determination of if a worker is considered an independent contractor or an employee in the eyes of the government. Several states require the use of the ABC test—in part or in whole—to determine the status of workers.

Here is how the Canada Revenue Agency (CRA) determines whether an individual is an employee or contingent worker.

How do I pay a contractor: What's the best contractor payroll model for your business?

If your organization is considering operating a contingent workforce or is currently re-evaluating your current program, below is a list of critical considerations about contractor payroll models that will help form an insightful decision on which is the right option for your business:

Who is doing your payrolling now? 

Any assessment should start with identifying who is managing your contractor payroll today. Is your organization running an internal program, outsourcing payroll to a single vendor or an adhoc program where multiple firms could be handing your program?  Once your provider is known, it’s important to evaluate the processes, documenting key points – like onboarding, worker classification and incident management. Are they well covered?

What is the contractor experience like? 

Review the contractor’s experience with your current payroll model. Is this experience good? Are workers being paid on time and satisfied? Are you experiencing high turnover? Is it easy to submit time sheets and expenses or has the organization received complaints? Is the contractor experience compatible with your hiring brand? In today’s competitive gig economy, providing a great candidate experience is essential. 

Is your program architecture open or closed?  

Can a vendor support all legal statuses, engagement types and job types (open architecture) or not (closed architecture)?

Who handles issue management? 

It doesn’t happen often, but workplace problems or incidents do happen, and there are frequently special considerations and compliance requirements when a contingent worker is involved. It’s important to determine who is responsible for issue management for your contingent workforce, especially for issues that have HR/contract and potential litigation consequences. Is there a process in place for recognizing and addressing these issues? What is the chain of command for escalations or decision making? If you’re using a third-party payroll provider, are they fully engaged, as to protect the integrity of the intended contractual relationships? 

Is there a process in place to manage misclassification and non-compliance? 

Classification is a critical step in contingent worker programs that relates to ensuring contingent workers are onboarded appropriately in the context of their worker status, overtime eligibility, workplace safety requirements and other important engagement management factors. Classification is a complex, time consuming process, and staying on top of the frequent changes to legislation can be problematic.

Any oversights will result in non-compliance, which could lead to serious consequences. To stay compliant and competitive, growing organizations will typically shift from a ‘direct contractor payroll model’ to a third-party payroll model, built around the selection of a dedicated supplier with established and verifiable procedures. 

Does your rate card have integrity?  

Most contingent worker programs use rate cards as a tool to control spending and evaluate program efficiency. This is great in theory, but in practice, it’s only as effective as the quality of an organization’s process for ensuring that contingent workers are assigned to the correct job categories.  Incorrect categorization – whether intentional or accidental – will negatively impact a rate card’s integrity and reported numbers like savings. 

When choosing a contractor payroll model for your organization, there is no scenario that is completely risk free; whichever model your organization chooses to go with, it’s crucial to know the benefits and risks associated with each.

Saving on costs is a consistent factor in contingent workforce management and contractor payroll, with organizations ranking contingent workforce costs as a top five spend category; however, cost management doesn’t just include contractor payrolling models -- but the total costs of the overall program. 

There is no risk-free scenario

Depending on your Independent Contractor payroll needs, there are a few options available to employers, yet there is no scenario that is completely risk free; whichever model your organization chooses to go with, it’s crucial to know the benefits and risks associated with each. Does your organization have a solid framework for identifying contingent worker risk? Download our free Checklist on CW risk factors:

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