[House Hearing, 110 Congress]
[From the U.S. Government Publishing Office]
THE EFFECTS OF MISCLASSIFYING WORKERS
AS INDEPENDENT CONTRACTORS
=======================================================================
JOINT HEARING
before the
SUBCOMMITTEE ON
INCOME SECURITY AND FAMILY SUPPORT
and
SUBCOMMITTEE ON SELECT REVENUE MEASURES
of the
COMMITTEE ON WAYS AND MEANS
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED TENTH CONGRESS
FIRST SESSION
__________
MAY 8, 2007
__________
Serial No. 110-37
__________
Printed for the use of the Committee on Ways and Means
----------
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COMMITTEE ON WAYS AND MEANS
CHARLES B. RANGEL, New York, Chairman
FORTNEY PETE STARK, California JIM McCRERY, Louisiana
SANDER M. LEVIN, Michigan WALLY HERGER, California
JIM McDERMOTT, Washington DAVE CAMP, Michigan
JOHN LEWIS, Georgia JIM RAMSTAD, Minnesota
RICHARD E. NEAL, Massachusetts SAM JOHNSON, Texas
MICHAEL R. McNULTY, New York PHIL ENGLISH, Pennsylvania
JOHN S. TANNER, Tennessee JERRY WELLER, Illinois
XAVIER BECERRA, California KENNY C. HULSHOF, Missouri
LLOYD DOGGETT, Texas RON LEWIS, Kentucky
EARL POMEROY, North Dakota KEVIN BRADY, Texas
STEPHANIE TUBBS JONES, Ohio THOMAS M. REYNOLDS, New York
MIKE THOMPSON, California PAUL RYAN, Wisconsin
JOHN B. LARSON, Connecticut ERIC CANTOR, Virginia
RAHM EMANUEL, Illinois JOHN LINDER, Georgia
EARL BLUMENAUER, Oregon DEVIN NUNES, California
RON KIND, Wisconsin PAT TIBERI, Ohio
BILL PASCRELL, Jr., New Jersey JON PORTER, Nevada
SHELLEY BERKLEY, Nevada
JOSEPH CROWLEY, New York
CHRIS VAN HOLLEN, Maryland
KENDRICK MEEK, Florida
ALLYSON Y. SCHWARTZ, Pennsylvania
ARTUR DAVIS, Alabama
Janice Mays, Chief Counsel and Staff Director
Brett Loper, Minority Staff Director
______
Subcommittee on Income Security and Family Support
JIM McDERMOTT, Washington, Chairman
FORTNEY PETE STARK, California JERRY WELLER, Illinois
ARTUR DAVIS, Alabama WALLY HERGER, California
JOHN LEWIS, Georgia DAVE CAMP, Michigan
MICHAEL R. McNULTY, New York JON PORTER, Nevada
SHELLEY BERKLEY, Nevada PHIL ENGLISH, Pennsylvania
CHRIS VAN HOLLEN, Maryland
KENDRICK MEEK, Florida
______
Subcommittee on Select Revenue Measures
RICHARD E. NEAL, Massachusetts, Chairman
LLOYD DOGGETT, Texas PHIL ENGLISH, Pennsylvania
MIKE THOMPSON, California THOMAS M. REYNOLDS, New York
JOHN B. LARSON, Connecticut ERIC CANTOR, Virginia
ALLYSON Y. SCHWARTZ, Pennsylvania JOHN LINDER, Georgia
JIM McDERMOTT, Washington PAUL RYAN, Wisconsin
RAHM EMANUEL, Illinois
EARL BLUMENAUER, Oregon
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C O N T E N T S
__________
Page
Advisory of May 1, 2007, announcing the hearing.................. 2
WITNESSES
John Kendzierski, President, Professional Drywall Construction
Inc., West Springfield, MA..................................... 6
Gonzalo Valencia, Covington, Washington.......................... 10
Sigurd Nilsen, Ph.D., Education, Workforce and Income Security
Issues, Government Accountability Office....................... 12
Rebecca Smith, Staff Attorney, National Employment Law Project... 29
Kelly D. Pinkham, Assistant Director, Center for Full Employment
and Price...................................................... 41
John S. Satagaj, President and General Counsel, Small Business
Legislative Council............................................ 45
SUBMISSIONS FOR THE RECORD
Associated Builders and Contractors, letter...................... 70
Contractor Management Services, statement........................ 72
Direct Selling Association, statement............................ 74
John J. Flynn, letter............................................ 76
Kathy Roman, Sequim, WA, statement............................... 78
National Association of Home Builders, statement................. 79
Richard A. Samp, statement....................................... 81
THE EFFECTS OF MISCLASSIFYING WORKERS
AS INDEPENDENT CONTRACTORS
----------
TUESDAY, MAY 8, 2007
U.S. House of Representatives,
Committee on Ways and Means,
Subcommittee on Income Security and Family Support,
Subcommittee on Select Revenue Measures,
Washington, DC.
The Subcommittee met, pursuant to notice, at 9:30 a.m., in
room 1100, Longworth House Office Building, Hon. Jim McDermott
(Chairman of the Subcommittee on Income Security and Family
Support), presiding.
[The advisory announcing the hearing follows:]
ADVISORY
FROM THE
COMMITTEE
ON WAYS
AND
MEANS
SUBCOMMITTEE ON
INCOME SECURITY AND FAMILY SUPPORT
CONTACT: (202) 225-1721
FOR IMMEDIATE RELEASE
May 01, 2007
ISFS-6
Congressman Jim McDermott (D-WA),
Chairman of the Subcommittee on
Income Security and Family Support, and
Congressman Richard Neal (D-MA), Chairman of
the Subcommittee on Select Revenue Measures,
Announce a Joint Hearing on the Effects of
Misclassifying Workers as Independent
Contractors
Congressman Jim McDermott (D-WA), Chairman of the Subcommittee on
Income Security and Family Support, and Congressman Richard Neal (D-
MA), Chairman of the Subcommittee on Select Revenue Measures, today
announced a joint hearing on the effects of misclassifying workers as
independent contractors. The hearing will take place on Tuesday, May 8,
2007, at 9:30 a.m. in room 1100, Longworth House Office Building.
In view of the limited time available to hear witnesses, oral
testimony at this hearing will be from invited witnesses only. However,
any individual or organization not scheduled for an oral appearance may
submit a written statement for consideration by the Committee and for
inclusion in the printed record of the hearing.
BACKGROUND:
Employers must generally take certain actions on behalf of their
employees, including withholding income taxes, paying Social Security
and Medicare taxes, paying unemployment taxes, providing workers'
compensation insurance, paying at least the minimum wage, and
permitting inclusion in qualified pension plans and other employer-
provided benefits. In addition, employers must abide by certain
workplace requirements that offer protections to employees. Employers
are not required to provide these benefits or protections to workers
who are classified as independent contractors.
The status of worker as an employee or an independent contractor is
made under a facts and circumstances test that determines if a worker
is subject to the control of the service recipient. The issue of
control relates not only to nature of the work performed, but the
circumstances under which it is performed.
In its last comprehensive estimate, the Internal Revenue Service
(IRS) found that 15% of employers misclassified 3.4 million workers as
independent contractors in 1984, resulting in $1.6 billion in lost
Social Security, unemployment and income taxes (or $2.7 billion in
inflation-adjusted dollars).
Studies suggest some employers misclassify workers as independent
contractors in order to cut business costs. This gives these employers
an unfair competitive advantage over employers who properly classify
their workers as employees. These studies find that the problem of
misclassification of workers has grown in recent years. For example,
one study found that the percentage of all workers misclassified in
Illinois grew from 5.5% to 8.5% (a 55% increase) between 2001 to 2005.
Another report found the percentage of employers misclassifying workers
in Massachusetts (according to the most conservative estimates) grew
from 8% between 1995-1997 to 13% between 2001-2003.
In announcing the hearing, Chairman McDermott stated, ``When
workers are wrongly classified as independent contractors, they lose
access to vital benefits, employers who play by the rules are unfairly
disadvantaged, and State and Federal programs are starved of resources.
We need a fair standard that is fairly enforced.''
Chairman Neal declared, ``Employers and the IRS need an easily
understood set of rules in order to classify workers. I am concerned
that workers may be disadvantaged by the current situation, and
hopefully this hearing can shed some light on what can be done. ''
FOCUS OF THE HEARING:
The hearing will focus on the effects of the misclassification of
workers as independent contractors.
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Chairman MCDERMOTT. The Committee will come to order.
Good morning. I am pleased today to convene this hearing
with my colleague, Richie Neal, from Massachusetts. He chairs
the Select Revenue Subcommittee and I chair the Income Security
and Family Support Subcommittee, and we are here today to
examine the effects on workers being misclassified as
independent contractors.
For workers in America, one word can make all the
difference in their well-being. That word is ``employee.''
Without such a designation, a worker is excluded from most of
the basic benefits and the protections provided in the
workplace. Millions of workers now find themselves in this
precarious position.
When a worker is classified as an independent contractor
instead of an employee, he or she might be subject to huge back
taxes because their employer did not withhold income taxes;
they may be denied Social Security and Medicare when they
retire because taxes were not paid on their behalf.
If they are injured on the job, they may not have access to
workers compensation. Of great concern to my Subcommittee, they
may be denied unemployment insurance if they are laid off. In
fact, a study commissioned by the Department of Labor in 2000
estimated that 80,000 workers are improperly denied
unemployment benefits every year because they are misclassified
as independent contractors.
There are certain times when the term ``independent
contractor'' is justifiably applied, such as when an individual
is in a business for himself, but there are other occasions
when a worker is under the control of an employer and should be
designated as an employee.
Misclassification can occur because of definition
uncertainties, but it likely happens at least as frequently
because some employers are looking for an easy way to cut
costs. Misclassifying a worker as an independent contractor
lets a business off the hook for various payroll taxes and
employee benefits.
When unscrupulous employers commit this type of fraud, it
hurts more than the workers. Responsible businesses who play by
the rules are placed at an unfair competitive disadvantage.
Just envision two construction companies bidding on the
same contract, and then consider what would happen if one of
them paid taxes and provided benefits for their workers, but
the other did not.
As a tax avoidance scheme, misclassification also robs both
the States and the Federal Government of revenue. Prior
estimates from the IRS indicate billions of dollars of taxes go
unpaid each year because of the misclassification.
The misclassification of workers is not a new problem. This
is not something we discovered since the last election.
However, the pressures of globalization and the rising costs of
health and other benefits as a portion of total payroll costs
suggest it will become a growing concern. Indeed, some of the
recent State-level studies find an increasing amount of risk
classification over the last few years.
For all those reasons, I hope we will consider sensible
solutions to prevent workers from being wrongly classified as
independent contractors.
I would now like to yield to the Chairman of the
Subcommittee on Select Revenue, Mr. Neal of Massachusetts.
Chairman NEAL. Thank you, Chairman McDermott and members of
the panel. Author and publisher, Elbert Hubbard wrote that ``We
work to become, not to acquire.'' For many of us here today,
that is true, our work is much more than a paycheck. From it we
derive satisfaction and a sense of responsibility.
I remember very well one of my first jobs when I was just
17 years old. I worked in the hardware department of Two Guys
Department Store in Springfield, Massachusetts, and Two Guys
was really a great place to work. Despite the fun of working
there, I also recognized that my job was a tremendous
opportunity and carried with it responsibility.
I think that most workers treat such opportunities the
same: They are eager to get their tasks done and to perform
well, but as we hear today, some fall victim to
misclassification. Some are so eager to work they simply do not
hear that they are not employees, some are disadvantaged or may
have language barriers and do not understand the implications,
many do not understand the law in this area. Even Treasury and
GAO have acknowledged that the law is confusing and
conflicting. According to the testimony we will hear today,
some have stepped into this gray area to take advantage of that
uncertainty.
It also seems clear, though, that we must do something to
reverse the trend. The GAO estimated that misclassification
results in a Federal income tax loss of $4.7 billion in 1 year.
Other experts have found that my home State of Massachusetts
loses hundreds of millions of dollars in tax revenues each year
from this problem. Legitimate businesses that play by the rules
are also hurt here.
We are fortunate to have with us today one of my
constituents from Springfield, Mr. John Kendzierski, a dry wall
contractor for almost three decades. John will tell us that he
is at a disadvantage when competing against other contractors
who treat all of their workers as independent contractors.
Thank you for sharing your story with us today, John; I am
delighted you are here.
I look forward to all the testimony today. In addition to
suggestions about refining the law, we will also hear
recommendations, additional--reporting that perhaps additional
withholding will help address some of the tax gap and
noncompliance issues surrounding independent contractors.
I know that the testimony today will help us find some
reasonable solutions to help us deal with this problem. Thanks
to Mr. McDermott.
Chairman MCDERMOTT. Thank you.
Now Mr. Weller from the Income Security and Family Support
Subcommittee.
Mr. WELLER. Thank you, Mr. Chairman, and good morning.
Welcome to all the witnesses and guests before us today in this
first joint hearing of this Congress for our Subcommittee, as
well as the Subcommittee on Select Revenue Measures, today.
Our economy continues to grow, creating about 2 million new
jobs each year. In this dynamic workplace, both employers and
millions of employees are seeking flexible working
arrangements. The Bureau of Labor Statistics estimates that in
February of 2005 there were over 15 million workers with
alternative employment arrangements, including over 10 million
independent contractors.
As we will hear today, these alternative work arrangements
pose both opportunities and challenges for workers, business
and government. Today, we will pay particular attention to
issues related to the misclassification of independent
contractors.
Independent contractors often fill a need for special
skills or experience, providing flexibility for both the
business needing assistance as well as the independent worker.
Technical and often complex labor and tax rules determine who
is an independent contractor. Confusion about these rules is
one reason why some workers may be incorrectly classified as
independent contractors, as we will hear today.
Other reasons are less benign. For example, some employers
may be willfully misclassifying workers as independent
contractors and some workers, including day laborers and
others, may willingly go along, if they even understand all the
complicated rules and their implications. These issues raise a
number of questions involving unemployment compensation and
other public and private benefits, as well as tax revenue
issues.
I look forward to exploring these important issues in more
detail both to ensure that workers get the benefits and
protections they deserve and that all taxpayers are treated
fairly and equitably.
Thank you, Mr. Chairman. I yield back.
Chairman MCDERMOTT. Thank you. Other members are welcome to
enter a statement into the record.
We are going to begin today with Mr. Kendzierski of West
Springfield, Massachusetts. You have got to tell me if I
pronounced your last name correctly.
Mr. KENDZIERSKI. You did pretty good.
Chairman MCDERMOTT. I used to live in the second-largest
Polish city in the United States, or in the world, Chicago, so
I learned a few things. Go ahead.
STATEMENT OF JOHN KENDZIERSKI, PRESIDENT, PROFESSIONAL DRYWALL
CONSTRUCTION INC., WEST SPRINGFIELD, MASSACHUSETTS
Mr. KENDZIERSKI. Good morning, everybody, and I am grateful
to be here. This is something that is actually very important
to me.
I have been working in this business for close to 30 years.
I have worked in residential, and I primarily work in
commercial business; I have worked with open shop labor and I
have worked with--now I am involved with union labor, and I
currently have around 150 carpenters and laborers working for
me.
I want to just tell you about the difficulties and, really,
the impossibility of people that are competing against people
that misclassify and what we call ``1099 their employees,''
these people that are avoiding Social Security taxes, workmen's
compensation, and unemployment insurance.
A lot of them are avoiding their Federal and State tax
liabilities, and these expenses add up to over 25 percent just
on a simple cost basis. So, if you are competing against them
on a price basis, that makes it virtually impossible to solve
that problem.
It also causes your insurance rates to rise, unemployment
insurance costs rise, workmen's compensation rates to rise,
because if the pool of people paying into that shrinks because
people are avoiding these taxes and fees and insurance fees,
then obviously the rates have to go up to, as the--for those
systems to work.
They also just save the expense of having to administer a
payroll and administer paying all these fees for these people
that effectively are employees, but who they have convinced to
often, sign things that say they are independent contractors.
Additionally, some tradesmen--it allows them to avoid any
government scrutiny.
So, there are people that are trying to hide, their
immigration status, their child support situations; they don't
want to pay their Federal taxes, they have taxes, unpaid tax
liens, and so they are avoiding--intentionally trying not to
show up on anybody's radar screen as an employee, because as
soon as you file a return or file information with the State
and Federal Governments, they can track these people down who
often have unpaid liabilities that they are trying to avoid.
You know, as an employer, I have always prided myself on
the relationship with my employees. One of the troubles I have
with this is you have a lot of people that have no insurance,
they have no health insurance, but they also don't have any
unemployment insurance, and have no workmen's compensation
insurance.
We work in dangerous businesses. People do get injured, and
when these people get injured, they have no place to turn,
neither the government nor the workmen's compensation system is
going to deal with them and everybody is going to turn their
back on them. They can really get caught in a very difficult
situation.
They are also generally not paying any Federal and State
taxes they are obligated to pay. The kind of illegitimate
contractors that trap these people, they say, well, look at all
the money you are saving, instead of, you can deduct this or
you can pay your own taxes. Generally, these people don't do
that; for one reason or another, they tend to be living
paycheck to paycheck.
When these people work as a subcontractor, sooner or later
they find themselves caught in some kind of a trap where they
come to work for someone like me, they report their earnings,
then later on somebody they work for gets audited, they owe
huge amounts of back taxes, and it is crippling for them. They
can owe sometimes a year's wages in back taxes because they
worked 3, 4 years in this kind of underground economy.
They will never escape that. They will be paying those
taxes for the rest of their lives. It is really kind of sad.
What a lot of these contractors do, they prey on these
employees and they take advantage of their lack of
understanding of the law and the risks they are really taking.
They convince these people that they are going to have more
money, because they are avoiding these taxes and fees, they are
somehow beating the system, although they are the ones who--
actually, I believe the employees are the ones getting beaten.
This is particularly true in the residential and small
commercial markets. Here, people like myself, it is virtually
impossible to compete with people that are paying these people,
these--whether they are paying them cash or they are paying
them as independent subcontractors, there is no way I can
compete with that economically. As a result, we lose--you lose
good jobs and you know people that want to have legitimate
income and have benefits and have the kind of American life
that a lot of us would like to have are closed out of those
markets.
The whole issue of being paid cash is another huge problem.
Owners would sometimes pay the contractors in cash. They, in
turn, use that to pay their employees. Nobody is paying taxes
on any of this money; nobody is paying any insurance fees,
nobody is paying their unemployment insurance, workmen's
compensation insurance. It is impossible to compete against. It
leaves no paper trail.
These people--it is a huge, unregulated underground economy
that is huge in construction, in particular, and like I said,
in residential and smaller markets. Once you get caught in
these things, and an employee gets caught working in this
underground economy, they almost can never come out, they are
captured because as soon as you show up somewhere or--where
have you been for the last 3, 4 years?
They might not have filed Federal tax returns, they have
shown no income, they haven't paid their child support or
whatever the issues might be. It is really a system where these
contractors that pay their people that way can trap and kind of
control a workforce that for some reason eventually have to
hide from any kind of scrutiny.
So, in conclusion, there are a couple of problems that are
created by misclassification of workers, one of which is that
it makes it--creates a competitive disadvantage for people like
myself to go out and compete in markets where you have people
that are paying their employees as independent subcontractors
when, effectively, they are employees. They are telling them
what to do every day, they work for them. It is kind of silly.
