Why America is going the way of the freelancer

June 22, 2011: 11:14 AM ET

While it's often less expensive upfront to hire independent contractors, it comes with considerable risks. Gene Zaino, CEO of MBO Partners, describes the challenges.

Interview by Tara Moore, reporter

Gene Zaino

Gene Zaino, CEO of MBO Partners

FORTUNE -- There's a change in the culture of 'work' in America, and the A.D.D., anxiety-ridden professional is faring better than his tenure-tracked counterpart. Yes it's cheaper to hire independent consultants, with no benefits, but companies are now more susceptible to compliance risk.

Gene Zaino, CEO of MBO Partners, an independent consultancy services firm, says companies hoping to keep down labor costs by banking on independents now realize the tightrope they're walking. Running lean could end up meaning running up massive unforeseen tax bills or inviting lawsuits.

We asked Zaino, currently serving on the expert advisory board of the Human Capital Institute, to walk us through how the corporate world is dealing with reinvented careers. [To read Fortune's cover story, Pulling off the ultimate career makeover, you can purchase it from Amazon or download Fortune's iPad App.].

FORTUNE: What is a temporary employee vs. an independent contractor?

Gene Zaino: Temporary employees are part-time workers and temporary people. They're basically employed by a staffing company, and are paid on a W-2, generally. They have a recruiter that places them on site.

Independent contractors include everyone that is not an employee—they are employees of themselves. Contractors can be defined as real estate agents, physical therapists, consultants working for a company, or they could be the gardener. Those are the people that are 1099s, or LLCs, or micro companies/small companies that are small employers of maybe one or two or three employees at the most.

So what are the risks associated with contractors?

Well there really are 3 main risks. The biggest risk is tax risk, the next risk is what I would call labor risk, and the third is business risk of liability.

In the environment we live in today which is deficit-rich, both the states and the federal government are looking for areas to collect taxes.

There is what's called a 'tax gap.' The most recent study was in 2007 and the total [gross] tax gap was $345 billion. Of that $345 billion, the overwhelming majority, is attributed to self-employed individuals. As a result of that, the IRS is pretty aggressive at trying to reclassify anyone they believe should be an employee as opposed to a self-employed worker.

There's a funding issue that is real that our society is based on—that most of our funding comes from payroll taxes. Without the payrolls being fully supported—which between the unemployment rate and more and more of the workforce becoming independent consultants or independent contractors—there's less and less funding coming in on a periodic basis.

On a state level, states also have unemployment insurance. As an independent contractor you don't pay unemployment insurance and there are huge unemployment deficits.

The second risk -- labor risk -- really has to do with overtime. In the independent contractor world the company is not paying them any overtime or paying them any benefits. The risk there is a class action suit being bought against the company for misclassifying these independent contractors that should have been employees. In today's environment where people are being overworked and underpaid, it's pretty easy to find a group of disgruntled people.

Finally there's business risk. If I engage someone who is not my employee, and they don't have the proper insurances -- general liability insurance, worker's compensation insurance, errors & omissions insurances -- if they do something that damages one of my employees or that damages my company, my property or one of my customers I can't go after them for their negligence. Independent contractors become an area where if they don't have the proper insurances, the enterprise could be at risk for its insurance not covering them and them having no recourse to reclaim whatever damages might have been a fault of that individual.

What's driving the move towards a project-based workforce?

Companies are forced to be very agile -- they've got to react to changes in a global environment, technology, and in the economy. If you're a large company obviously you have your core staff but on the fringe, maybe 20%, 30% of your workforce, maybe more, you want it to be very agile. You want to be able to turn it on and turn it off.

I've actually seen things move from a temporary world into a project world because now they're able to buy things in packages -- small units. They have now gone beyond hiring a temporary employee to just buying some thing. They can outsource to a local or domestic expert.

On the individual side, people are becoming more specialized. It's easier for an individual to really focus on a core area of expertise, and the Internet has made it really wonderful to be able to advertise and market skills as an individual. It's made it easier for people to find projects and for projects to find people. I think the small specialist is very valuable today.

I think the genie's out of the bottle, it's going to continue, and my view is that a very big part of the workforce will be project-based.

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