Introduction to using Associates and a 1099 independent contractor agreement to help you deliver assignments.
Understanding the importance of a robust 1099 independent contractor agreement is a prerequisite to understanding the true nature of your relationship with your subcontractors. On this site I use the terms 'Associate' and 'Subcontractor' interchangeably.
Developing the theme of lead consultant and sub-contractors, you are likely at some point to find yourself in the position that you have more work than you can personally deliver and at this point you have a key decision to make.
Simply, you need to decide whether you will engage an associate or subcontractor to deliver this additional piece of work on your behalf OR whether you will decline the assignment and concentrate on delivering client work personally. This can be quite a tough decision but it is critical that you think carefully about which route to take. Essentially this decision is more about the type of business you see yourself as operating rather than specifically relating to that opportunity. Review the spectrum of consulting operating models to more fully understand the advantages and disadvantages of working solo vs gearing up with sub-contractors.
If you decline the work then you are acknowledging that you operate simply as a solo consultant and as such your fee earning potential will be capped to the number of chargeable days that you work each year multiplied by your daily rate. This can be a substantial annual income depending on your level of expertise, the nature of the client businesses that you work with and the proportion of the year for which you are chargeable to clients (your utilisation). This is the model that I have successfully operated over a period of five years.
If you accept the assignment with the intention of engaging a subcontractor to deliver it on your behalf then your business model, risks and potential financial rewards will change quite fundamentally. Furthermore, at this point the use of a well drafted 1099 independent contractor agreement becomes essential to protect your professional relationship with your client and your tax exposure.
In this situation you become the lead consultant. You remain accountable for the successful delivery of the assignment BUT you delegate responsibility for delivery to the subcontractor who will sign a 1099 independent contractor agreement. You will need to maintain an overview of the work that the subcontractor is doing on your behalf. This supervision will extend to include both speed and quality of deliverables, and ensuring that the subcontractor works within the constraints of the contract that you have with the end client.
You will require two separate contracts to operate this model: Firstly, the main (lead) contract will be between you and the end client. In simple terms, this contract will define what the client is expecting to be delivered during the proposed consulting assignment. In principle, the client is not interested in who is responsible for doing the work; just as long as it gets done within the time and budget available and to the necessary quality standards.
Secondly, you will have a separate contract with your subcontractor (associate). This contract (in the US the 1099 independent contractor agreement) will define the relationship between each of the three parties i.e. you, the subcontracting consultant and the client.
In the U.S. this contract is commonly known as the 1099 independent contractor agreement, and more generally outside of the US simply as a subcontractor consulting agreement. More details on the 1099 independent contractor agreement are set out at the foot of this page.
The impact on risk faced by the lead consultant will depend upon the reliability and calibre of the subcontractor chosen. There is a risk of non delivery, or that deliverables may not meet either the client's or your own quality standards. If the client is not satisfied with the work of the subcontractor then it is your own professional reputation that is at risk, in addition to that of the sub contractor. If the subcontractor makes mistakes or fails to impress the client then there is more at risk than simply the fees associated with that assignment; potentially your whole relationship with that client, which may have taken you many years to build, could be damaged.
On a positive note, if the subcontracted assignment is delivered successfully, then you will have substantially increased your income in that you will have made a margin on the work that the subcontractor has delivered on your behalf, and in the meantime you will have been generating fees from clients for the work that you deliver personally. Some of my peers, albeit few in number, have successfully operated this model.
There are a number of practical challenges associated with operating as a lead contractor managing a number of sub-contractors. Principally your focus will switch from delivery, to sales and team management. Making this transition from solo consultant to lead consultant with a number of sub-contractors is difficult to achieve and sustain.
The practical challenges you will face working with subcontractors will include:
- Logistic challenges arising from managing sub-contractors operating in different geographic locations; you will need to attend client meetings in different cities on different days through each week. This will impact your domestic and personal life quite dramatically compared with the relative stability afforded by delivering one client assignment yourself, substantially based in one location;
- The risk that the subcontractor may attempt to contract direct with the client following the initial introduction, and therefore cut you out of the relationship. I have seen this happen many times and the result is typically an ugly and unprofessional series of exchanges into which the client may well be dragged and inevitably the wasting of a lot of time and emotional capital with each consultant attempting to wrestle the client relationship from the other. The net result of such a circumstance is typically a client who is understandably disappointed and a series of relationships that are fundamentally damaged;
- You will need to substantially revise and increase your professional indemnity insurance cover to reflect the change in nature and risk of your core business activity, namely, that you will be using third parties to deliver on your behalf. There will be a requirement for you to obtain assurance that the subcontractor is suitably qualified and experienced for the assignment;
- You will need to engage your lawyer to ensure that contracts are in place that clearly define the triangular relationship between the client, yourself and the subcontractor. A strong, well drafted 1099 independent contractor agreement will be essential for your protection.
Other considerations and challenges include the following:
- Typically the client will want you to deliver the work personally, rather than for you to pass the ball to some faceless subcontractor, who, to the client may be an unknown quantity;
- To operate this model effectively you will need to build a business which is supported by a small group of reliable and proven sub-contractors, badged to the client as Accredited Delivery Partners (ADPs) of your firm. You will be able to draw down from this pool of resource and expertise when selling and delivering assignments, however, the challenge is to ensure that there is a steady pipeline of assignments to keep these consultants busy. If this is not the case, at the end of an assignment the consultant will simply walk away and secure his next piece of work elsewhere. This effectively makes a hole in your delivery team and can potentially damage your reputation and credibility with your clients;
- Never assume that your clients are stupid. This seems like an odd thing to say, but you need to be very clear and straightforward in the way that you deal with your clients, and don't be greedy or try to be smart. If you are unable to deliver an assignment yourself then be big enough to explain this to your client. It is better for all concerned if you do not attempt to deliver an assignment for which you clearly do not have the resource, experience or capability.
Why is the 1099 independent contractor agreement important?
When a subcontractor or consultant is paid by the lead consultant a 1099-misc form is completed. The subcontractor is paid by the lead contractor without tax being deducted. This is as would be expected given that the relationship between the two parties is a business to business relationship. The subcontractor is then responsible for declaring that income to the Inland Revenue / IRS and paying the tax on the taxable profits of his business.
What does the 1099 independent contractor agreement achieve?
A good 1099 independent contractor agreement defines and frames the relationship between a subcontractor and a lead consultant in such a way as to ensure that the relationship is a business to business relationship rather than that of employee / employer. This provides protection for both the lead contractor and the subcontractor. Clearly if the true nature of the relationship is that of employer / employee, then the income has been misclassified and the IRS will potentially be losing tax revenue.
The key criteria used to determine whether a realtionship is Business to Business OR Employee / Employer are set out on the schedule of independent contractor tests.
How can a 1099 independent contractor agreement help protect your tax position?
In the case of an investigation by the IRS in to the status of a subcontractor a well constructed 1099 independent contractor agreement will be an essential element in defence of any claim. The agreement will set out the rights and responsibilities of each party, particularly focusing on the risks and reward associated with the relationship, for example, the agreement will specify that the subcontractor has complete discretion as to how he approaches the work, and that he has the right of substitution.
The presence of these example characteristics in the commercial relationship and reflected in the 1099 independent contractor agreement document will strengthen your position.
The 1099 independent contractor agreement will assist you not only in defining the work that is to be performed by the subcontractor on your behalf, including price, timescales and quality but also it will serve to reinforce the independent nature of the relationship between the subcontractor and your own consulting business.
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