Second, it creates a second class of tradesmen who can be
talented at what they do, but that takes huge personal,
physical and financial risks that they might not even
understand; and like I said, can get trapped in a way that they
can eventually find very hard to escape from.
So, I really think the Federal Government needs to take
kind of an active role in defining and regulating who can be
paid as an independent subcontractor, specifically in
construction. In following the money trail, there should be a
limit to the level of subcontracting. At some point someone has
got to be an employee in that relationship somewhere.
Chairman MCDERMOTT. Could you sum up your testimony?
Mr. KENDZIERSKI. So, besides that, just hopefully help, so
these people can trace the cash, so that these people have some
fear of getting caught paying cash--so we can avoid that
problem.
So, thank you very much.
Chairman MCDERMOTT. Thank you.
[The prepared statement of Mr. Kendzierski follows:]
Prepared Statement of John Kendzierski, President,
Professional Drywall Construction Inc., West Springfield, MA
Good morning, my name is John Kendzierski and I am the President of
Professional Drywall Construction Inc., a regional commercial drywall
contractor in western New England. I have been in the drywall business
since 1979 and have worked in both the residential and commercial
markets, with both open shop and union labor. Currently I am signatory
with the carpenter and laborers unions, employing 150 tradesmen.
I am here today to tell you the difficulties of competing against
contractors who misclassify their employees as subcontractors and
``1099'' them instead of paying them as the employees they truly are.
These contractors thereby avoid paying Social Security and Medicare
taxes, federal and state taxes, federal and state unemployment
insurance, workman's compensation and liability insurance. These
expenses add over 25% to the cost of labor, putting us ``legitimate''
contractors at a competitive disadvantage when competing for the same
work. This also causes insurance and other rates to rise because there
is less money being contributed in total therefore burdening the
contractor who pays the appropriate taxes and fees. It also allows
these contractors to save the expense of running a payroll and
administering the payment of these taxes and insurances. (Additionally,
it conveniently allows some tradesmen to avoid any government scrutiny
such as immigration status and the paying of child support and back
taxes, effectively not showing up on anyone's radar screen.)
As an employer who has always prided myself on my relationship with
my employees, I find it troubling that some tradesmen have no insurance
coverage of any kind, particularly workman's compensation insurance. We
are in a dangerous business and people do get injured. Uninsured
workers cannot collect unemployment when not working, are not paying
into the Social Security and Medicare systems, and often are not paying
the state and federal taxes they are obligated to pay. I can tell you
many stories about employees who have worked as subcontractors, and not
paid taxes, and then as a result of an audit find themselves owing the
government several months wages in back taxes, which is crippling for
your average worker.
What these contractors do is actually prey on their employees and
take advantage of their lack of understanding of the law and of the
risks that they are taking. They convince these employees that they are
getting more money by avoiding the taxes and fees that they should have
had paid for them, and that they are somehow ``beating the system''. In
my experience the employees are just getting beaten. This is
particularly true in the residential and small commercial markets. In
those markets legitimate contractors have no real chance to compete,
which costs good jobs and income for hard working Americans. There is
an additional part of this problem caused by employers who pay cash.
Often owners pay contractors in cash, which they in turn use to pay
their employees. This cash economy is impossible to compete against and
leaves no paper trail. In those situations no one is paying taxes or
insurance premiums, nor are they verifying any legal status before they
are paid creating a huge, unseen, unregulated economy that hurts real
businesses and can capture workers in a trap from which they cannot
escape. (They can never report income or come clean without the threat
of huge tax liabilities.)
In conclusion, there are really two significant problems that are
caused by the misclassification of employees. First, the contractors
take work away from legitimate contractors that treat the employees
fairly, because of the significant cost advantage of avoiding taxes,
insurance and fees. Secondly, it creates a second class of tradesmen
that are at huge personal, physical and financial risks and often get
trapped in an underground economy from which they cannot escape.
I believe that the federal government needs to take an active roll
in defining and regulating who can be paid as an independent
contractor, specifically in construction, and in following the money
trail on construction contracts to keep the ``cash pay'' contractors
fearful of being caught. (They know it is illegal but have no fear.)
For instance not allowing deductions for anything paid with cash would
be useful.
Thank you for this opportunity to speak with you on this very
important issue.
Chairman MCDERMOTT. Mr. Valencia is from Washington State.
Mr. Valencia?
STATEMENT OF GONZALO VALENCIA, CARPENTER, COVINGTON, WASHINGTON
Mr. VALENCIA. Good morning, sir.
I have been a carpenter for 18 years. I started my
apprenticeship in 1989. When September 11 happened, jobs slowed
down the market, and I was basically obligated to look for a
new resource to bring income to my house. What I did, I went to
a development of houses that was in process and I asked for
employment.
Basically, one of the subcontractors hired me as a framer;
and he asked me to see if I could come up with another two
guys, to frame a house. I did, and we framed this house, we did
a good job. They liked the way we frame, and asked me if I
wanted another one.
Well, we built about five houses, and the superintendent
from the job which he worked for, the general contractor,
suggested to me if I could go and get my own license and go on
my own because I was doing good. Basically, that is what I did.
I started working with those guys, and the development got
done and they recommended me, did a recommendation for me with
another contractor and--which is the contractor that I am still
working with. I have been working with them off and on for 5
years, and I have been working with them--basically they've got
their own way to frame and I've got to accommodate myself to
their own standards--the windows, the way they want their
corners.
If the house has upgrades, basically we're not making any
more money for these upgrades. They said it is square footage
for the houses, and this is what we get paid.
I think we are obligated to continue and frame this way;
otherwise, they will get somebody else to do it. They say,
start walking the houses. They have a system now where we're
not even done with the second floor, and they start coming up
with a list, telling us that we have to get the houses in a
certain way, following a certain schedule that has to meet the
standards and their expectations.
If I didn't show up to the job, I get yelled at; they start
calling me up, say, where am I? So, basically I become one of
the employees.
I have to walk my houses on a daily basis. I come up with a
list for these houses, and the house has to pass several
inspections which is city, one from the department, and I have
to walk my own list.
I am pretty sure that they are conscious about what they
are paying us. They know that it is not enough to pay our
employees. They set the wages for us. Basically, it is quite
foolish, we frame garages for free; we don't get paid anything
for these garages. We have houses that have detached garages,
and we didn't get a nickel for that.
Like I say, they can come up with new upgrades in these
houses--porches, plant shelves, anything they want to make the
house attractive to the customer? This doesn't increase our
pay. It is all included and it is quite foolish. We have to set
windows too.
So, from my own perspective, I think they are neglecting
the pay. They are fully aware that this money is not enough to
cover all the compensations for the employees that we have.
I have a son that is working with me right now and we are
very proud of what we do, and he has seen me for years working
with the union and working as a carpenter, and he knows that we
are honest people. This is what we do for a living, and I can
teach him how to be a good carpenter and I can teach him how to
make a living out of it.
That is my statement.
Chairman MCDERMOTT. Thank you very much.
[The prepared statement of Mr. Valencia follows:]
Prepared Statement of Gonzalo Valencia, Covington, Washington
Chairman Jim McDermott and Chairman Richard Neal:
My name is Gonzalo Valencia. I have worked as a carpenter for 18
years.
I went through the Union apprenticeship starting in 1989. I worked
for fourteen years on union jobs.
After 9-11-2001 work slowed down. I went out looking for work. I
went up to a guy who was framing a house. He said, ``Can you frame?'' I
said, ``I can frame anything.'' He said, ``Can you get two guys to work
with you?'' I said, ``Sure''. He paid me as a 1099. Then he recommended
me to the homebuilder. I got my contractor license in August of 2003
and they hired me to frame houses. I've been there ever since.
I am good at building houses. I love to build houses. I am an
honest man. I have tried to do it right. Many others don't even try to
pay the taxes for the carpenters. The homebuilders have accountants and
lawyers who decide how much it will cost to build a new house. I think
they know that the footage rates are not enough to pay ourselves a wage
and cover our own payroll taxes.
It is very difficult to be an independent contractor framing
houses. The homebuilder is a big company. I am a carpenter working with
my tools. The builder tells you how much you will be paid. On some
houses there is not enough money to keep a wage for myself. The
homebuilder provides all of the material. The homebuilder sets the
schedule. The superintendent calls and yells at you when you don't show
up for work.
The reason I work as an independent contractor is because nobody
tells the homebuilders that they have to pay their carpenters as
employees.
This homebuilder has a system for building houses. I do the work
the way that they say to do the work. They like the windows a certain
way, the corners framed a certain way. Now, they started walking
through the house when you are halfway done and they make a list of
things they want you to change or do-over. On my last house the list
had 80 items.
They pay me by piece rate by square footage. This winter the boss
told me that the housing market is slowing down and he cut my piece
rate from $4.85 a foot to $4.50 a foot. Garages are not included in the
footage rate, even detached garages. I am required to frame garages for
free if I want to keep the job. If the homeowner wants plant shelves,
or archways, or a vaulted ceiling the homebuilder says OK. It requires
more hours of work, but it doesn't cost the homebuilder anymore. They
require me to frame the extras and I make less money on the house.
I have framed for the same large homebuilder for five years. I
understand that this is an ongoing job; so long as I continue to
perform they will keep me on. Sometimes the boss says if I don't do
something that he wants he will fire me. Recently he demanded that I
fire one of the guys on my crew.
I'm not a contractor like a plumbing or electrical company. I don't
bid work to other contractors, I don't have an office or a secretary. I
don't have a company name on the side of my truck. I go to work
everyday for the same builder. If this was a commercial job I would be
a foreman. Building houses I am called a framing subcontractor.
My situation is very common in new home construction. In five years
I have seen many framing crews, hundreds of workers. The workers often
get paid less than they were promised or don't get paid at all. None of
the tract homebuilders in our area hire carpenters as employees.
Today, my son is working with me. He is learning the trade. I can
teach him to be a good carpenter. I can't teach him how to make a
living working on houses.
I hope that you will help to fix this problem so that good
carpenters can be proud of our work and proud of how we get paid.
Chairman MCDERMOTT. Mr. Nilsen, Dr. Nilsen. You work for
the GAO?
Dr. NILSEN. GAO, Government Accountability Office, yes.
Chairman MCDERMOTT. Yes, sir.
STATEMENT OF SIGURD R. NILSEN, DIRECTOR, EDUCATION, WORKFORCE,
AND INCOME SECURITY, GOVERNMENT ACCOUNTABILITY OFFICE
Dr. NILSEN. Chairman McDermott, Ranking Members Weller and
English and other members of the Subcommittee, I am pleased to
be here today to discuss our work on misclassification of
employees as independent contractors. This is an important
issue because being classified as an employee brings with it
many benefits and protections that independent contractors do
not have.
The information I am presenting today is based on findings
from our July 2006 report on the size and nature of the
contingent workforce of which independent contractors are a
significant part. First, with regard to the size of the
independent contractor workforce, the number of independent
contractors has increased by 25 percent since 2000 to 10.3
million workers in 2005, now representing 7.4 percent of the
total workforce. About two-thirds of independent contractors
are men; they are, on average, 46 years old and at least two-
thirds had some college education.
Independent contractors were employed in a wide range of
industries, but in 2005, 23 percent were in professional
services and 22 percent were in construction. Independent
contractors were also in a range of occupations, such as sales,
which accounted for 17 percent; management, 16 percent; and 15
percent in construction trades.
No definitive test exists to distinguish whether a worker
is an employee or an independent contractor. The tests used to
determine whether a worker is an independent contractor or an
employee are complex, subjective and differ from law to law.
For example, the National Labor Relations Act, the Civil Rights
Act, the Fair Labor Standards Act and the Employee Retirement
Income Security Act each uses a different definition of an
employee and various tasks or criteria to distinguish
contractors from employees.
Aside from the complexities of distinguishing employees
from independent contractors, employers have economic
incentives to misclassify employees as independent contractors.
Namely, employers are not obligated to make certain financial
expenditures for independent contractors that they make for
employees, such as paying certain taxes like Social Security,
Medicare and unemployment taxes, providing Worker's
Compensation insurance, paying minimum wage and overtime wages
or including independent contractors in employee benefit plans
such as pensions and health insurance.
In addition, employees misclassified as independent
contractors are generally excluded from coverage under laws
designed to protect workers. In general, because these laws are
based on the traditional employer-employee relationship, they
generally cover only workers who are employees. Independent
contractors, therefore, are not covered.
The Department of Labor detects and addresses employee
misclassification when enforcing the Fair Labor Standards Act
minimum wage and overtime pay provisions. Labor relies on
complaints as a primary way to identify potential violations
for investigation.
All FLSA investigations of minimum wage and overtime pay
complaints begin with an examination of the worker's employment
relationship because FLSA applies only to employees, not to
independent contractors. If investigators determine that a
worker is an employee and not an independent contractor, they
continue with their FLSA investigation to determine whether the
employee was provided the required minimum wage and overtime
pay. Employee misclassification alone is not a violation of
FLSA, but may contribute to minimum wage and overtime pay
violation or violations of tax, Worker's Compensation or
unemployment insurance laws.
According to Labor's field operations handbook, regional or
district officials are required to share information with other
Federal and State agencies whenever investigators find
instances of possible violations of other laws. Labor officials
in nine district offices told us they could not provide the
number of misclassification cases they referred to other
agencies because they do not track this information. However,
their responses indicated that district offices vary in how
often they refer cases to other agencies.
Some of Labor's district offices told us that they refer--
they notified IRS and State agencies when they found
misclassification, while others told us they had little or no
contact with other agencies regarding misclassification issues.
The district offices also reported that it was rare for them to
receive misclassification referrals from other Federal or State
agencies.
In conclusion, to help workers potentially misclassified
get the protection and information they need, we recommended
that the required FLSA workplace poster provide additional
contact information that would facilitate the reporting of
potential employee misclassification complaints. We also
recommended that Labor make improvements in the process it uses
to ensure that referrals of cases of misclassification are made
to other agencies.
This concludes my prepared statement. I will be happy to
answer any questions you may have.
Chairman MCDERMOTT. Thank you.
[The prepared statement of Dr. Nilsen follows:]
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
Chairman MCDERMOTT. Rebecca Smith is from the National
Employment Law Project. Rebecca.
STATEMENT OF REBECCA SMITH, COORDINATOR, JUSTICE FOR LOW-WAGE
AND IMMIGRANT WORKER PROJECT, NATIONAL EMPLOYMENT LAW PROJECT
Ms. SMITH. Thank you, Chairman McDermott, Chairman Neal,
and other members for inviting me to testify here today.
Misclassification has been a large focus of my work and the
work of the National Employment Law Project for many years; and
as you will hear from the state of national studies, it is a
large, growing and common problem in many industries across the
country.
Why do employers misclassify? They stand to save in some
cases up to 30 percent of their payroll tax costs by
misclassifying and they hope to avoid their responsibilities
under labor protective laws, as has been mentioned.
Misclassification has huge impacts on State and Federal revenue
systems, on the tax gap and on employers and taxpayers who have
to foot the bill.
My focus today is going to be on the impact on workers. I
want to talk to you about Rhina Alvarenga.
Ms. Alvarenga works for Coverall North America, cleaning in
an assisted living facility in Massachusetts. Shortly after she
was hired, she was presented with a franchise agreement which
cost her $10,000 to pay back to Coverall. Coverall dictated the
methods by which she performed her work and provided a
supervisor for her work in the assisted living facility. When
she lost her job, she applied for unemployment insurance and
there they sent her on a 3-year battle to make sure that she
was classified as an employee and not an independent
contractor, all the way to the Massachusetts Supreme Court.
Many workers who are in this position will not apply for
unemployment insurance. They assume that if their employer
tells them they are an independent contractor, then they must
be an independent contractor. Others may not file because they
fear they will never be rehired by that particular employer if
they complain. Those who do file bear the burden of showing
that they have been misclassified and at any point in the
appeals process they either risk not being considered an
employee or having a reversal of that determination and facing
overpayment liability.
So, how do audits work for these employers? States are only
required to audit 2 percent of employers in their UI systems
and only 1 of these must be large employers. In cases like Ms.
Alvarenga's, the fact that the company operates across State
lines does not necessarily mean the company will be referred to
the neighboring State where it operates or to the IRS for an
audit.
The IRS is similarly hampered in its ways of auditing by
the existence of Section 530 of the Internal Revenue Code.
Under that section, as long as an employer has consistently
classified certain workers as independent contractors, IRS may
not inquire further about whether misclassification has
occurred, may not assess penalties and may not even require the
employer to prospectively reclassify workers as long as the
employer has some reasonable basis for its classification of
workers as independent contractors.
A reasonable basis can be supplied by the practice of a
significant portion of an industry. So, in industries that are
misclassifying 20 percent or more of their workers, Section 530
operates as an incentive for more to misclassify. Essentially,
the more businesses that violate the law, the more businesses
are allowed to violate the law.
Where penalties are assessed, there is a $50 penalty for
failure to file the correct forms. So, it is no surprise that
employers may choose to save on the payroll costs and risk a
very small risk of an audit or any sort of penalty.
There are some straightforward answers to these problems.
Congress should allow IRS to require employers to fix past
wrongs, to reclassify their employees as employees going
forward.
We should eliminate the ``everybody else does it'' defense.
That doesn't work for my teenage children and it shouldn't work
for employers who are doing wrong either.
We should enlist the help of workers in reclassifying.
Although workers can ask for a determination from the IRS, they
are not guaranteed confidentiality and they are not guaranteed
protection from retaliation.
Finally, we need to step up enforcement. Audits show that
when audits are done, workers are found whose rights have been
violated. We need to step up targeted audits in industries we
know to be misclassified, and we need more coordinated
enforcement efforts across State lines. We also need to look at
innovative ways to shut down the underground economy.
In the context of claimant fraud, the Department of Labor
has financed creative pilot programs in the States, given
States grants for new technologies and new detection systems
and earmarked money for enforcement. We could do the same here.
We could increase cross-matching, and we could increase
reporting in order to get at not only 1099'ed workers, but
workers paid in cash off the books. These steps would recover
billions of dollars and would increase the equity and the
fairness in the system.
Thank you.
Chairman MCDERMOTT. Thank you very much.
[The prepared statement of Ms. Smith follows:]
Prepared Statement of Rebecca Smith, Staff Attorney,
National Employment Law Project
Chairmen McDermott and Neal and members of the Committee: thank you
for this opportunity to testify today on the important subject of
independent contractor misclassification and its impacts on workers and
their families, law abiding employers, and our economy.
My name is Rebecca Smith, and I coordinate the Justice for Low-wage
and Immigrant Worker Project of the National Employment Law Project
(NELP), a thirty-five year old national non-profit law and policy
organization dedicated to research and advocacy on issues of concern to
low wage and jobless workers. We work to promote policies that advance
economic opportunity, increase enforcement of baseline workers' rights,
and help jobless workers reconnect to the promise of economic progress.
