Why do (some) large companies require that individual contractors come through a vendor?

Question

I work at a large company as a contractor. Every contractor at the company goes through one of several vendor companies whom the client company pays and then they pay us W-2. The vendor company does nothing in terms of team or project management, they only do the payroll and hiring.

I think the client company has a policy of not dealing with individual contractors directly for some reason. I am curious what such a reason may be? Is it some sort of business insurance that the client may be requiring and that each individual contractor couldn't afford? Or something else?

Answer 1

It depends on the company, of course. Some of the more common reasons, though

• Minimizing the number of vendors helps the hiring company minimize the amount of vendor management they have to do. There is overhead in doing things like negotiating with a vendor, processing a vendor's invoice, ensuring that the vendor's paperwork is in order, etc. Working with individual contractors rather than going through contracting companies substantially increases these overheads.
• Large company HR departments want to be very certain that they don't get dinged by the IRS for treating contractors like employees (I believe from your earlier questions that you are in the US but many other countries have similar laws). If they are going through large contracting companies that have many different clients, it is much harder for the IRS to argue that a particular contractor is a de-facto employee than if they work individually with consultants that don't have multiple other clients.
• Working with large consulting companies makes it much easier for the hiring company to add additional resources as needed. If they're working with a large contracting company that has dozens of contractors on the bench, it is relatively easy to add a few resources or to switch one resource for another. If they're working with individual contractors, though, that's obviously much more difficult.
• If the company requires liability insurance for contractors, that is generally cheaper when you can spread the cost across a large number of contractors than if you're getting it yourself. From the hiring company's standpoint, it is also a lot more likely that a large contracting company would be able to resolve issues than a single contractor could. The large company can much more easily do things like giving a discount or giving away some hours. If there is a problem with an individual contractor, the hiring company's options are much more limited.

Answer 2

I think the client company has a policy of not dealing with individual contractors directly for some reason. I am curious what such a reason may be?

Section 1706 of the Tax Reform Act of 1986 is responsible. By removing the "safe harbor" (which is section 730 of the Revenue Act of 1978) provisions, this act made it too risky for employers to continue to hire engineers and computer professionals as contractors. If the IRS later reclassified the independant contractors as employees, the employer becomes retroactively responsible for the employer share of the taxes along with interest and possible penalties. A "safe harbor" would allow the employers to skip the past taxes, interest and penalits. Since our profession has been specifically excluded as a matter of law, it is almost impossible to be a 1099 contractor without setting up your own company. The contract agencies get around this issue by making you a W-2 employee of the agency while the bodyshop gets paid on a 1099. This issue bothered one person so much that he flew his airplane into an IRS office in 2010.

Some easy-to-read information.

As for myself, I'm working on a "Plan B" to get my accounting degree (and later CPA license) as one potential exit plan from programming. This stuff is covered in tax accounting courses because the "independant contractor versus employee" issue is a very thorny and expensive mistake that many businesses get themselves stuck into.

Answer 3

Justin Cave covers a number of key points, you could loosely summarize as "it's easier to deal with existing vendors". Our company is quite flexible in this regard, but any new vendor (individual or company) still needs to have a contract in place, which requires legal review (unless our "stock" contract is acceptable to the vendor), setting up the vendor with accounting, etc. As a manager needing your services, it's just easier for me if I don't have to do this, but if you can offer something that I can't easily get from an existing vendor, then I'm willing to do it. If I was at a company where the hassle factor was a lot higher for legal reviews, vendor setup, etc., it might just be easier to say no.

Answer 4

I'll also point out that from the corporate standpoint, it is less of a risk to use a known company.

If the developer quits a known company they will have someone in place fairly quickly (that's one reason why they maintain that bench of people). If the indivdual contractor quits or is run over by a bus, then there is no one available immediately to replace that person and they may not even have all the source code avaiable for someone else once they find him. Losing an indivudual contractor may mean starting the project over from scratch.

There is also a lot of effort you may not see in hiring people and continuing to use a known entity means that you have a partner who knows your needs and you already have in place the legal stuff you need. That saves a lot of time and money in the long run over negotiating with indivdual contractors. Plus finding competent and capable indivdual contractors is harder than hiring a copmany to do the hiring.