NELP has partnered with community and advocacy groups to promote good
models for closing independent contractor loopholes and increase access
to the unemployment insurance system. For twenty-five years, I have
represented low-wage workers on employment issues, including issues
related to the unemployment insurance systems in my home state of
Washington and around the country. I worked with over half the states
on state level implementation of the SUTA Dumping Prevention Act of
2004, and I have previously provided written testimony to this
committee on SUTA dumping implementation and on the FY 2007 US
Department of Labor (USDOL) budget for unemployment insurance.\1\
---------------------------------------------------------------------------
\1\ Implementation of the SUTA Dumping Prevention Act of 2004 (June
2005) (with Rick McHugh); U.S. Department of Labor's FY 2007 Budget For
Unemployment Insurance (May 2006) (with Andrew Stettner).
---------------------------------------------------------------------------
In my testimony today, I will describe misclassification of workers
as independent contractors and relate what we know about the extent of
misclassification and its impact on the nation's tax gap. Then I will
discuss the impacts of misclassification on unemployed workers, in the
unemployment insurance (UI) system and beyond. I will also touch on the
implications of misclassification for the ``tax gap'' in the UI and
other tax systems. Finally, I will propose some key initiatives
reducing the incidence of misclassification and increasing the degree
of fairness in the unemployment insurance system for workers, taxpaying
employers and state trust funds.
A. Background: Independent Contractor Misclassification
Employers across the United States have found that tax laws and
worker protections can be avoided by entering into a ``contract''
relationship with their workers, even where the worker is providing
personal services that are completely integrated into the employer's
business. Generally, employers accomplish this by giving their
employees an IRS Form 1099 instead of a Form W-2, or by paying them in
cash, off the books. Misclassification may occur at the time of hire,
or an employer may convert a worker to ``independent contractor''
status at a later date in the employment relationship. Employers may
require workers to sign a contract stating that they are an independent
contractor, or take out their own business licenses or insurance
coverage.
By this simple arrangement, employers hope to avoid paying
unemployment insurance, workers' compensation, and social security
taxes, and to escape the cost of withholding income taxes, since
employers are not obligated to make these payments to, or on behalf of,
independent contractors.\2\ Misclassifying employers stand to save as
much as 30% of their payroll costs if they count workers as independent
contractors. Thus, they can undercut law-abiding employers because they
don't account for these normal payroll costs.
---------------------------------------------------------------------------
\2\ Workers classified as independent contractors also lack
coverage under labor protective laws such as minimum wage, overtime,
discrimination, and freedom of association laws. U.S. Government
Accountability Office, Employment Arrangements: Improved Outreach Could
Help Ensure Proper Worker Classification, GAO-06-656 (July 2006), at 7,
25. Though these are significant issues, my testimony today will focus
on work-related benefits and the payroll taxes that fund them.
---------------------------------------------------------------------------
Workers who have been misclassified as independent contractors lose
out on workplace protections. When they lose jobs, they face
potentially insurmountable obstacles in correcting their files and
determining eligibility for unemployment insurance. If they are injured
on the job, they may be burdened with huge medical bills, and
uncompensated for lost wages. They may never receive Social Security
benefits and may be on their own for retirement savings and Medicare.
In addition, misclassification of workers as independent
contractors contributes significantly to the nation's tax gap. Total
losses, from unpaid federal and state income and payroll taxes show a
hefty loss of revenue due to independent contractor misclassification,
in the form of unpaid and uncollectible income taxes, payroll taxes,
and unemployment insurance and workers' compensation premiums. The GAO
estimated that misclassification of employees as independent
contractors reduces federal income tax revenues up to $4.7 billion.\3\
Coopers & Lybrand (now PriceWaterhouse Coopers) estimated in 1994 that
proper classification of employees would increase tax receipts by $34.7
billion over the period 1996-2004.\4\
---------------------------------------------------------------------------
\3\ U.S. Government Accountability Office, Tax Administration
Information: Returns Can Be Used to Identify Employers Who Misclassify
Employees, GAO/GGD-89-107 (1989).
\4\ Projection of the Loss in Federal Tax Revenues Due to
Misclassification of Workers, Coopers & Lybrand (1994).
---------------------------------------------------------------------------
In systems such as unemployment compensation, nonpayment of taxes
can lead to trust fund deficits. When some employers are not paying
their fair share, compliant employers must make up the difference.
Genuine independent contractors constitute a small proportion of
the American workforce, because by definition, an ``independent
contractor'' is a person who is in business for him- or herself. True
independent contractors have specialized skill, invest capital in their
business, and perform a service that is not part of the receiving
firm's overall business.\5\ Most workers in labor-intensive and low-
paying jobs are not operating a business of their own.
---------------------------------------------------------------------------
\5\ GAO 06-656, at 43. Examples are a plumber called in by an
office manager to fix a leaky sink in the corporate bathroom, or a
computer technician on a retainer with a shipping and receiving company
to trouble-shoot software glitches.
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Misclassification has significant negative consequences for
workers, employers and state and federal tax revenues.
B. Misclassification of workers is pervasive.
Recent studies at both the national and state levels give some
indication of the extent of this illegal practice. In 2000 the US
Department of Labor commissioned a study of the extent of
misclassification in the unemployment insurance system. That study
found that up to 30% of firms misclassify their employees as
independent contractors.\6\ The percentage of employers who had
misclassified workers ranged from a low of 9% in New Jersey to a high
of 42% in Connecticut.
---------------------------------------------------------------------------
\6\ Lalith de Silva et al., Independent Contractors: Prevalence and
Implications for Unemployment Insurance Programs i-iv, prepared for
U.S. Department of Labor, Employment and Training Division by
Planmatics, Inc. (``Planmatics'') (Feb. 2000), available at http://
wdr.doleta.gov/owsdrr/00-5/00-5.pdf.
---------------------------------------------------------------------------
The states have been leading the way in documenting and recovering
taxes unfairly denied the state treasuries due to misclassification.
Recent studies document rates of misclassification from 10-20%, with
higher rates of misclassification in the construction industry.
The state studies found not only high rates of misclassification,
but also that misclassification is a growing problem. For example, the
Massachusetts researchers found a misclassification rate of 8.2% in
1995-1997, but that rate grew to 13.4% in 2001-2003.\7\
---------------------------------------------------------------------------
\7\ Massachusetts, 7.
Table 1--Recent Studies of Misclassification, Using UI Data
----------------------------------------------------------------------------------------------------------------
Percent of
Employers Number of
State Misclassifying Workers Years Source
Some of their Misclassified Studied
Workers annually
----------------------------------------------------------------------------------------------------------------
Illinois 18% 387,000 2001-2003 Kelsay et al.
(2006) \8\
----------------------------------------------------------------------------------------------------------------
Maine 11% 573,000 1999-2002 (Carre and
Wilson, 2006)
\9\
----------------------------------------------------------------------------------------------------------------
Massachusetts 13% 126,000-248,0 2001-2003 (Carre and
00 McCormack,
2004) \10\
----------------------------------------------------------------------------------------------------------------
New York 10% 705,000 2002-2005 (Donahue, et
al., 2007) \11\
----------------------------------------------------------------------------------------------------------------
Average 13%
----------------------------------------------------------------------------------------------------------------
\8\ Michael Kelsay, James Sturgeon, Kelly Pinkham, ``The Economic Costs of Employee Misclassification in the
State of Illinois,'' 4-5, (Dept of Economics, University of Missouri-Kansas City: December 2006)
(``Illinois''), available at http://www.lecetchicagoarea.org/pdfs/Illinois_Misclassification_Study.pdf.
\9\ Francoise Carre and Randall Wilson, ``The Social and Economic Costs of Employee Misclassification in the
Maine Construction Industry,'' 2 (Construction Policy Research Center, Labor and Worklife Program, Harvard Law
School and Harvard School of Public Health: April 2006) (``Maine''), available at http://www.mccormack.umb.edu/
csp/publications/Maine_misclassification.pdf.
\10\ Francoise Carre, J.W. McCormack, ``The Social and Economic Cost of Employee Misclassification in
Construction,'' 2 (Labor and Worklife Program, Harvard Law School and Harvard School of Public Health:
December 2004) (``Massachusetts''), available at http://www.mccormack.umb.edu/csp/publications/
misclassification.pdf.
\11\ Linda H. Donahue, James Ryan Lamare and Fred B. Kotler, ``The Cost of Worker Misclassification in New York
State,'' (Cornell University: 2007) (``New York''), available at http://digitalcommons.ilr.cornell.edu/cgi/
viewcontent.cgi?article=1009&context=reports.
Second, while misclassification rates are especially high in
construction, (where as many as 4 in 10 construction workers were found
to be misclassified),\12\ this practice has expanded to nearly all
major industries, including delivery services like FedEx, which has
been found to be misclassifying its employees in New Hampshire and
California, to building maintenance and janitorial services companies
like Coverall, found in Massachusetts to have misclassified employees,
to agriculture,\13\ home health care,\14\ child care \15\ and other
industries. The Massachusetts study provides a helpful table
documenting the scope of misclassification across industries.
---------------------------------------------------------------------------
\12\ See Fiscal Policy Institute, ``New York State Workers
Compensation: How Big is the Shortfall?'' (January 2007); Illinois;
Peter Fisher et al, ``Nonstandard Jobs, Substandard Benefits'', Iowa
Policy Project (July 2005); Massachusetts; State of New Jersey,
Commission of Investigation, ``Contract Labor: The Making of an
Underground Economy'' (September 1997).
\13\ See, Secretary of Labor v. Lauritzen, 835 F.2d 1529 (7th Cir.
1988).
\14\ See, Bonnette v. Cal. Health & Welfare Agency, 704 F.2d 1465
(9th Cir. 1983).
\15\ See, IL Executive Order conferring bargaining status on child
day care workers otherwise labeled independent contractors, available
at http://www.gov.il.gov/gov/execorder.dfm?eorder=34.
Massachusetts Prevalence of Misclassification by Industry 2001-2003
------------------------------------------------------------------------
Moderate estimate (All Audits
\16\)
------------------------------------------------------------------------
Transportation/utilities 28.70%------------------------------------------------------------------------
Construction 23.70%
------------------------------------------------------------------------
Professional/business services 22.20%
------------------------------------------------------------------------
Other services, private 20.00%
------------------------------------------------------------------------
Education/health services 18.70%
������������������������������������������
------------------------------------------------------------------------------------------------------------------
Leisure/hospitality 13.70%
------------------------------------------------------------------------
Trade 13.40%
------------------------------------------------------------------------
\16\ ``All audits,'' refers to a combination of both targeted audits and
random audits. Targeted audits generally result in a higher rate of
misclassification.
Nonpayment of taxes is likely underrepresented in these studies.
This is because studies can not adequately capture the so-called
``underground economy,'' where workers are paid off the books,
sometimes in cash. These workers are de facto misclassified independent
contractors, because the employers do not withhold and report taxes or
comply with other basic workplace rules.
Unreported cash pay is one facet of this growing problem that is
particularly difficult for the IRS to catch, since employers have no
record of pay. The problem is complicated by company's failure to
report payments they make by means of a 1099 to other companies. For
instance, a construction employer can subcontract labor and pay the
subcontractor $600,000 in the course of a year. That number is added
into the contractor's business expenses, but the payments to that
subcontractor are not identified in any reporting to the IRS. The
subcontractor is then free to pay workers cash and only report $100,000
of income.
C. Unemployed workers whose employers have misclassified them lose out
on vital safety net benefits.
As the Committee knows, a critical purpose of the unemployment
insurance (UI) safety net is to partially replace lost wages of jobless
workers. This income replacement function prevents extreme hardship,
maintains essential household spending, and supports work search and a
return to work. According to a 2004 report by the Congressional Budget
Office, UI benefits during 2001 and early 2002 ``played a substantial
role in maintaining the family income of recipients who experienced a
long-term spell of unemployment.'' The CBO report found that job loss
reduced family income by 40 percent for those receiving UI benefits, as
compared to an average income loss of 60 percent for those not
receiving unemployment benefits.\17\
---------------------------------------------------------------------------
\17\ Congressional Budget Office, Family Income of Unemployment
Insurance Recipients (March 2004).
---------------------------------------------------------------------------
Large numbers of workers who should be classified as employees lose
out on these vital safety net benefits when they are separated from
their jobs and file for unemployment compensation. Many may simply
forego filing for unemployment compensation benefits. These workers may
wrongly assume that if their employer has told them they are an
``independent contractor,'' that the state unemployment agency will not
question that determination. Still others, having signed a confusing
array of papers claiming they are independent contractors, may fear
that they will create problems for themselves if they now claim to be
an ``employee.'' Finally, workers may fear that applying for benefits
and challenging their employer means they will not be offered a job by
that particular employer again.\18\
---------------------------------------------------------------------------
\18\ Illinois, 10-11.
---------------------------------------------------------------------------
D. Jobless workers face lengthy court battles to establish UI Claims.
Some workers have overcome these obstacles and filed their claims
for unemployment insurance, only to find themselves embroiled in
lengthy legal battles, in which they must disprove their employer's
claim that they are an independent contractor:
Rhina Alvarenga was a janitor employed by Coverall, a national
cleaning company. After her initial hire in November 2002, Ms.
Alvarenga was presented with a $10,500 ``Franchise'' package by her
employer. She paid for the package by taking out a loan from the
employer. She was directed to sign a contract with the company written
in English, a language that she does not fully understand. The
contract, including the hours that she would work and amount that she
would earn per week, had already been negotiated by the janitorial
company and the nursing home where she worked. The method that she used
to clean was dictated by the company, and a company employee was her
supervisor. Ms. Alvarenga applied for unemployment insurance benefits
in November of 2003, after losing her job, but the cleaning company
argued that she was a ``franchisee'' and thus not eligible for
unemployment compensation. The Massachusetts Supreme Court eventually
found that Ms. Alvarenga was the employee of the cleaning company, in
December, 2006.\19\
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\19\ Coverall North America, Inc., v. DUA, Supreme Judicial Court
of Massachusetts. No. SJC-09682 (December 12, 2006). The Massachusetts
Court decided Ms. Alvarenga's case using the ``ABC'' test, a common
test of the employer-employee relationship used in about half of the
states. To be exempted from the requirement of contributions to the
fund, an employer must establish that an individual providing services
is an independent contractor. Under Massachusetts' law, the employer
bears the burden of proving ``that the services at issue are performed
(a) free from control or direction of the employing enterprise; (b)
outside of the usual course of business, or outside of all the places
of business, of the enterprise; and (c) as part of an independently
established trade, occupation, profession, or business of the worker.''
Mass. Gen. Law Sec. 151A, 2.
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In New Hampshire, a worker lost his long-term job and applied for
unemployment compensation. He was hired to deliver packages for FedEx
national package delivery service. The service required him to receive
a particular kind of training from a particular company, purchase his
own van (of a type specified by the company) from a particular dealer
and install the company's logo on the van. He was required to wear a
certain uniform, and the company specified his work days. He could not
use his van for any purpose but to deliver packages for the company.
Nonetheless, the company argued that he was an independent contractor
and not eligible for unemployment insurance when he was separated from
his job. Although he eventually won UI benefits, he was without income
from December 2005 through July 2006 while he appealed this denial.\20\
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\20\ NH Employment Security Appeal Tribunal, Decision of Appeal
Tribunal, Docket No. 06-0463 6016-06.
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Even where unemployed workers have the understanding,
sophistication and wherewithal to challenge an employer's claim that
they are independent contractors, they may go many months or years
without UI benefits before their case is resolved. Even if they prevail
at a lower level of appeal, they face the risk of reversal, and of
being obligated to repay UI benefits should they lose the appeal at a
higher level. In addition, filing a claim for unemployment compensation
does not necessarily trigger an audit of the particular employer. In
short, misclassification of workers as independent contractors wreaks
havoc on the wage replacement purpose of the unemployment compensation
program.
E. Misclassification distorts the playing field for business and
undermines UI trust funds.
Employers who misclassify their workers as independent contractors
undercut law-abiding employers who pay their fair share of taxes. In
addition, they cheat average taxpayers.
The 2000 study commissioned by the U.S. Department of Labor found
nearly $200 million in lost UI tax revenue per year through the 1990s
due to misclassification of workers as independent contractors.
Carrying this number forward to 2005, estimated losses would be on the
order of $343 million per year. The more recent state studies found
much higher losses:
In New York, the researchers estimated a loss to the
state UI fund of $176 million annually--a 7.4% of total taxes
paid in the state.
In Illinois, the loss was estimated at $39.2 million,
and in Massachusetts, a range of $12.6 to $35 million annually
was discovered.\21\
---------------------------------------------------------------------------
\21\ New York, 10; Illinois, 18; Massachusetts, 2.
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Total losses from unpaid federal and state income and
payroll taxes show a hefty loss of revenue due to independent
contractor misclassification, in the form of unpaid and
uncollectible income taxes, payroll taxes, and unemployment
insurance and workers' compensation premiums.
The GAO estimated that misclassification of employees
as independent contractors reduces federal income tax revenues
up to $4.7 billion.\22\
---------------------------------------------------------------------------
\22\ U.S. Government Accountability Office, Tax Administration
Information: Returns Can Be Used to Identify Employers Who Misclassify
Employees, GAO/GGD-89-107 (1989).
---------------------------------------------------------------------------
Coopers & Lybrand (now PriceWaterhouse Coopers)
estimated in 1994 that proper classification of employees would
increase tax receipts by $34.7 billion over the period 1996-
2004.\23\
---------------------------------------------------------------------------
\23\ Projection of the Loss in Federal Tax Revenues Due to
Misclassification of Workers, Coopers & Lybrand (1994).
---------------------------------------------------------------------------
The New York State analysis found that noncompliance
with payroll tax laws means as many as twenty per cent of
workers' compensation premiums--$500 million to $1 billion--go
unpaid each year.\24\
---------------------------------------------------------------------------
\24\ New York State Workers' Compensation: How Big Is the Coverage
Shortfall?, (New York: Fiscal Policy Institute, Jan. 2007).
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The Massachusetts construction industry found that
misclassification of employees resulted in annual losses of up
to $278 million in uncollected taxes and premiums.\25\
---------------------------------------------------------------------------
\25\ Massachusetts, 15-17.
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Total tax loss in California due to misclassification
is as high as $7 billion.\26\
---------------------------------------------------------------------------
\26\ Jerome Horton, California State Assembly Member,
51st Assembly District, recorded interview within ``1099
Misclassification: It's Time to Play by the Rules,'' video stream
available at http://www.mosaicprint.com/client_preview/1099/
index.html#.
In order to achieve its program goals, the UI program must, of
course, be adequately financed. Employers who misclassify make other
employers foot the bill for the program.\27\ Some amount of the loss to
funds is recaptured when workers such as those mentioned above apply
for UI and an audit is triggered. More of it shifted to other
employers, whose taxes may increase because the trust fund is not
sufficiently solvent.\28\
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\27\ Employers pay two types of UI payroll taxes: the federal tax
under FUTA is .8% of the first $7,000 of a worker's earnings, or $56
per year. State taxes vary according to the health of the state fund
and the individual employer's experience with layoffs, with an average
tax rate on total wages of .8% in 2006. U.S. Department of Labor,
Employment and Training Administration, Unemployment Insurance Data
Summary, 2006.4.
\28\ In Illinois, while the researchers found that the national
recession was the major contributing factor to the state's UI trust
fund deficit, misclassification also contributed to negative outcome in
fund. Illinois, 12.
F. Misclassification is inefficiently addressed by current tax law and
---------------------------------------------------------------------------
practice.
Both state and federal authorities have responsibility for auditing
employers to determine whether they are misclassifying workers as
independent contractors. At the federal level, federal law creates a
gaping loophole that allows employers both to misclassify workers and
to escape any future liability for doing so. This loophole is
compounded by a lack of serious, concentrated efforts to detect
misclassification by employers and recover unpaid taxes. At the state
level, greater attention to use of IRS 1099 data and to auditing
employers could improve collections.
1. The tax gap and the ``Safe Harbor'' provision of the tax code.
In 1978, Congress adopted a ``safe harbor'' provision (Section 530
of the Revenue Act of 1978), which precludes the IRS from collecting
employment taxes against employers who ``reasonably'' misclassify their
workers as independent contractors.\29\ In addition, the IRS is
prevented from reclassifying these workers prospectively as employees
under the safe harbor statute.
---------------------------------------------------------------------------
\29\ The safe harbor provision does not apply to IRS determinations
related to income taxes, which are subject to the traditional 20-factor
``common law'' test used by IRS to distinguish employees from
independent contractors.
---------------------------------------------------------------------------
When adopted by Congress, the safe harbor provision was intended to
provide ``interim relief for taxpayers who are involved in employment
tax status controversies with the Internal Revenue Service, and who
potentially face large assessments, as a result of the Service's
proposed reclassification of workers, until the Congress has adequate
time to resolve the many complex issues involved in this area.'' \30\
The provision was extended ``indefinitely'' in 1982, and subsequently
amended again in 1996.\31\ Significantly, since 1978, the federal law
has also prohibited the IRS from issuing any regulations or revenue
rulings ``clarifying the employment status of individuals for purposes
of employment taxes. . . .'' \32\
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\30\ P.L. 95-600, Revenue Act of 1978, Senate Report No. 95-1263,
95th Cong., 2nd Session, 92 Stat. 2763 (1978).
\31\ P.L. 97-248 [Tax Equity and Fiscal Responsibility Act of
1982], title II, Sec. 269(c)(1), (2), 96 Stat. 552.
\32\ Section 530 of the Revenue Act of 1978, Section(b).
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Section 530 of the Internal Revenue Code prohibits the IRS from
correcting erroneous classifications of workers as independent
contractors for employment tax (but not income tax) purposes, including
prospective corrections, as long as the employer has a reasonable basis
for its treatment of the workers as independent contractors.\33\
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\33\ Statement of Donald C. Lubick, Acting Assistant Secretary (Tax
Policy), Department of the Treasury, Before the Subcommittee on
Taxation and IRS Oversight Committee on Finance, U.S. Senate (June 5,
1997), 4.
---------------------------------------------------------------------------
To qualify for the safe harbor provision, the employer must have
consistently filed 1099s with the IRS identifying their independent
contractors and treated all similar workers the same with regard to
their employment status. If these requirements are met, then the
employer will have a ``reasonable basis for not treating an individual
as an employee'' if the employer's decision was in ``reasonable
reliance'' on any one of three factors: Judicial precedent, published
rulings, technical advice with respect to the taxpayer, or a letter
ruling to the taxpayer; a past IRS audit; or, a ``long-standing
recognized practice of a significant segment of the industry in which
such individual was engaged.'' (Section (a)(2))
According to the 1996 IRS compliance manual, the ``safe haven most
commonly argued, and the one which causes the most controversy between
businesses and the Government, is industry practice.'' \34\ The GAO
analysis also found that about 40% of the recommended unpaid taxes and
penalties they identified could not be assessed because of the Section
530 restrictions.\35\
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\34\ Department of Treasury, Internal Revenue Services, Independent
Contractor or Employee? Training Material (October 30, 1996) I-26.
\35\ U.S. Government Accountability Office, Tax Administration:
Information Returns Can Be Used to Identify Employers Who Misclassify
Workers, 8 (September 1989).
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Under current law, there are only limited penalties, reporting
requirements and complaint procedures that regulate employers who hire
independent contractors. These include a minimum $50 penalty. While
there is a procedure for individuals to correct their records with the
IRS using form SS-4, that procedure lacks any private right of action
or safeguards against retaliation by employers.
2. The Department of Labor and State level audits of employers.
Within the Unemployment Insurance system, the federal Department of
Labor does not itself conduct audits of employers. Instead, the
Internal Revenue Service audits employers for unreported federal taxes,
including the FUTA tax, and USDOL recommends that states audit 2% of
employers each year, in order to determine whether or not they are
misclassifying workers as independent contractors.\36\ In 2004, for the
eighth year in a row, states audited only 1.7% of their employers, and
focused their audits on small employers.\37\ In program year 2006,
audits also focused on small employers. Forty-four percent of that
year's audits resulted in some change in the audited employer's
liability or taxes due.\38\
---------------------------------------------------------------------------
\36\ U.S. Department of Labor, Employment Security Manual,
Unemployment Insurance Program, para. 3677.
\37\ 2004 UI Performs, 38, available at http://
www.workforcesecurity.doleta.gov/unemploy/pdf/ar_04.pdf.
\38\ UI Performs, PY 2006, 37-39, available at http://
www.workforcesecurity.doleta.gov/unemploy/pdf/ar_05.pdf.
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States perform random, non-random and targeted audits. Some states
conduct only random audits, which generally will show a lower rate of
misclassification.\39\ Non-random audits are those that are triggered
by the filing of a claim for UI benefits. Targeted audits are those
that are focused on particular indicators of non-compliance with the
law, such as delinquent filings, high degree of employee turnover, type
of industry, or prior reporting history. Not surprisingly, the state
studies mentioned above find a much higher degree of misclassification
when state conduct targeted audits, giving the states a better return
on their enforcement dollar.\40\ Nonetheless, USDOL permits states to
conduct all of its required investigations by random, rather than
targeted, audit.\41\
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\39\ In Illinois, for example, 98% of audits are random. Illinois,
4.
\40\ Maine, 13.
\41\ DOL encourages states to select some employers in a more
targeted fashion, but requires 10% of audits be random. Employment
Security Manual, para. 3679.
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USDOL requires only 1% of the 2% of audited employers to be large
employers of 100 or more employees.\42\
---------------------------------------------------------------------------
\42\ Employment Security Manual, para. 3681.
---------------------------------------------------------------------------
Some states rightly view misclassification as a serious, compelling
problem, and have set aside their scarce administrative funding to
perform additional audits. For example, New York increased both random
and specific audits over the four year period covered in study 2002-
2005, but cited limited staff and resources as a reason it could not do
more. \43\ State administrators with whom we have spoken cite the
continued reduction in federal administrative funding as a reason that
these efforts fall short. Cash-strapped state administrations are
increasingly skimping on their audit functions, with the result that
program integrity measures intended to recover unpaid taxes have been
hampered.
---------------------------------------------------------------------------
\43\ New York, 15.
---------------------------------------------------------------------------
One tool that has been made available to the states by the IRS and
USDOL is a cross-match between IRS 1099 forms filed by employers and
state wage reports. The IRS has several data sets showing payments made
by companies using 1099 forms, since employers are required to file
1099 reports with the IRS for workers paid $600 or more. IRS has made
this data available to states. \44\ Two-thirds of the audits resulted
in changes in the employer's reports of taxes. At least one state that
uses the IRS process to target employers, New Jersey, has an even
higher success rate, of 70%.
---------------------------------------------------------------------------
\44\ U.S. Department of Labor, Office of Inspector General, Use of
Form 1099 Data to Identify Misclassified Workers, (September 2005).
Despite these success rates, as of the time that the Office of
Inspector General reviewed this system in 2005, only nine states were
using the data. OIG anticipated that an additional sixteen states would
make use of the data in the following year. States reported
difficulties with their own IT processes, procedural difficulties in
communicating with the IRS and meeting its safeguards, as well as
``other priorities'' as reasons that they were not using the IRS data
sets. Because the IRS data sets are so large, states were required to
load it on their mainframe computers. They also faced IT challenges in
converting the tapes to documents that could be useful to auditors in
the field. While OIG was satisfied that ETA, having convened a
telephone conference call and presented this issue at its National UI
Tax Conference, was meeting its obligations, there are many other
activities, in provision of IT resources, training, and grants to
states to help them prioritize use of this data, that can uncover
additional tax cheating. The OIG projected that sixteen more states
would use the data in 2006.
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G. Some Key Federal Policy Reforms
While misclassification presents a multi-faceted problem, there are
several initiatives that could close the tax gap and protect America's
workers.
1. Close the Section 530 ``safe harbor'' loophole that promote
misclassification.
Allow IRS to require that employers correct their books
prospectively.
Although there is a strong case that could be made to repeal the
entire safe harbor scheme, the specific language that prevents the IRS
from reclassifying workers prospectively as employees is especially
ripe for reform.
In its 1989 testimony to Congress, the GAO strongly supported this
reform of the federal law. Specifically, the GAO stated ``In view of
the equity issues and tax revenues involved, Congress may want to
consider repealing this restriction against requiring employers to
prospectively reclassify employees who have been misclassified as
independent contractors.'' \45\ In response to the GAO's
recommendation, the IRS wrote ``we support your recommendation that
Congress reconsider Section 530 of the Revenue Act of 1978. Although we
continue to seek improvements in our compliance programs, their
effectiveness will be limited by the statutory restrictions of Section
530.'' \46\
---------------------------------------------------------------------------
\45\ Tax Administration: Information Returns Can Be Used to
Identify Employers Who Misclassify Workers, 10.
\46\ Id.
---------------------------------------------------------------------------
Eliminate the ``everybody does it'' defense.
Another safe harbor rule that significantly compounds the problem
of misclassification is the provision that applies to those employers
who relied on ``long-standing recognized practice of a significant
segment of the industry in which such individual was engaged.''
(Section (a)(2)(C)) Not surprisingly, the 1996 IRS compliance manual
states this provision has created the most controversy with employers.
Increase penalties for violations.
To address the more blatant abuses associated with those employers
who pay their workers off the books, new penalties far in excess of the
$50 minimum should be established that apply to employers who fail to
file 1099s as recommended by the GAO.\47\ Elimination of the minimum
$50 penalty was also recommended by the Advisory Council on
Unemployment Compensation in 1996. \48\ The funding generated by these
new penalties could be designated to help fund more targeted
enforcement on this issue. As the GAO concluded, increased penalties
can help increase the number of 1099s filed by employers. And when the
1099's are on file with the IRS, far more income is reported by
misclassified workers.
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\47\ Statement of Natwar M. Gandhi, Before the Subcommittee on
Taxation and Finance, Committee on Small Business, House of
Representatives, ``Tax Administration: Issues Involving Worker
Classification'' (August 2, 1995, at page 7.).
\48\ Advisory Council on Unemployment Compensation, Collected
Findings and Recommendations: 1994-1996, Recommendation 1995-15.
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Increase notification and reporting requirements.
In addition, as recommended by GAO, businesses should be required
to notify their workers in writing of the rights and IRS
responsibilities as independent contractors, including their rights to
file for a status determination and, if adopted, the new complaint
procedures proposed above.
Finally, in order to more accurately discover off the books
employment, Employers should be required to keep records on and to
report to the IRS the amount of payments made to their independent
contractors (above the existing $600 threshold), including corporations
and other businesses. For instance, a construction contractor should be
required to file an information return on payments to a subcontractor,
even if that subcontractor is incorporated. In addition to alerting the
IRS about misclassification problems and unreported cash pay, this
proposal, which is also supported by the Bush Administration, would
raise nearly $8 billion over 10 years. \49\
---------------------------------------------------------------------------
\49\ U.S. Dep't of the Treasury, General Explanations of the
Administration's Fiscal Year 2008 Revenue Proposals 63 (Feb. 2007),
available at http://www.treas.gov/offices/tax-policy/library/
bluebk07.pdf.
---------------------------------------------------------------------------
By enacting these reforms, Congress would remove a clear incentive
in the law that specifically rewards industries and employers that
misclassify their workers as independent contractors.
2. Enlist Workers' Help in Locating Misclassifying Employers and
Collecting Taxes.
Building on the current Form SS-8 now provided by the IRS to
workers wishing to correct misclassification, a series of new
procedural protections should apply to workers who seek to have their
status determined by the IRS.
Procedural protections for workers.
The law should expressly authorize workers to request employee
status determinations and require an IRS decision on the request while
maintaining the worker's confidentiality to the maximum extent
possible. In addition, the law should authorize third-parties
(including unions and other worker representatives) to initiate a
status determination on behalf of an individual or a group of workers,
similar to the worker representative complaint procedures available
under the OSHA.\50\ The federal law should, as well, include an anti-
retaliation provision protecting workers who request a status
determination, backed by serious penalties imposed on employers who
violate the new law.
---------------------------------------------------------------------------
\50\ 29 U.S.C. Section 657(f)(1).
---------------------------------------------------------------------------
In order to ensure that workers are treated equally with taxpayers,
workers and their representatives should have the right to appeal a
negative determination by the IRS, just as taxpayers can appeal a
decision in connection with an IRS examination or audit. Finally,
workers should have the right to a court proceeding under standards
that specifically define fraud in the context of misclassification and
provide significant damages to the worker in those cases where the
employer acted illegally.
These changes would bring workers' own resources to identification
of employers who are misclassifying. Workers' participation is
important, not only because the tax system is not the only entry point
to discover misclassification, but because workers' participation can
be a valuable tool for tax authorities. First, workers are in the best
position to either answer or operate as a check on employer
information, as tax authorities apply the IRS 20-factor test, such as
questions about the degree of control that the employer exercises over
workers, who sets hours of work, whether the employer furnishes tools
and materials, whether they work for one employer at a time, or whether
the employer can fire them.\51\ Second, most of the cross-matching
currently used by states relies on a paper trail of 1099 forms and does
not capture workers who are paid entirely off the books. Enlisting
these workers' help via the SS-8 process, with the proper assurances of
protection against retaliation, could go a long way towards shutting
down the underground economy.
---------------------------------------------------------------------------
\51\ The test is reprinted in GAO, Tax Administration: Information
Returns Can Be Used to Identify Employers Who Misclassify Workers, GAO
GGD-89-107 (1989), available at http://archive.gao.gov/d26t7/
139838.pdf.
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3. Increase Targeted and Coordinated Federal Enforcement.
Repairing Section 530 is, however, a necessary, but not sufficient,
solution to the problem of misclassification. There is more that the
Federal Department of Labor can do to assist states in identifying
payroll tax cheaters and collecting taxes owed at the state and Federal
level. Two good models exist for increased enforcement activity:
USDOL's approach to claimant fraud and its approach to SUTA dumping.
In recent years, the Administration's budget proposals and
practices have included a number of elements to track down and recover
overpayments from workers. These include increased penalties for
claimant fraud overpayments and allowing state to use 5% paid benefits
recovered for additional program integrity efforts, earmarking for
claimant fraud detection efforts, and special grants to the states to
enable them to beef up their claimant fraud efforts. USDOL publishes
yearly an estimate of the amount of UI benefits overpaid, carrying
forward its sampling and applying it to the total workforce.\52\
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\52\ See, e.g., U.S. Department of Labor's FY 2007 Budget For
Unemployment Insurance (May 2006) (with Andrew Stettner); NELP, The
Whole Truth: Employer Fraud and Error in the UI System (2003).
---------------------------------------------------------------------------
Both Congress and USDOL should be commended for their approach to
SUTA dumping in 2004, for bringing resources to detection of this
particular employer fraud scheme.\53\ Members of this Committee may
recall GAO testimony identifying national accounting firms that at the
time were advising their clients that they should engage in SUTA
dumping, one suggesting that the employer ``move your employees on
paper into another type of organization to obtain more favorable
rates.'' \54\ After the SUTA dumping bill was passed, USDOL worked with
the states to develop a SUTA dumping detection tool, and has
commissioned a report to evaluate the states' success in this area.
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\53\ SUTA dumping entails the transfer of employees from a
company's direct payroll into the account of a new or existing shell
corporation or to a corporation with a lower tax rate, which lists
itself as the nominal ``employer'' of workers, and thus lowers the
initial employers' tax rates. Work remains to be done on the use of
Professional Employee Organizations (PEOs) in SUTA dumping.
\54\ GAO, Unemployment Insurance: Survey of State Administrators
and Contacts with Companies Promoting Tax Avoidance Policies, Testimony
before the Subcommittee on Oversight and Subcommittee of Human
Resources, Committee on Ways and Means, U.S. House of Representatives,
GAO-03-819T (June 19, 2003).
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USDOL and IRS should prioritize misclassification in their
enforcement efforts, as follows:
Target audits in problem industries.
USDOL should mandate that states investigate the extent of
misclassification problems within a state, and require that all states
perform targeted audits in industries most susceptible to employer
misclassification, as well as random audits. This approach was
recommended in detailed studies of the UI system as far back as 1995,
but has not yet been implemented.\55\ The state studies noted above
demonstrate its effectiveness.
---------------------------------------------------------------------------
\55\ ``From this perspective, profiles of noncompliant firms can
improve significantly the collection of UI taxes in two ways. First, UI
agencies may be able to detect and collect a large proportion of the
taxes that continue to go unreported. Second, employers may be induced
to voluntarily report the correct amount of taxable wages to avoid the
more certain detection of tax evasion that results from using the
profile.'' at pages 2-3. Paul L. Burgess, Arthur E. Blakemore, Stuart
A. Low, ``Improving Employer Compliance with Unemployment Insurance Tax
Reporting Requirements,'' Advisory Council on Unemployment Compensation
Background Papers, Vol. II, July 1995.
Engage in enforcement across state lines against major
---------------------------------------------------------------------------
violators.
As GAO identified with respect to SUTA dumping in 2003, and as the
cases cited here demonstrate, major firms engage in major
misclassification across state lines. Yet USDOL currently only requires
that states audit 1% of large employers, out of their 2% total audits.
The Department of Labor should engage directly where corporations that
are found in one state to be misclassifying. across state lines of
Make special grants and pilots projects to encourage
state innovation.
As it has done with SUTA dumping, USDOL could issue special grants
and pilot projects to fund new technology and new statistical models,
in order to help states identify employers who are misclassifying
workers. The 2000 study conducted by Planmatics and cited here
suggested that USDOL investigate new technologies (e.g. intelligent
collection systems, pattern recognition) that can be used to track
``independent contractors'' and their employers.\56\ The Planmatics
study also recommended that USDOL develop a repository of information
on independent contractor issues, best practices, new initiatives, and
legislative measures, to be updated, publicized, and its contents made
accessible to agencies dealing with independent contractors.\57\
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\56\ Planmatics, 94.
\57\ Planmatics, 95.
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Regular reporting of data.
USDOL should develop models to update the national Planmatics study
and provide a yearly estimate of numbers of employers who are
misclassifying workers, number of workers affected, industries
involved, and the effect on the tax system, in order to support state
efforts in this area. IRS should engage in a similar effort with
respect to use of the ``safe harbor.''
Again, I offer my thanks to the Committee for inviting me to
testify on this issue of vital importance to America's workforce.
Myself, as well as other staff at NELP, invite your questions as these
policy proposals develop.
Chairman MCDERMOTT. Mr. Pinkham.
STATEMENT OF KELLY D. PINKHAM, ASSISTANT DIRECTOR, CENTER FOR
FULL EMPLOYMENT AND PRICE STABILITY, DEPARTMENT OF ECONOMICS,
UNIVERSITY OF MISSOURI--KANSAS CITY
Mr. PINKHAM. Good morning, Chairman McDermott, also
Chairman Neal, Ranking Members Weller and English and other
Committee members.
I have been asked to share with you the result of a study
completed by Dr. Kelsay, Dr. Sturgeon and myself of the
Department of Economics at the University of Missouri in Kansas
City. Our study is entitled, The Economic Costs of Employee
Misclassification in the State of Illinois, and it covers the
time period of 2001 through 2005. Support for our research was
supplied by the National Alliance for Fair Contracting, and I
do want to publicly express my colleagues' and my appreciation
to the employees of the Illinois Department of Employment
Security. Without their thoughtful, and also their professional
assistance, we could not have completed our study.
Since our time is short, I am going to focus on the
conclusions of our study and move directly into those numbers,
if that is all right. One of the things that we find is that
the practice of misclassification, both as discovered in our
study and in other studies that have been done, a growing
problem across the country. It is particularly acute in the
construction sector.
What our studies are not able to quantify is the extent of
the problem embodied by the underground economy. That is simply
outside the scope of the studies that have been done. So,
surely any numbers that are reported by our study and others
will underestimate the actual scope and extent of the problems
that we are discussing.
The data for studies like ours come from the unemployment
insurance audits performed by the individual States. Generally,
three kinds of audits are conducted: the random audits that are
mandated; nonrandom audits, which tend to be more benefit-
related, which occur when an employee will apply for funding;
and also targeted audits. States that perform targeted audits
discover a greater extent of misclassification.
Illinois is one of those States that do not perform
targeted audits. In fact, for the 5-year period, 77 percent of
the audits performed in Illinois were random audits.
In 2001, the State unemployment insurance audits found that
more than 14 percent of the Illinois employers that they
audited had misclassified workers as independent contractors.
In 2005, the percentage was nearly 20 percent; this translates
into approximately 64,000 total employers statewide. Given the
fact that most of the Illinois audits are random in nature, the
full extent of the problem is probably greater than what was
covered by random audits.
It was also discovered that when an employer practices
misclassification, the results showed that that practice is
pervasive within that employer. The percent of violating firms'
employees who have been misclassified has risen from 23 percent
in those employers in 2001, to 28 percent in 2005. The practice
seems to be habitual and intentional by certain employers.
That increase from 2001 to 2005 was a 21 percent increase.
Total statewide employees in Illinois who were misclassified
during that period grew from a level of 5.5 percent in 2001 to
8.5 percent in 2005, and by 2005 that number amounted to nearly
420,000 employees in the State of Illinois.
In terms of lost revenue to the unemployment insurance
system, we estimate that during 2005 alone the State of
Illinois lost $54 million in uncollected unemployment insurance
premiums.
State income tax revenues: When workers are classified as
independent contractors, IRS reports show that up to 32 percent
of their income is not reported, not taxed. Other revenue
studies show, that can go as high as 50 percent. Using those
figures, we estimated--in Illinois, the lower figure of 30
percent of income--that in the State of Illinois in just 2005
the estimate would be that $149 million of State income tax was
not collected.
Using the higher estimate of 50 percent of income not being
reported by independent contractors--the practice of
misclassification, if the higher percentage holds true, would
have resulted in uncollected State income taxes in 2005 alone
of nearly $250 million.
Worker's comp insurance premiums are one of the factors
that drive the practice of misclassification. This can be
particularly a problem in the construction industry. Statewide
in Illinois the average work comp premium is around $3 per $100
of payroll. Within the construction industry, some trades, the
work comp premium can be as high as $30 per $100 of payroll.
When an employer misclassifies, it is obvious they can
displace and avoid a tremendous amount of employment-related
cost. So, the problem of work comp insurance premiums being
displaced onto those businesses who play by the rules is a very
serious problem.
Basically, we recommended several steps be taken in
Illinois that would probably apply to other States. We asked
that the legislature empower the IDES, the Illinois Department
of Employment Security, to perform targeted audits. We also
asked that meaningful penalties be developed to deter those
employers who intentionally and habitually violate the spirit
of this law.
We are not after the person who employs the friend of the
family for the summer when they graduate or the internships and
those kinds of things that are an integral part of our economy.
We are after habitual and criminal kinds of behaviors. We ask
that the different agencies seek to align their definitions of
what an independent contractor is.
We found that the work comp commission, the Illinois
Department of Employment Security and the Department of Revenue
all have different definitions. Then, just sharing information,
in the State of Kansas we succeeded in helping a change in the
law occur there, where the Department of Revenue and the
attorney general's office, along with the Department of Labor,
cooperated in that testimony.
They now have a Web site in that State, and we can discuss
other things that have been done during the question and answer
period.
Chairman MCDERMOTT. We thank you very much.
[The prepared statement of Mr. Pinkham follows:]
Prepared Statement of Kelly D. Pinkham,
Assistant Director, Center for Full Employment and Price
Introductory Remarks
Good morning Chairman McDermott, Chairman Neal, Ranking Member
Weller, Ranking Member English and members of the Committee: thank you
for allowing me the opportunity to make a few remarks about the growing
national problem of the improper classification of employees as
independent contractors, a practice known as ``misclassification.'' I
have been asked to share with you the results of a research study
completed by Dr. Michael Kelsay, Dr. James Sturgeon and myself in the
department of economics at the University of Missouri--Kansas City.
Our study is titled ``The Economic Costs of Employee
Misclassification in the State of Illinois'' and covers the period of
2001 through 2005. Support for our research was provided by the
National Alliance for Fair Contracting, a labor-management
organization. We would also like to thank the staff of the Illinois
Department of Employment Security. Without their thoughtful and
professional assistance, our study could not have been completed.
Since our time together is short, my testimony will focus on the
summary section of our study. The complete study, along with related
supporting materials, will be submitted with our written statement.
Given the amount of numerical data I am presenting, figures will be
rounded when possible (for example, instead of 18.2%, I will say 18%).
Notes Regarding Misclassification Research Studies
Other studies in addition to ours have shown that misclassification
by employers is increasing across the United States.\1\ The prevalence
of misclassification varies across different industries and is
particularly acute in the construction sector. Moreover, the
``underground economy'' (that is, workers paid in cash) is outside the
scope of these studies. Thus, the numerical estimates provided by these
studies surely underestimate the full extent of the problems associated
with the employer practice of misclassification.
---------------------------------------------------------------------------
\1\ In a report by the National Employment Law Project, it was
reported that US DOL quarterly audits found 30,135 employees
misclassified in 2002. This was a 42% increase from the prior year.
---------------------------------------------------------------------------
The data for studies like ours comes from the unemployment
insurance audits performed in the individual states. Generally, three
kinds of audits are conducted by the states: random, non-random
(normally benefit-related) and targeted audits. States that perform
targeted audits discover a greater extent of misclassification.
Illinois is one of those states that do not perform targeted audits. In
fact, from 2001-2005, 77% of the audits in Illinois were random audits.
Employee Misclassification in Illinois
In 2001, state unemployment insurance audits found
that more than 14% of the Illinois employers audited had
misclassified workers as independent contractors. By 2005, this
percentage was nearly 20%. This translates into approximately
64,000 total employers statewide. \2\ Since 77% of these audits
were the random kind of audit, the rate of misclassification
found in Illinois suggests that the actual extent may be higher
in Illinois than in other states that have been studied.
---------------------------------------------------------------------------
\2\ According to the Illinois Department of Employment Security,
the average number of employers over 2001-2005 was 34,954 in
construction and 319,054 in all industries. In 2005, there were 36,154
construction employers and 326,945 in all industries. These numbers
exclude local, state, and federal government.
---------------------------------------------------------------------------
When an employer practices misclassification in
Illinois, the results show that this behavior is pervasive. The
percentage of employees that are misclassified at a given
company indicates that it is a common occurrence, not a random
one, in those companies that do misclassify. In 2001, 23% of
the violating firms' workers were misclassified; this had
increased to almost 28% in 2005. That means the rate of
misclassification by violating employers increased 21% from
2001 to 2005.
We estimate that an average of almost 8% of employees
in Illinois was misclassified annually for the period 2001-
2005. This grew from a level of 5.5% in 2001 to 8.5% in 2005.
This represents a 55% increase in the rate of misclassified
employees.
The number of employees statewide that were affected
by the improper practice of misclassification averaged nearly
370,000 annually from 2001-2005. For 2005, this estimate
increased to almost 420,000.
Estimates of Revenue Losses to the State of Illinois
1. Unemployment insurance system: We estimate that the unemployment
insurance system lost an average of over $39 million every year from
2001-2005 in unemployment insurance taxes that were not levied on the
payroll of misclassified workers as they should have been. During 2005,
we estimate that the unemployment insurance system in Illinois lost
almost $54 million.
2. State income tax revenue: According to published data, workers
classified as independent contractors are known to underreport their
personal income; as a result Illinois suffers a loss of income tax
revenue when employees are misclassified. According to the IRS reports,
wage earners report 99% of their wages whereas non-wage earners (such
as independent contractors) report approximately only 68% of their
income. This represents a gap of 31%. Other reliable studies estimate
this gap to be as high as 50%.
Based upon IRS estimates that 30% of the income of
misclassified workers is not reported, we estimate that an
average of $125 million of income tax was lost annually in
Illinois for 2001 through 2005. In just 2005, we estimate that
$149 million of income tax was not collected in Illinois.
Based upon the higher estimate that up to 50% of the
income of misclassified workers is not reported, an average of
$208 million of state income tax was lost annually in Illinois
from 2001 through 2005. For just 2005, we estimate this loss to
have been $248 million.
3. Worker's compensation insurance: Misclassification also impacts
worker's compensation insurance. Among other effects, costs are higher
for employers that follow the rules placing them at a distinct
competitive disadvantage. A national study reported that the cost of
worker's compensation premiums is the single most dominant reason why
employers misclassify (Planmatics, 2000). Employers who misclassify can
underbid the legitimate employers who provide coverage for their
employees. The practice of misclassification shifts the burden of
paying workers' compensation insurance premiums onto those employers
who properly classify their employees. It has the further effect of
destroying the fairness and legitimacy of the contract bidding process.
The same national study (Planmatics, 2000) reported that many
previously misclassified workers were later added to their company's
worker's compensation policy by their employer after they were injured,
resulting in the payment of benefits even though premiums had not been
collected.
Based upon the statewide average worker's
compensation insurance premium rates published by the State of
Illinois, we estimate that, on average, $96 million annually of
worker's compensation premiums were not properly paid for
misclassified workers.
Worker's compensation premiums are much higher in the
construction industry. In Illinois the statewide rate for all
industries is less than $3.00 (per $100 of payroll). However,
within construction, rates can range from $8.01 for electrical
wiring to $27.94 for concrete construction. Using an average
premium rate of $10 per $100 of payroll, we estimate an annual
average of $23 million of worker's compensation premiums were
not properly paid by construction employers in Illinois. Using
a higher average premium rate of $15 per $100 of payroll, we
estimate this average annual amount to be $35 million.
Concluding Remarks
Misclassification of employees has a negative
financial impact on individual workers, the Illinois state
government, and the private sector in Illinois. The workers are
directly impacted by being denied the protection of various
employment laws and by being forced to pay costs normally borne
by employers. State income tax revenues and the unemployment
insurance system in Illinois are adversely affected.
Misclassification also imposes additional costs on honest
employers who play by the rules, on taxpayers, and the public
at large. Furthermore, the operation of fair, competitive
markets is profoundly compromised when the bidding process is
undermined by the practice of misclassification. Illinois will
stand to benefit from better documentation of
misclassification, from adopting measures that help to improve
compliance with state statutes and from targeting employers who
intentionally and repeatedly misclassify their employees.
Recommendations
As a beginning, we recommend the following steps for consideration
by policy makers and public officials in Illinois: (1) the Legislature
empower the IDES to perform ``targeted'' audits on problem employers
like those done in other states,\3\ (2) develop meaningful penalties to
deter those employers who intentionally and/or repeatedly violate state
laws on misclassification, (3) seek to align the three different
definitions for what constitutes an ``independent contractor''
currently applied by the IDES, the Department of Revenue and the
Worker's Compensation Commission, and (4) review current authorities
and procedures for the sharing of information among state agencies so
that violations of state statutes will receive a comprehensive and
coordinated response with the intent of recovering all payroll-related
funds that are due and of deterring future willful violations.
---------------------------------------------------------------------------
\3\ Targeted audits are those audits identified where a higher
degree of misclassification may be observed. For example, targeted
audits might be audits of employers with (1) delinquent filings or (2)
multiple delinquent quarters of unemployment insurance due. Planmatics
(2000) encouraged states to maintain audit selection criteria that
reflect potential noncompliance (e.g. high employee turnover, type of
industry, and prior reporting history).
---------------------------------------------------------------------------
Chairman MCDERMOTT. Mr. Satagaj.
STATEMENT OF JOHN SATAGAJ, PRESIDENT AND GENERAL COUNSEL, SMALL
BUSINESS LEGISLATIVE COUNCIL
Mr. SATAGAJ. Good morning, Mr. Chairman. We have Polish
bookends, by the way. I am also Polish. I am down the river
from Middletown, Connecticut. So, we are Polish bookends here.
Thank you. I am John Satagaj, President of the Small
Business Legislative Council. I was thinking this morning,
preparing myself for this hearing, I don't know how many
Members of the Committee are familiar with Tom Sullivan. Tom
Sullivan is the Chief Counsel For Advocacy at the Small
Business Administration, and one of his jobs is to provide
information to all of you about the state of the economy.
I was thinking, what would happen if Tom had appeared
before the Committee on Small Business, and he reported that
there is a trend, the number of small businesses are going down
in this country? I suspect all of us would react with alarm
because they are the job creators, the innovators; they provide
the economic diversity that is important to the communities. We
would get very concerned because the truth is, we try to
promote small businesses--we have loan programs, we have
investment programs, all of them with risk associated with
them.
We have made a choice. We are going to take a chance and,
yes, we are going to lose some loans, some investments are not
going to work; but we support it because we want small
businesses.
The same is true of the tax policy. We do things there to
promote small business. Particularly in this area we have to
decide whether folks are independent contractors or employees.
Those independent contractors are the professional drywall
company of tomorrow. If we have a rule--I would agree, yes,
there are folks that are abusing the law, but if we have a
rule, we have got to find where you draw that line, because,
while I want to catch the abusers; at the same time if I lose
one independent contractor, then it might be that business of
tomorrow with a bunch of employees, it is a big loss for us,
too.
Now, our organization has been involved in this for 30
years--unfortunately, 29 myself. I have gone through more
definitions of where you draw this line. It is a very humbling
experience to try to do it, things have changed dramatically in
the 30 years. The last time we tried--it was in the 107th
Congress--to come up with some rules, just between the 107th
Congress and today, look what has changed. You would need to be
more flexible than ever in an economy, be adaptive to these
things. So, it is very important that we protect that at all
costs.
Now there are other things that we can do in addition to
looking at these rules. My colleagues, N.F.I.B--the Chamber and
myself, have been meeting with the IRS, with Treasury, with our
friends at GAO, with other Hill folks, to talk about what other
things we can do, mostly in the context of the tax gap of how
we can we do it better.
The IRS has been very generous with their time. The
Assistant Commissioner for Small Business/Self-Employed, Kathy
Petronek, has met with us; her predecessor, Kevin Brown has met
with us. We are constantly talking, looking for ways we can get
a good tax compliance system without killing the
entrepreneurial spirit. It is important we do that. So, we work
constantly with them.
One of the things we set out 10 years ago, we said to the
IRS, you need to do a better job of not just using the stick,
but you need to teach. You, Congress, said to the IRS you need
to go out and engage in outreach and education.
They have been doing a good job over that 10 years of
increasing their outreach. We meet with them formally every 2
months to talk about that very subject. How are you doing? What
can we do better to make sure we are reaching people so they
understand the responsibilities? Those who are starting out,
that they understand what it is to be a small business, their
responsibility to pay taxes, all those things. We meet
constantly to update and improve that.
We are getting better at it; we have a long ways to go, but
we are making great progress and we are making sure everybody
does understand that. At the end of the day whatever we do in
this thing, at the same time we have to prevent the abuses, we
also have to make sure we are protecting that entrepreneurial
spirit. So, whatever we do, let's keep that in mind. We have
got to reach both of those objectives.
Thank you, Mr. Chairman.
Chairman MCDERMOTT. Thank you.
[The prepared statement of Mr. Satagaj follows:]
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
Chairman MCDERMOTT. We thank all of you. Your full
statement, your written statement will be entered into the
record. We appreciate your coming here to do this today.
I want to start by asking a question, first, to Mr.
Valencia.
If I understood you correctly, you say that you have become
not a foreman, but an independent contractor who has a team of
people working for you; is that correct?
Mr. VALENCIA. Yes, it is.
Chairman MCDERMOTT. Do you have liability responsibility if
one of them gets injured?
Mr. VALENCIA. Yes, I do.
Chairman MCDERMOTT. So, are you paying Worker's Comp
insurance?
Mr. VALENCIA. Yes, I am.
Chairman MCDERMOTT. You are getting that from the company
you work with? Is that an item that is passed through you from
the employer or from the homebuilder?
Mr. VALENCIA. No. Basically, everything--all they pay me is
my square footage; and based on that price, they pay me like a
dual invoicing twice a month. It is in that price that I got to
pay my people.
I have to pay the taxes. I have to pay the L&I and still at
the end of the year, I have to come up with my 941s. For just
this year, 2006, last year--I had to refinance my house this
year because I have to pay $60,947 to the IRS right now out of
my pocket. I have to refinance my house to pay this money out.
So, 2005, I refinanced my house again to pay again the IRS.
Chairman MCDERMOTT. Do I understand, though, that the
homebuilder tells you when to go to work, where to work, what
to build, and how much you are going to get paid; is that
correct?
Mr. VALENCIA. Yes, it is correct.
Chairman MCDERMOTT. So, you don't have any flexibility in
when you want to work or anything? You are building to his
specs as to how the house looks and what the size of the rooms
are and so forth. It is all according to his specs?
Mr. VALENCIA. Right.
Chairman MCDERMOTT. They can make changes at any time?
Mr. VALENCIA. They provide--they provide me with the
blueprints and give me the lumber and all. What I provide is
the labor.
Chairman MCDERMOTT. Let me ask a question of you, Ms.
Smith. If I understand correctly, Mr. Valencia does not get
credit for Social Security, he doesn't get credit for Medicare
coverage unless he pays it?
Ms. SMITH. Right.
Chairman MCDERMOTT. He is not included in any kind of
retirement plan or anything else. That has to be independently
set up, whatever he has?
Ms. SMITH. Yes.
Chairman MCDERMOTT. He has no unemployment benefits if he
is laid off; if there is no work, he can't go and apply for
unemployment insurance benefits?
Ms. SMITH. Right.
Chairman MCDERMOTT. He is not covered by minimum wage
requirements. If he doesn't make money out of this per foot
stuff, he winds up working for $3.70 an hour. There is no
requirement that he be given enough money to get the wages out
of it?
Ms. SMITH. That is what it sounds like.
Chairman MCDERMOTT. No family and medical leave
requirements?
Ms. SMITH. No.
Chairman MCDERMOTT. No right to collectively organize as a
union?
Ms. SMITH. No.
Chairman MCDERMOTT. Is there a prevention in the law that
says if you are an independent contractor that you cannot
organize a union?
Ms. SMITH. The National Labor Relations Act covers only
employees.
Chairman MCDERMOTT. Employment discrimination, he has no
protections in that area?
Ms. SMITH. No, not if he is truly considered an independent
contractor.
Chairman MCDERMOTT. OSHA does not apply? There is no
workplace safety?
Ms. SMITH. Not for independent contractors.
Chairman MCDERMOTT. Now does the OSHA cover his workers
that are on his team? The workers that he has gathered up, does
that cover them?
Ms. SMITH. Yes. If he is considered the employer of others,
then he incurs all the liabilities for payroll costs, payroll
taxes, and to comply with labor protective laws like minimum
wage and overtime and health and safety.
Chairman MCDERMOTT. If this Committee were to make one
change in Federal law, what would be your suggestion to us?
Ms. SMITH. My recommendation--I think the most immediate
problem is the Section 530 loophole. It makes no sense to me
that we would prohibit the IRS from correcting problems that
occurred in the past and that we would allow industries to say,
I do this because everybody else does it, whether or not it
complies with the law.
I think that is the most immediate problem and the most
immediate thing that we can fix.
Chairman MCDERMOTT. My understanding is, the Treasury
recommended that almost 10 years ago, that it be done; is that
correct?
Ms. SMITH. Yes, it is.
Chairman MCDERMOTT. Is that a study by the Treasury
Department on that issue?
Ms. SMITH. There was a study--my recollection is, there was
a study by GAO, and GAO recommended some changes and that IRS's
response to the study was that, yes, indeed, there should be
some changes to the IRS safe harbor.
I think that was back in 1989.
Chairman MCDERMOTT. Okay. Do you know that to be true, Dr.
Nilsen?
Dr. NILSEN. Yes. That was a 1989 study when we made that
recommendation, that Congress direct the IRS to make some
changes to 530 to ensure better coverage of their
investigations.
Chairman MCDERMOTT. Thank you.
Mr. Neal will inquire.
Chairman NEAL. Thank you very much, Chairman McDermott.
Mr. Kendzierski, you have referred to these misclassified
workers as a second class of tradesmen who work in dangerous
business where workers often get injured. What happens to these
workers if they do get injured?
Mr. KENDZIERSKI. Well, they are ineligible to collect any
unemployment. Generally their lives just become very distraught
and they have no place to turn.
Chairman NEAL. Are there any government initiatives that
you are aware of that come to their assistance at that moment?
Mr. KENDZIERSKI. None that I am aware of, sir.
Chairman NEAL. Mr. Valencia, when you started that first
job as a framer, did you have a full understanding of why the
builder sent you a 1099 form, or was it a surprise to you?
Mr. VALENCIA. Back then it was a surprise for me, but when
I learned the whole process of that, I was assuming the taxes
and everything at the end of the year, it shocked me.
Chairman NEAL. Mr. Satagaj, you have heard the comments of
the last two witnesses, Mr. Kendzierski and Mr. Valencia, about
the types of construction workers probably misclassified as
independent contractors. Your testimony seems to suggest that
independent contractors are really just entrepreneurs in the
embodiment of the American dream.
Would you disagree that these gentlemen--disagree with
these gentlemen that these workers really need the protection
of employee status, given the risks that they run every day?
Mr. SATAGAJ. As I said, there are certainly those that
abuse the system, but the funny thing, the truth of the matter
as I sit here--and I have to be very honest--I am hopeful about
the future of Mr. Valencia. I am expecting 5 years from now,
you are going to see a better businessman who is going to have
more employees, work for more builders, and be successful. I
see this as a positive entrepreneurial opportunity here. That
is the good thing about it.
Yes, let's get rid of the abuses, but let's encourage him
to be a better small business. That is what we should be doing.
Chairman NEAL. I don't think anybody disputes that. I think
one of the concerns that we legitimately raise is what happens
to that injured worker.
Mr. SATAGAJ. Well, the owner of a business has similar
issues, too. One of the risks of becoming a business owner, you
take some of the risks. I want everybody to have the coverage,
but the employer has the same problem as the employees or the
independent contractor there. Keep that in mind.
So, there is risk there for everybody. There are no owners
in the Worker's Compensation system.
Chairman NEAL. No. We accept the notion of risk in
successful entrepreneurship. What happens if the employee that
Mr. Kendzierski referred to is an Iraqi veteran or a veteran of
the Afghan war, but he is injured on the job?
Mr. SATAGAJ. I am not disputing. Where it is appropriate,
it should be there, under those circumstances, but as I said,
you show me where we draw that line. It is going to be
extraordinarily difficult to find the place to draw that line.
Chairman NEAL. If the injury prevents you from going to
work, would you object to Medicaid coverage for that
individual?
Mr. SATAGAJ. Beyond my level. It is beyond my level, Mr.
Chairman.
Chairman NEAL. Thank you.
Ms. SMITH, your testimony shows that one Massachusetts
survey found that construction was not the leading industry for
misclassified workers. That survey seems to show that
misclassification can occur in lots of different work sectors,
including some with highly educated workers who might otherwise
be predisposed to understand the downside.
Do you know why the information industry would have more
misclassified workers than construction workers?
Ms. SMITH. I don't know why that is. Some of the folks who
have done some of the studies might know the answer to that
question.
One thing that I did want to say is that oftentimes in
these cases the impetus to create a new business and a new
independent contractor is not coming from an individual
entrepreneur. It is coming from the company for whom that
person would like to work, as in my example, as in Mr.
Valencia's example and other examples in our testimony.
So, it is really not misclassification by accident, but
misclassification as a business model.
Chairman NEAL. If the employee that I have described, based
on Mr. Kendzierski's testimony, were called to duty in Iraq and
then to return, would he be able to reclaim his status
necessarily as an employee?
Ms. SMITH. If it were someone in Mr. Valencia's situation,
I am not certain. My guess would be ``no.''
Chairman NEAL. Okay. Thank you.
Thank you, Mr. Chairman.
Chairman MCDERMOTT. Mr. Weller will inquire.
Mr. WELLER. Thank you, Mr. Chairman. Again thanks to our
witnesses and panel for joining us this morning.
Dr. Nilsen, what is the breakdown of the type of workers
that tend to be independent contractors? Mr. Valencia is in the
construction business. He is a framer; he is a carpenter; he
has people who work with him.
Are all independent contractors in the construction trades?
Can you give us kind of a breakdown of who they are?
Dr. NILSEN. It covers a wide range of occupations and
industries. Construction is significant, but also business
services and professional services, as we heard, are also
significant. It goes across the spectrum in terms of industries
and workers, as well, occupations as well.
So, it is not--it may be concentrated. As I said, about 22
percent are in construction, 23 percent another--23 percent in
professional services; but then the other roughly 50 percent
are spread across all other industries.
Mr. WELLER. You studied all the various reports and studies
that have been done and analyzed them as part of your
responsibility. When it comes to those who are misclassified as
independent contractors, is there a trend in which particular
industry they may be in, or is that across the board as well.
Dr. NILSEN. It seems to be across the board. We haven't
found any particular concentrations in particular industries
that I recall.
Mr. WELLER. Mr. Pinkham used the word ``criminal'' when he
was describing the use of independent contractors by certain
employers. For those who misclassify, is that a criminal act in
our States? Illinois is an example in his study, my home State.
Dr. NILSEN. It is more the consequences of misclassifying
that could be. If people are misclassified, and it is found
that they have not been paying minimum wages, overtime wages,
then that would be a violation.
Mr. WELLER. What are the current penalties?
Dr. NILSEN. I can't answer that. Perhaps Ms. Smith can
answer that at this time.
Mr. WELLER. Mr. Pinkham, you are the one----
Dr. NILSEN. Certainly back wages need to be compensated.
Mr. WELLER. Mr. Pinkham, you are the one who used the word
``criminal.'' Can you describe the penalties for someone who
intentionally misclassifies an independent contractor in
Illinois, since you did the study there?
Mr. PINKHAM. Yes. I was recalling testimony provided by a
former official with the Department of Labor and Industrial
Relations with the State of Mississippi during the hearings in
Kansas where she described a Kansas contractor who had a
prevailing-wage job in Missouri where he had 150 employees
building a dormitory in Merriville, Missouri. Every employee
was classified as an independent contractor.
The same individual had a similar set-up going on on a
publicly funded construction project in Iowa. The State did
seek back payment, and there was a court case in which there
was a settlement of over a half million dollars.
Now, the use of the word ``criminal'' would apply in this
case more in terms of the illegality. The actual penalties may
be more civil in mind, but there are cases where people are
facing jail time. There is a developer who lives in the Kansas
City area who is currently in court and is facing some jail
time for abuses in the Lake of the Ozarks area of Missouri.
Mr. WELLER. Mr. Pinkham, you indicated this was a
prevailing-wage contract. Was the employer in this case paying
the prevailing wage as honoring his contract with the
university for that dormitory?
Mr. PINKHAM. When you use independent contractors, that is
a way in which you are not accountable to the prevailing wage
and benefit requirements.
Mr. WELLER. Even though the contract required it?
Mr. PINKHAM. Even though the State normal contract would
require that, yes.
Mr. WELLER. Mr. Pinkham, you had also noted in the Illinois
report, that 18 percent of audited employers had misclassified
at least one worker as an independent contractor and about 7\1/
2\ percent of all workers were misclassified. In your Illinois
study did you determine that the employers of these workers
that were misclassified, that they did it intentionally?
Mr. PINKHAM. What we noticed is that the activity tends to
be concentrated within certain employers. That when you do find
employers who misclassify, they tend to misclassify a higher
percentage of their employees than what the random practice
would show; and that in States where targeted audits are
allowed, where they will focus audit activity on businesses who
have problems with filing their paperwork or other kinds of
indicators that are used, for instance in Massachusetts, the
incidents of misclassification there that was discovered was
quite high.
Mr. WELLER. So, you are saying there are certain bad
actors, but not all employers are bad actors if they
misclassify; some may have made a mistake?
Mr. PINKHAM. No, of course not.
Mr. WELLER. One last follow-up, if the Chairman would
indulge me here. In your study you talked about the loss of
revenue to the Unemployment Insurance Fund because of the use
of independent contractors. If their classification would
change, did you also analyze what the outflow of money to pay
unemployment benefits would be? What would be the impact on the
Unemployment Insurance Fund if those workers were not
classified as independent contractors or fully covered by
unemployment insurance; what would be the impact from the
standpoint of money going out?
Mr. PINKHAM. In terms of the increased claims that might
occur for unemployment insurance?
Mr. WELLER. That is correct.
Mr. PINKHAM. I don't know of anyone that has actually
analyzed that phenomenon, but I do know that what we have heard
from--again, when I was providing testimony in Kansas, I was
approached by some masonry contractors in the rotunda who were
talking about some of these issues and about people that worked
for them. I don't have a projection for what would be the
incidence of people who would file for claims, but there are a
lot of people who have casual work relationships that are not
filing.
Mr. WELLER. It is one thing to say we are not collecting
enough tax, and there are always people that want to raise
taxes and collect more tax revenue, but I think it would be
useful from our perspective to not just look at the standpoint
of what this means to the tax collector, but what is also the
impact in money going out the door for unemployed workers on
their ability to collect. To me it would be useful to look at
both the inflow as well as the outflow. I know as a Member of
this Committee, I would appreciate it if you would take a look
at that and provide that.
Mr. PINKHAM. I would be very happy to carry that request
back to my colleagues.
Mr. WELLER. I would ask unanimous consent that be included
as part of the record.
Chairman MCDERMOTT. So ordered. Thank you.
Mr. WELLER. Thank you, Dr. Pinkham.
Chairman MCDERMOTT. Mr. English will inquire.
Mr. ENGLISH. Thank you, Mr. Chairman. Since I was not here
at the beginning of the hearing, I wonder if I can seek
unanimous consent for the record to have my statement inserted?
Chairman MCDERMOTT. It has already been granted, so, yes,
you may.
Mr. ENGLISH. Thank you very much.
[The prepared statement of Mr. English follows:]
Prepared Statement of The Honorable Phil English,
a Representative in Congress from the State of Pennsylvania
Chairman McDermott and Chairman Neal, thank you for calling this
hearing on this subject. The issue of worker status as employee or
independent contractor is not a new one to the Committee. This is a
complex area of the law with valid concerns on both ends of the
spectrum and I look forward to exploring this issue as others who have
sat at this dais in many previous Congress have done.
Let me start by saying that this Committee should have little
patience for those taxpayers who willfully flaunt the law. Those
employers and workers who do so should be dealt with appropriately. But
for those whose non-compliance with the law is not a product of
malfeasance but is, rather, an act of nonfeasance, we must inquire why.
If non-compliance is the result of unnecessarily complex or nebulous
tax rules, then Congress should seek to lighten this burden on
employers and workers.
I look forward to hearing the viewpoints of the witnesses today on
this issue.
Mr. ENGLISH. I guess listening to the testimony, Mr.
Satagaj, I am intrigued by some of the testimony we have heard
with regard to the tax gap, which seems to suggest that there
is a lower compliance rate among independent contractors than
employees. In your view, is this directly the result of
misclassifications of employees as independent contractors?
Mr. SATAGAJ. Unfortunately, I spend what seems like every
waking moment thinking about the tax gap these days. We have
spent a lot of time looking at the data and how it affects
results to close the tax gap. I cannot come to that conclusion,
that it is driven by this.
GAO had mentioned the diversity of the independent
contractor community. There are so many different reasons for
why the gap exists, and the solutions are going to be a lot of
tiny, discrete solutions, and they are not going to add up to a
lot. We are not going to go much beyond the 84, 85 percent
compliance rate. We have a pretty good compliance record right
now voluntarily compared to the rest of the world. Historically
it has been very consistent. So, the answer is it is not this.
There are a lot of different things.
Mr. ENGLISH. I noted last year Congress enacted the 3
percent independent contractor withholding provision, and that
was targeted at increasing the compliance rate among
independent contractors. This only applied in situations where
the contractors were doing business with the Federal, State and
local governments.
Can you comment on your view of the consequences if we were
to impose withholding on all independent contractors, including
their nongovernmental contracts?
Mr. SATAGAJ. Well, as you know, Mr. English, that hasn't
gone in effect yet. I happen to believe before it does we are
going to be revisiting it, because I don't think it is going to
work. It is not going to work at the level with the government.
Frankly, it is an even more difficult challenge if you try to
impose it in nongovernmental settings. You have got to deal
with net profits, the net income versus gross income. It is
different in every industry where you pick a number for it. It
is different for every business. Let's say you want to enter a
new market and you might be very aggressive. Your margins are
going to be different. The notion that you can pick a number
that would work across all industries or even for an individual
business in a given year, given circumstances, is impossible. I
still believe that we are going to be coming back to the
government withholding one, because I don't believe it is going
to work there.
Mr. ENGLISH. Stipulating that we have seen situations where
there is clear misclassification going on there is a real issue
here. I have been on this Committee for 13 years. I have come
to appreciate that there are very legitimate concerns about
misclassification. I am very grateful, by the way, to the two
chairmen for creating an opportunity here to freshen our
understanding of what is going on.
Nevertheless, it strikes me that there are some situations
where small businesses could be dramatically impacted by a lack
of access to certain kinds of independent contractors. After
all, small businesses as the most dynamic sector of our economy
are also able sometimes to import expertise or technology by
tapping into certain kinds of people who can be brought into
the organization with the status of independent contractor
temporarily or on something short of a full-time basis. It
seems to me that is very significant for certain parts of our
economy, that there is access to independent contractors.
Stipulating that we may want to revisit the rules, are
there specific concerns on that front that we need to be
cognizant of?
Mr. SATAGAJ. I think you raise a point, and I don't recall
whose opening statement mentioned globalization, but one of the
reasons we are competing in a global market with the changes in
technology is our ability to be flexible in certain industries
and address whatever we need to compete globally. I am certain
there are industries where the flexibility has only grown
exponentially in the direction of flexible arrangements.
You look, again, at our economy, for a lot of women in our
economy who are getting opportunities, that very ability to be
in a flexible market allows you to do that. It is providing
more opportunity, so it is a very positive.
Mr. ENGLISH. That is a very important caveat.
My time is expired. Mr. Chairman, again, I want to thank
you for creating the opportunity for maybe some of the Members
who haven't been as involved as we have over the last 13 years
to freshen the understanding and maybe appreciate how
substantial an issue this is perhaps not only of worker rights,
but also of the dynamics of our economy. Thank you all for
testifying.
Chairman MCDERMOTT. Thank you.
Ms. Berkley will inquire.
Ms. BERKLEY. Thank you, Mr. Chairman, for holding this
hearing, and I would request also unanimous consent to submit
my opening remarks.
Chairman MCDERMOTT. So ordered.
[The prepared statement of Ms. Berkley follows:]
Prepared Statement of The Honorable Shelley Berkley,
a Representative in Congress from the State of Nevada
Thank you, Mr. Chairman. I am happy to have this opportunity to
work with my colleagues from both subcommittees to address the
misclassification of employees as independent contractors.
Over the years, Congress has taken steps to ensure that employers
are providing their workers with a certain level of security. Employees
are entitled to a minimum wage, overtime pay, and safe and healthy work
places. If an employee is hurt at work, he or she receives workers'
compensation; if that worker is let go they receive unemployment
benefits.
Employers of these individuals pay unemployment taxes and workers'
compensation insurance as well as their half of Social Security and
Medicare or (FICA) taxes.
My district of Las Vegas is one of the fastest growing areas in the
country and a significant portion of my constituents are employed in
construction--an industry where misclassification is quickly becoming
common practice.
Unfortunately, when employees are incorrectly classified as
independent contractors, they are robbed of these important
protections. These misclassified workers are also often excluded from
employer provided retirement accounts, health insurance and other
benefits.
It is vital that Congress do everything in its power to ensure that
individuals receive the benefits and protections they deserve.
I look forward to hearing the witnesses' testimony and I thank you
all for being here today.
Ms. BERKLEY. Thank you. I want to thank all of you for
being here. I am new on this Committee, and this is an issue
that I haven't been exposed to. I represent Las Vegas, Nevada,
and we have a tremendous amount of building going on and a
number of abuses that I checked into when I knew that this
hearing was going to take place. So, it is an issue that I know
affects the people in my community.
Now, I have been hired as an independent contractor in a
past life, and I have also been an employee in a past life. It
seems to me that I knew the difference when I was hired of
which way I was being hired and for what services I would be
performing.
I wanted to ask Mr. Valencia, if I may, now, you have been
a carpenter for over 18 years. In your view, does it seem that
employers in the construction industry are more likely to
classify workers like you as an independent contractor now than
they were 18 years ago, or has it been the same problem all of
these years and I just didn't know about it?
Mr. VALENCIA. No, I think it has been an issue that has
been going on forever.
Ms. BERKLEY. Do you think that most workers know when they
are given independent contractor status, do they have an
understanding that they are going to be losing certain
protections when they are not characterized as employees? Do
they know that?
Mr. VALENCIA. They do, but the situation as an employee,
they are obligated to work. So, even if they acknowledge the
situation, there is not much they can do.
Ms. BERKLEY. They need the job, they need the work, they
need the cash?
Mr. VALENCIA. Right, they do.
Ms. BERKLEY. So, is there anything in your experience that
if an employee goes, gets a job with a contractor, and the
contractor says, well, you are an independent contractor, so I
don't have to pay you any benefits, I don't have to do this, I
don't have to do that, is there any recourse that the employee
has, other than either you don't take the job or you take the
job? Is there another option for them?
Mr. VALENCIA. Of course, yes. Basically the way it is set
up is the general contractor sets the rules. They tell you that
you have to go get a bond and insurance. In my situation I am
covered by an umbrella with a wrap insurance. They take 3
percent out of my contract on top of whatever they pay me. They
pay me certain money for square footage. They take 3 percent
out of that to cover my insurance. On top of that I got to pay
my employees, I got to pay all the liabilities and provide my
own salary after that, too.
Ms. BERKLEY. Mr. Nilsen, you stated in your testimony that
the test used to determine whether a worker is an independent
contractor or an employee is very complex, subjective,
different from law to law, and you discussed the impact of a
worker who is misclassified. Do you believe that the growth in
the misclassification of workers is attributable solely to the
fact that the laws are very complex and subjective, or are
there other factors that play a part in determining whether a
worker is classified as an employer or independent contractor?
Dr. NILSEN. We haven't specifically looked into what is
driving this, but there are certainly benefits for both a
potential employer and for the worker.
Ms. BERKLEY. What are the benefits to the worker of being
misclassified?
Dr. NILSEN. The benefits to the worker are, as Mr. Pinkham
said, the rate of which people pay taxes decreases if you are
working as an independent contractor that they found. I think
some of the estimates, Meyer-Emco, people pay taxes on 30 to 50
percent of their income.
Ms. BERKLEY. Do you think that is the main reason that
contractors are misclassifying?
Dr. NILSEN. I think it is driven by both sides, as we said.
Also, there are a lot of drivers for savings and simplification
for the employer in terms of not paying a whole host of costs
and taxes. As you have heard from others, one being workers'
comp is a major expense that employers probably are trying to
avoid. I think you have heard that from Mr. Valencia here as
well.
Ms. BERKLEY. Let me make sure. You have the most charming
name, and I don't want to insult you by not pronouncing it
right.
Mr. SATAGAJ. That is all right. Everybody does.
Ms. BERKLEY. Satagaj?
Mr. SATAGAJ. Satagaj.
Ms. BERKLEY. Satagaj. Very lovely.
Your testimony describes the benefits to the small business
of having the flexibility, and I understand that. How do you
respond to business owners who properly classify their workers
and then suffer a distinct competitive disadvantage for obeying
the law? That had to do with Mr. Kendzierski's testimony. What
are we going to do about these employers that follow the law?
Mr. SATAGAJ. The distinction is what is the law and what
are you making the choice on. There are things you make a
choice on in terms of benefits that you might offer regardless
of what the law is. If I offer health care or I offer a type of
health care, you are making competitive choices. That is the
marketplace. I would be fully supportive of where there are
violations of the law.
Certainly we talked about cash, paying under the table. I
have no patience for anybody who pays that way. I don't know
any business owner who wants to have a competitor that is
paying under the table. Nobody wants that, I don't care who you
are. So, the answer is, yes, the things that are the law, but
you have to make a distinction between what is the competitive
marketplace and competitive because of the law.
Ms. BERKLEY. Mr. Chairman, may I ask one more question?
Chairman MCDERMOTT. Maybe we can come at a second round.
Ms. BERKLEY. I don't think I will be here for a second
round. Could I just make this one question?
Chairman MCDERMOTT. All right. If it is short.
Ms. BERKLEY. It is very short. It may be a long answer, but
a very short question.
What recommendations does your organization have in
addressing this chronic problem of worker misclassification?
Mr. SATAGAJ. Our view is it is going to be extraordinarily
difficult to deal with it in the notion of having some set of
standards, as I have mentioned. I believe you were here. We
have been involved in other legislative activities to draw the
bright line for this, and it is very, very difficult to do. I
am willing to try again.
I think some of the other things we are doing, we are
trying to identify tax gap solutions. There are reporting
issues, how you would report if you are an independent
contractor. Do you report a line item that says I have got X
amount of cash?
There are things that we can do. I mentioned we are part of
a coalition on the tax gap. It is not against the tax gap, it
is to find solutions. You can go to our Web site, and we talk
about things. So, we are looking for solutions. We met with the
small business commissioner yesterday in an ongoing series to
talk about other things we are going to do. So, there are other
things you can go to tighten up the system somewhat in
reporting and so forth.
Ms. BERKLEY. Thank you. I yield back the balance of my
time.
Mr. SATAGAJ. I think I took most of it.
Chairman MCDERMOTT. I will mark it down for the next
hearing.
Mr. Porter will inquire.
Mr. PORTER. Thank you, Mr. Chairman, and thank you all for
being here. It is a very complex issue, and I am sorry I missed
part of the opening presentation, but I grew up in a family
where my dad was an electrical contractor, and my mom worked in
the family business, and my brother and I worked in the family
business. I remember the debates at the dinner table in a small
town in Iowa, how it was difficult for my father to compete
with someone that wasn't following the rules, where some
businesses would hire individuals or some individuals would act
as a business and would intentionally not want to follow the
rules so they would try to fudge the system.
So, there are folks on both sides of the employees. There
are some that abuse their position and plead with businesses to
work as independent contractors. Then you have the legitimate
employees that want to follow the rules, but you also have
businesses that are trying very hard. So, I understand the
complexity of it.
I had my own business for 20 years, and I can tell you time
and time again of potential employees that pleaded with me to
pay them as independent contractors.
Now, what I have also found through the years, the
businesses that are abusing the independent contractor rules
are also the ones that are abusing workmen's comp, and they are
abusing an array of other areas of not paying taxes. So, there
are definitely bad businesses.
Now having said all that, my question is I see lots of
stats, and, Mr. Pinkham, you mentioned misclassification in
Illinois, so I am going to use you as an example. On page 3 you
give three or four examples, and I am a little confused as to
how many are misclassified. Is it 20 percent, is it 23 percent,
is it 8 percent? I am sorry I didn't hear your testimony, but
could you clarify for me?
Mr. PINKHAM. Sure. We try to identify the employers who are
practicing misclassification. Then we look at the employees
within those employers who are misclassified. Then we also look
at the total number of employees across all industries.
Mr. PORTER. So, was it about 13 percent?
Mr. PINKHAM. Across all industries statewide in Illinois,
the level of misclassification grew from 5\1/2\ to 8\1/2\
percent.
Mr. PORTER. So, out of 8\1/2\ percent, how many do you
think are doing it intentionally?
Mr. PINKHAM. Out of that 8\1/2\ percent that were
misclassified according to the unemployment insurance audits,
how many were intentional and habitual? You probably would need
to refer back to the employers who have an incidence of as high
as 28 percent of their employees, whereas the State average is
8 percent, and look at the percentage of employers who are
doing that. I think that would be a way of arriving at----
Mr. PORTER. You are not assuming they are all guilty of
doing this on purpose?
Mr. PINKHAM. No, of course not.
Mr. PORTER. How many do you think are doing it on purpose?
What percent of employers are doing it on purpose?
Mr. PINKHAM. It is hard to tell without knowing the track
record of the employers and if they have been fined in the
past.
Mr. PORTER. When you did your research, did you look at
these businesses if they were violating other laws or had a
track record?
Mr. PINKHAM. The data that you obtain when you do a study
like this is necessarily deidentified. There are no company
names, addresses, ZIP codes, Social Security numbers or
anything else.
Mr. PORTER. Could you guess how many do it on purpose?
Mr. PINKHAM. There might be statistical methodologies for
backing into something like that, but we didn't attempt to do
that.
Mr. PORTER. Let us assume for a moment it is--did you say
28 percent?
Mr. PINKHAM. Twenty-eight percent of the employees at firms
who were engaged in misclassifying were misclassified. When you
had a business that was misclassifying its workers, they
weren't just doing it a little bit, they were doing it a lot.
Mr. PORTER. So, they would be more apt to be intentionally
doing it?
Mr. PINKHAM. They would be more apt to be doing it a lot,
the intentional ones.
Mr. PORTER. So, what percentage of businesses in Illinois
do you think are intentionally doing this?
Mr. PINKHAM. Well, the employers who were found to be
misclassifying, in 2005 it was nearly 20 percent.
Mr. PORTER. So, 20 percent?
Mr. PINKHAM. Twenty percent of the employers were
misclassifying, but not all of them would be habitual.
Mr. PORTER. My point is having been in that position where
I had accountants and bookkeepers and attorneys trying to help
me as a small business owner myself for 20 years, I tried so
hard not to make mistakes. I think it is very complex, and I
don't think every mom-and-pop business can afford to have all
the experts look at how to hire.
I would like to believe--there is no doubt there are a lot
of businesses out there abusing rules, laws, taxes, there is no
question. Most family business and most businesses and
corporations want to follow the rules. So, having been there
firsthand and trying to decipher what the laws are, is there a
way we can simplify this so we could penalize those businesses
that abuse employees, but also provide the rules that are easy
to follow for a small business? Are there some things that you
have determined that would make it easier for businesses to
follow the rules?
Mr. PINKHAM. I think one of the points that has been made
today is how delicate it is to fashion a statute that will
satisfy the needs of work comp commissions, unemployment
insurance agencies and the Department of Revenue. It is
necessarily an area that has some complexity to it.
I think it is important because all of us who have grown up
in this country--particularly myself, my father was an
entrepreneur. He was a contractor developer. I grew up picking
up wood scraps under subfloors at the age of 10 and began
framing and did all those kinds of things for my father's
business, so I have a deep appreciation for the need for
flexibility and how unintentional errors can occur. I think it
is important to have safeguards that the presumption is that
you are not out to use a sledgehammer, you are out to prohibit
and prevent the habitual and intentional recurrence.
Mr. PORTER. If I may interrupt, because I know we are kind
of short. In Nevada we have grown from 66,000 small businesses
in 1997 to 151,000 in 2004. I just can't believe that 20
percent of these businesses are intentionally--and I know we
are talking Illinois to Nevada--I just don't believe that
intentionally they are trying to break the law. There is no
question there is a percentage, but what I ask of this
Committee and Mr. Satagaj----
Mr. SATAGAJ. Satagaj.
Mr. PORTER. Satagaj, I am sorry--if you could just briefly
say what could we do to make the business environment easier so
employers can hire more people and follow the rules, because
most really want to follow the rules.
Mr. SATAGAJ. I couldn't agree more the line you are
pursuing here. In simplification, the challenge--for the small
business owner, is that the Tax Code in its entirety is too
complex. To get to these individual classification issues, we
are trying to get in the heads of these people and trying to
think about their decision. We need to be focused on, okay,
here is what your responsibilities are; that we will help you
through it, provide the outreach and education--I talked about
the IRS, otherwise we will just never get there.
Mr. PORTER. Again, there are bad businesses, and I think
they should be penalized and held accountable, but I don't
think the businesses who are trying to follow the rules should
fall in this area. They just need to know what they are.
Mr. Pinkham, you grew up in a family business, as did I.
You know that your dad was there at 6:00 in the morning and
left at midnight and was worried about all these things to try
to follow the rules, as most businesses are.
Mr. PINKHAM. One of the things that was done in Kansas is
the Department of Revenue and other agencies after the new law
was passed conducted a series of statewide training sessions
for employers to attend before they implemented the information
sharing between departments. As a heads up, I think States, if
they are going to ratchet up the penalties and increase the
oversight, need to reach out and do attempt to provide the kind
of education that would be important.
Mr. PORTER. Again, as a business owner nothing infuriates
me more than having to compete with someone who is not
following the rules. So, again, very complex. I appreciate all
of your testimony today, and I agree, there are those that need
to be held accountable, and we need to simplify the systems.
Thank you all very much.
Chairman MCDERMOTT. Thank you.
I have one more question here. Mr. Valencia, your contract
of $4.85 cents a foot, that is a square foot, is it?
Mr. VALENCIA. Correct.
Chairman MCDERMOTT. Is that a negotiated price, or he just
tells you that is what he is going to give you?
Mr. VALENCIA. That is what he tells me I am going to do. He
says $4.85 a square foot, whether the house has so many arches,
how many shelves, so many columns that we got to frame,
soffits, whatever. Whatever he wants to add on the house, that
is what I got to make. On top of that, we got to set windows.
Chairman MCDERMOTT. It is take it or leave it? You can't
say ``five and a quarter, I didn't make any money off the last
house we built?''
Mr. VALENCIA. Yes. As a matter of fact, last January he
lowered my price from $4.85 to $4.50 because he said that the
sales of the houses were decreasing. I told him that, last
year, the year before, I was short in my taxes, and I wasn't
making enough money, and if he lowered my price, it was going
to be worse. He said, well, you have a choice: You either do
it, or you walk out.
Chairman MCDERMOTT. Did he ever tell you what being an
independent contractor meant? Did you have a training session?
Mr. VALENCIA. No.
Chairman MCDERMOTT. He just said, this is what I pay, and
you are on your own?
Mr. VALENCIA. Yes.
Chairman MCDERMOTT. How did you get from there to then
hiring a crew? He said, ``why don't you be in charge of finding
some other guys to bring in; we need 5 people instead of just
you?''
Mr. VALENCIA. Right. Well, you are obligated. If you are a
subcontractor, and you come over to build a house, and the
house is so big that you can't do it on your own, you have to
go and hire some more people to help you out. That is basically
what it is. You are subject to do it in their own terms.
Chairman MCDERMOTT. So, you get $4.50 per foot for
everybody on your team, right?
Mr. VALENCIA. No. Basically, if the house, for instance, is
a 5,000-square-foot house, he pays me--every house is a
contract. He pays me $4.50 a square foot times 5,000 square
feet. That is my pay. That is what I pay. I got to pay my guys
with the liability, and I got to pay all of my----
Chairman MCDERMOTT. Out of the $4.50 per square foot.
Mr. VALENCIA. Exactly.
Chairman MCDERMOTT. So, you could do it all yourself and
take a while? That would be okay?
Mr. VALENCIA. Basically that is what it is. You haven't
asked me this question, but if you ask me why did I propose to
change the system, I will tell you from my own experience. One
of the people here is saying, educate subcontractors. If the
government obligates whoever wants to become a subcontractor to
go to a program and tell them the way it is going to be
learning the process and learning how to bid, because if you
are not going to bid, you are going to do something illegal, so
you are subject to attend these courses. If you are going to
make $4.50, are you going to have enough money to pay the
liability, to pay your own expenses and your family. So, that
will make people think more than once before they go and do it.
Chairman MCDERMOTT. Mr. Smith or Mr. Pinkham, in the
information industry, people working in software and computer
programming and that kind of stuff, that is another different
level of work that is done by independent contractors. Are
those people instructed as to what this means in terms of no
unemployment insurance, no workers' comp? Is that all part of
the training in those operations?
Ms. SMITH. I don't have that much experience in the
information technology system. I can tell you about my
experience in my home State, Washington State, with forestry
workers who were hired by large forestry companies to harvest
ferns and salal that go into the making of floral evergreen
wreaths and bouquets. It is an industry that operates around
the world and is exported from Washington State.
I had a series of clients coming in my office who had been
told by the forestry company that they could only work for the
forestry company if they worked as independent contractors.
They certainly weren't told what that meant. My task then was
to tell these folks, most of whom were immigrants from Mexico
and Guatemala, who spoke Spanish, who had no familiarity with
our legal system, what that meant in terms of their tax
obligations, what kind of licenses they had to get, what kind
of liability insurance they had to get.
At a certain point I really decided that this just wasn't
right. I couldn't in all good faith tell folks exactly what
they needed to do because it was my judgment that they were
just not capable of complying. This again was not their idea.
It was the idea of the company that they become entrepreneurs,
and they just did not have the wherewithal to comply with all
the things that you have to do to set up a business.
Chairman MCDERMOTT. Does an independent contractor have to
be licensed? In other words, if you are working for a large
computer maker or a large instrument maker, and you are hired
as an independent contractor, do you have to go down and get a
license?
Ms. SMITH. You might need to get a business license. In
Washington State these folks were having to get business
licenses. Then they had to get licensed as farm labor
contractors. Then the company was insisting that they have
liability insurance. So, the company was really dictating all
the things that they had to do as an independent contractor. Of
course the company dictating all those things is a pretty
strong indication that they are not independent contractors,
they are employees.
Chairman MCDERMOTT. Mr. Weller has something, a unanimous
request.
Mr. WELLER. Thank you, Mr. Chairman. Mr. Chairman I had
directed a request to Mr. Pinkham, and I would also ask others
that are participating in the panel if they have information as
well. As we look for good information and look at the facts
strictly on the impact on the Unemployment Insurance Trust
Funds of the misclassification. Of course the study Mr. Pinkham
had prepared dealt with the issue of tax collection, but it did
not address the issue of unemployment benefit collection, the
outflow of dollars.
Mr. Chairman, I would note that in February of 2000 during
the Clinton Administration, the Department of Labor did have a
report that was prepared regarding independent contractors,
particularly pages 65 through 71. That particular report did
look at the impact and misclassification in trust funds, and
that particular study, which looked at years in the 1990s,
actually addressed the issue, as many have suggested, of
misclassification. Actually, there was a net negative impact on
the unemployment insurance trust fund because of the money that
went out. Now, that was in the 1990s. We are now in the 21st
century, and it would be useful to have more current data.
Mr. Chairman, I would like to put this report in the
record, particularly noting pages 65 through 71, and ask
unanimous consent for that purpose. Again I ask all the
participants today if you have information on the impact on the
unemployment insurance fund, particularly the outflow, as well
as the inflow, of funds, that would be greatly appreciated and
we would put it for the record with unanimous consent.
Chairman MCDERMOTT. Without objection it will be in the
order.
Ms. SMITH. If I may, we have looked at the climate report,
the report that you are referring to, and it estimated that the
loss to the UI Trust Funds was about $200 million a year at
that time. We sort of carried that forward to today's economy,
and the number that my colleague came up with was $343 million
that is now projected to be lost to the UI systems for
nonpayment of UI payments because of misclassification.
Chairman MCDERMOTT. Is that input or outgo?
Ms. SMITH. That is taxes that are unpaid by employers.
Mr. WELLER. Ms. Smith, the question is if you change the
classification here, and if the tax revenue is being collected,
then also these workers would have the opportunity to collect
unemployment benefits, what is the impact? You don't address
that with the information you have, and that is why I have
requested it, because obviously if more workers go into the
system, there is going to be more tax revenue collected. The
question is if more workers go into the system, what is the
impact going to be on unemployment benefits? So, what is the
net overall benefit coming and going? That is the information
that I hope that we can obtain.
I do note that the Clinton Administration did commission a
study which looked at the 1990s. Well, let us look at the
current decade and what that impact will be because of the
larger number of workers impacted.
Dr. NILSEN. If I might add also, to me, I have done a lot
of work at GAO on the UI system, and ultimately it is a self-
financing system. So, I am not sure exactly how they got the
net outflow.
We did a study last year that showed that certain
industries pay more than their fair share into the system than
they get out for their workers. Other industries get more
benefits than the taxes, but in the end basically the UI system
is funded out of UI taxes, so ultimately I think it nets out to
zero in the end.
Mr. WELLER. Well, again, if the individual has the
information.
Dr. NILSEN. Yes. Each individual business does not
necessarily pay its fair share.
Chairman MCDERMOTT. We want to thank all of you for coming.
You have been helpful. Without some kind of understanding of
the problem, it is hard to fix the problem. So, we thank you
for coming.
[Whereupon, at 11:10 a.m., the hearing was adjourned.]
[Submissions for the Record follow:]
Associated Builders and Contractors
May 9, 2007
The Honorable Jim McDermott
Chairman, House Ways and Means Subcommittee on Income Security and
Family Support
B-317 Rayburn House Office Building
Washington, D.C. 20515
The Honorable Richard Neal
Chairman, House Ways and Means Subcommittee on Select Revenue Measures
1135 Longworth House Office Building
Washington, D.C. 20515
Dear Chairmen McDermott and Neal:
On behalf of Associated Builders and Contractors (ABC) and its more
than 24,000 merit shop contractors, subcontractors, materials
suppliers, and related firms from across the country, we appreciate the
opportunity to submit the following letter for the official record. We
appreciate Chairmen Jim McDermott and Richard Neal for holding this
hearing on ``The Effects of the Misclassification of Workers as
Independent Contractors.''
While Congressional action may be necessary to clarify the entire
independent contractor regime, we caution this Committee and Congress
to carefully consider the impact of any such action to ensure that
good-honest hard working businesses and their workers are not overrun
with increased and costly regulatory requirements.
ABC will address three topics:
First, ABC supports a level playing field for all
businesses and ABC supports efforts to ensure that workers who
are misclassified receive appropriate relief;
Secondly, Independent Contractors are integral to our
industry and our country's dynamic economy; and
Lastly, what potential resolutions are available to
address worker misclassification.
1. All Parties Desire a Level Playing Field
While the construction industry provides significant opportunities
for independent contractors, all parties must function under a
confusing framework of rules that inadequately address the
classification of workers as either employees or independent
contractors. Initially, it is critical to distinguish between wrongful
classification and misclassification. In construction, wrongful
classification by a competitor can result in a competitive disadvantage
to other contractors. Contrast this with misclassification, which can
easily occur because current law and rules are extremely complex.\1\
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\1\ Consider that the instructions for the three pages Form SS-8
(Rev. 11-2006), Determination of Worker Status for Purposes of Federal
Employment Taxes and Income Withholding, that the IRS requires to
secure a determination letter on the status of a worker, reflects 22
hours for recordkeeping and two hours to complete.
---------------------------------------------------------------------------
Those companies not paying employee taxes or worker's compensation
by wrongful classification can undercut the competition by offering
lower bids. ABC in no way condones intentional misclassification by
businesses that shirk their duties to society and their workers. We
endorse a level playing field for all businesses and workers. For those
workers who are faced with improper misclassification we believe they
should be accorded every opportunity to have their financial situation
corrected. Also employment agencies that do not properly pay workers
should face severe enforcement.
Under current tax law, taxpayers use a 20-factor common law test
that can be controversial and cumbersome because it is so subjective,
leading to disputes between the IRS and businesses. Even if
misclassification is unintentional the ramifications can be dramatic to
both the worker and business owner in the form of back taxes, interest,
applicable penalties, and even the possible disqualification of
retirement plans.
Adding further confusion is that in addition to the IRS methodology
for determining status a business owner may confront other
methodologies for differing purposes.\2\ For example, the Common Law
``Right to Control'' test which is often used by courts to determine
employee status in various types of cases, including employment
discrimination and benefit cases, tax cases, and tort liability cases.
And, the Department of Labor uses a model of analysis known as the
``economic realities test'' to determine coverage under, and compliance
with, the minimum wage and overtime requirements of the Fair Labor
Standards Act. Further many states have similar but not identical
methods for state purposes.
---------------------------------------------------------------------------
\2\ There are many non-Federal income factors that may be relevant
to independent contractor vs. employee status: Workers compensation
benefits; Federal and state civil rights laws; Fair Labor Standards
Act; National Labor Relations Act; Occupational Safety and Health Act;
Americans with Disabilities Act; and State income/unemployment taxes.
---------------------------------------------------------------------------
Independent Contractors are Integral to the Construction Industry
Independent contractors are often the perfect answer to a pressing
need for special skills and experience needed on short-term projects.
The flexibility an independent contractor provides to a small, fledging
operation as well as larger enterprises creates numerous advantages for
all parties involved. The independent contractor has freedom to choose
his or her work schedule, while the small business owner maintains the
flexibility to adjust work demands with current business activity, and
the consumer enjoys the benefit of a reasonably priced, quality
product. Lawful utilization of independent contractors provides a good
source of labor for projects where the contractor does not need to
exercise the type of control that would necessitate the hiring of an
employee.\3\
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\3\ Many ABC members started their own businesses by initially
working as an independent contractor. It is not unusual for these
individuals to work as employees during regular hours and as
independent contractors during off-hours and weekends. There is no
better way to become established as a small business than to begin as
an independent contractor. Because of the cyclical nature of the
industry, many businesses cannot afford to keep certain specialized
trade craftspeople as employees. Sometimes, skilled craftspeople are
needed several times throughout the year, but not enough to warrant
full-time or even part-time employment. Having to place two or three
extra employees on the payroll just to finish a short-term project
places a significant and unnecessary burden on companies.
---------------------------------------------------------------------------
Potential Resolutions
Four resolutions are commonly discussed:
1. Increase Reporting Requirements--Within the context of
``The Federal Tax Gap'' it has been proposed to Congress that
increased information reporting may provide part of the
solution.\4\ IRS statistics indicate that when reporting
requirements such as Forms 1099 are required, compliance
increases from approximately 57% to 96%. \5\ Eliminating the
exemption from 1099 reporting for corporations would facilitate
elevated reporting for independent contractors. By approaching
the issue this way, less emphasis is placed on unclear
classification rules while emphasis is shifted to the
relatively clear laws of filing annual information returns.
---------------------------------------------------------------------------
\4\ The Causes and Solutions to the Federal Tax Gap: Hearing Before
the Senate Committee on the Budget, 109th Cong. (2006) written
statement of Nina E. Olson, National Taxpayer Advocate available at:
http://budget.senate.gov/republican/hearingarchive/testimonies/2006/
NinaOlsenTestimony.pdf.
\5\ IRS Updates Tax Gap Estimates, IR-2006-28 (Feb. 14, 2006).
---------------------------------------------------------------------------
2. Elevate Enforcement--IRS indicates that for every dollar
invested in enforcement four dollars in increased revenue to
Treasury is returned. Further, the Commissioner of the IRS has
stated, ``This 4:1 return on investment does not consider the
indirect effect of increased enforcement activities in
deterring taxpayers who are considering engaging in non-
compliant behavior.'' \6\ Departments of Labor--both Federal
and the States--can also elevate enforcement on this issue.
---------------------------------------------------------------------------
\6\ Written testimony of Commissioner of Internal Revenue Service,
Mark Everson, before The Senate Committee on the Budget (Feb. 14, 2007)
---------------------------------------------------------------------------
3. Clarify and simplify the 20-factor subjective test and
educate businesses and workers.\7\
---------------------------------------------------------------------------
\7\ ABC previously testified on July 26, 1995 before the House
Small Business Committee in support of increased education and
clarification of the 20-factor independent contractor test.
---------------------------------------------------------------------------
4. Eliminate availability of independent contractor status.
ABC supports the three initial listed with the understanding that
we remain concerned that any action taken by Congress should be
measured against the impact on good-honest hard working businesses and
their workers to ensure they are not overrun with increased and costly
regulatory requirements.
However, the mechanics of eliminating independent contractors from
our economy is wrought with technical problems that are not clearly
explained by constituencies who have concerns with the legal
availability of independent contractors. These technical issues may be
the reason you don't hear the IRS constructively discussing the option
of eliminating independent contractor status.
Further, this would not be a viable alternative in the construction
industry. Consider one fundamental concern for the contractor who is
properly functioning as an independent contractor: Cash flow would be
impaired for the independent contractor who exceeds FICA limits since
each ``employer'' would withhold up to the limit. \8\ For significant
technical and practical reasons, ABC cannot advocate that independent
contractor status is eliminated and no credible consideration can be
given to such option.
---------------------------------------------------------------------------
\8\ The end result will be increased construction costs. Also
consider: a) It would force the independent contractor to adopt a
massive record keeping structure that they may not be equipped to
handle. At times the independent contractor may be the employer when
performing small projects, then switch to an ``employee'' status when
working as a sub. The resulting tax payment requirements would be
difficult to monitor; b) Monitoring the unemployment rates in some
states would be very difficult and rules would have to be established
to help determine which ``employer'' would be responsible for the
unemployed worker; c) Companies in some states may be forced to take on
additional exposure in the area of workers compensation for which they
may not be familiar and for which duplicative or exorbitant safety
program costs may be the result; d) The new ``employer'' would have to
take on all of the financial risks of a project rather than mitigating
some of that risk by using the independent contractor for a lump sum
job. Bidding jobs would thereby become more complex.
---------------------------------------------------------------------------
Again, thank you for allowing ABC to submit this letter to the
official record and we look forward to working with the House Ways and
Means Committee on this important issue.
Statement of Contractor Management Services
Thank you for granting this opportunity to submit comments on the
Subcommittees' joint hearing on the effects of misclassifying workers
as independent contractors.
The issue of independent contractors is complex and not one that
can be resolved in one session. There are many interests, some
conflicting, which need to be considered and weighed. Not the least of
these is the extent to which individuals and businesses should have the
freedom to enter into contractual arrangements without governmental
interference. The problems with the use of independent contractors
today fall into one of two categories: The lack of clear and consistent
standards that businesses can rely upon when using the services of
independent contractors and the increasing attempt by some government
agencies and courts to classify all workers as employees, regardless of
the wishes of the parties.
Admittedly, there have been businesses and employers who have
classified workers as independent contractors when those workers are
clearly employees. These employers have attempted to change the
workers' classification from employee to independent contractor without
changing the relationship between the workers and the employers or the
manner is which they deal and interact with the workers. However, many
businesses using independent contractors do not fall into this
category. These businesses want to give the workers the freedom that
independent contractors should have, while still maintaining the
ability of the business to operate. Unfortunately, those who have
intentionally misclassified employees as independent contractors have
caused unwarranted suspicion and accusations against the many
businesses that are making a good faith attempt to use the services of
independent contractors in order to survive in today's competitive
environment.
Many businesses attempting to use the services of independent
contractors find themselves accused of misconduct, not because the
business is attempting to subvert the law, but because the laws are not
clear or consistently applied. A recent example of this involves a
ruling by the Illinois Supreme Court that a truck driver was an
employee of a motor carrier that was subject to the regulations of the
U.S. Department of Transportation. In order to protect the public,
Congress and the Department of Transportation established certain
standards and regulations when a motor carrier contracts to use a truck
owned by a driver and the services of the driver. The regulations
require the carrier to have ``exclusive possession, control, and use of
the equipment for the duration of the lease.'' Recognizing this
exclusive control and other requirements of the regulations may impact
the ability of the carrier and driver to establish an independent
contractor relationship, the regulations at 49 C.F.R. Sec. 376.12(c)(4)
state:
``Nothing in the provisions required by paragraph (c)(1) of this
section is intended to affect whether the Lessor or driver provided by
the Lessor is an independent contractor or an employee of the
authorized carrier lessee. An independent contractor relationship may
exist when a carrier complies with 49 U.S.C. 14102 and the attendant
administrative requirements.''
Despite clear language in the federal regulations that compliance
with these regulations was not intended to impact the ability of a
carrier and driver to enter into an independent contractor
relationship, the Illinois Supreme Court determined that the carrier,
by ensuring compliance with the federal regulations, exercised control
over the driver and compliance with the federal regulations was a
permissible factor in finding the driver was an employee of the
carrier.
This ruling is contrary to the rulings of many federal and state
courts finding compliance with government imposed regulations does not
constitute control by the entity using the workers services. In
National Labor Relations Board v. Associated Diamond Cabs, Inc., 702
F.2d 912 (11th Cir., 1983) the 11th Circuit Court
of Appeals in ruling that drivers of taxi cabs were not employees said:
Consistently the courts have held that regulation imposed by
governmental authorities does not evidence control by the employer. Air
Transit v. N.L.R.B., 679 F.2d at 1100; Local 777, Seafarers, 603 F.2d
at 875-76; SIDA of Hawaii, Inc. v. N.L.R.B., 512 F.2d at 359. Indeed,
employer imposed regulations that incorporate governmental regulations
do not evidence an employee-employer relationship, Air Transit v.
N.L.R.B., 679 F.2d at 1100; Local 777, Seafarers, 603 F.2d 875-76; SIDA
of Hawaii, Inc. v. N.L.R.B., 512 F.2d at 359; see also N.L.R.B. v.
Deaton, Inc., 502 F.2d at 1226-28; Portage Transfer Co., Inc., 204
N.L.R.B. No. 117 (1973); Reisch Trucking and Transportation Co., Inc.,
143 N.L.R.B. 953 (1963); unless pervasive control by the employer
exceeds to a significant degree the scope of the government imposed
control. Local 814, I.B.T. (Santini Brothers), 223 NLRB 752, 753,
enforcement ordered, 546 F.2d 989 (D.C.Cir.1976); N.L.R.B. v. Cement
Transport, Inc., 490 F.2d 1024, 1027 (6th Cir.), cert. denied, 419 U.S.
828, 95 S.Ct. 47, 42 L.Ed.2d 52 (1974).
And recently, the Florida Court of Appeals in Miami-Dade County v.
Florida Dept. of Labor and Employment Security, 749 So. 2d 574 (App.,
2000) stated: [G]overnmental regulations constitute supervision not by
the employer but by the state. See Global Home Care, Inc. v. State,
Dept. of Labor and Employ. Sec., 521 So.2d 220 (Fla. 2d DCA 1988); La
Grande v. B & L Servs., Inc., 432 So.2d 1364 (Fla. 1st DCA 1983).
Businesses, especially those involved in interstate commerce, faced
with conflicting rulings such as these find it difficult to use the
services of independent contractors without risking being accused of
misclassifying those who are providing services to the business.
Further, a ruling like that of the Illinois Supreme Court that is
clearly contrary to the intent of the federal regulations, makes
suspect statistics reported by Illinois and other states that the
misclassification of workers as independent contractors has increased.
Businesses need a clear definition of what constitutes a legitimate
use of independent contractor services regardless of whether the
business is conducting operations in New York, California, Florida or
Pennsylvania. In addition, businesses need straight forward guidelines
they can rely on and know that compliance with these guidelines will
result in a legitimate utilization of independent contractors. Further,
individuals who have been provided full and complete information
regarding the benefits and consequences of working as an independent
contractor as opposed to as an employee should have the right to enter
into an independent contractual arrangement without a paternalistic
government claiming it knows what is better for that person.
The social issues that are frequently raised in discussions about
the use of independent contractors--i.e., collection of taxes,
protection of workers in the event of injury, short term protection in
the event of loss of a job--can all be addressed through means other
than the death of the independent contractor model. Entities using the
services of independent contractors on an ongoing basis could be
required to withhold a set percentage and remit to the taxing authority
unless the independent contractor provides proof of filing and
remitting quarterly taxes. Independent contractors could be required to
show proof of coverage under either self-employed workers' compensation
or occupational accident insurance in the event they are injured while
providing services as an independent contractor. And, independent
contractors can be given the opportunity to voluntarily participate in
some level of unemployment insurance program if their business losses a
significant portion of its work.
Some states have recently moved to provide more clarity to
businesses utilizing the services of independent contractors. These
states recognize the right of individuals to contract provided the
person is provided full and completed disclosure of the consequences of
providing services as an independent contractor. The states of Colorado
and Georgia provide two examples. In these states, the contract between
the independent contractor and company using the services of the
independent contractor must clearly state in conspicuous language, in
one case in larger type and bold faced, that the independent contractor
will not be covered by workers' compensation and unemployment insurance
providing services as an independent contractor. Georgia further
requires the contract advise the independent contractor that he/she is
required to pay social security taxes that may be higher than if the
person were working as an employee. The obvious purpose of these
statutes requiring full disclosure and notice is so a person can make
an informed decision whether or not to provide services as an
independent contractor. If the person agrees, he/she knows the
consequences and ramifications of his/her decision.
The independent contractor issue does not need further regulations
designed to limit the ability of businesses to use the services of
independent contractors. What is needed are clearer guidelines that are
exercised on a more consistent basis and that allow persons who are
provided full and complete information as to the benefits, risks and
consequences of working as independent contractors to knowingly and
voluntarily agree to enter into an independent contractor relationship.
The problem is not an increase in the misclassification of workers as
independent contractor; the problem is the increasing view by many
agencies and courts that the American worker is not capable of
protecting himself and of making a decision based on his own.
Statement of the Direct Selling Association
The Direct Selling Association (DSA) appreciates the opportunity to
submit comments to the Committee regarding its May 8, 2007 hearing on
the effects of misclassifying workers as independent contractors.
The Direct Selling Association (DSA) is the national trade
association representing over 200 companies that sell their products
and services by personal presentation and demonstration, primarily in
the home. The home party and person-to-person sales methods used by our
companies and their independent contractor sales forces have become an
integral part of the American economy. Our industry represents over $30
billion in domestic sales and over $89 billion in worldwide sales each
year. The 14.6 million individual direct sellers who sell for direct
selling companies in the U.S. are independent contractors; they
typically sell on a part-time basis to their neighbors, relatives, and
friends to supplement their family income. These direct selling
companies include some of the nation's best known commercial names,
such as Alticor (parent of Quixtar), Avon Products, Inc., Mary Kay
Inc., The Pampered Chef and Tupperware. The direct selling industry
attracts individuals seeking job flexibility, with low start-up costs
and often-minimal work experience. Their direct selling activities are
generally neither extensive nor elaborate. Government officials have
suggested that other entities covered by information reporting
requirements, direct sellers have a high tax compliance rate.
The Independent Contractor Status of Direct Sellers is Well-Established
We believe that you can find no better example of the proper
classification of a worker as an independent contractor than individual
direct sellers. They are truly the quintessential and classic example
of an independent contractor. The independent contractor status of
direct sellers has long been recognized for Federal tax purposes.
Almost 30 years ago direct sellers' status as independent contractors
was confirmed for tax purposes under common law. (Aparacor. Inc. v.
United States, 556 F. 2d 1004 (Ct. CI. 1977)). In 1982, Congress
adopted I.R.C. Sec. 3508 to ``provide a statutory scheme for assuring
the status of . . . direct sellers and real estate salespersons as
independent contractors.'' (Staff of the Joint Committee on Taxation,
General Explanation of the Revenue Provisions of the Tax Equity and
Fiscal Responsibility Act of 1982 (1982), 382)
Internal Revenue Code Section 3508 establishes three conditions in
order for a person to qualify as a ``direct seller'' treated as an
independent contractor by statute. First, the person must be engaged in
the business of selling consumer products to any buyer on a buy-sell,
deposit-commission, or similar basis, in the home or otherwise than a
permanent retail establishment. Second, substantially all of the
remuneration paid must be directly related to sales or output, rather
than to the number of hours worked. Third, the direct selling must be
performed pursuant to a written contract between the direct salesperson
and the direct selling company, and the contract must provide that the
direct salesperson will not be treated as an employee of the company
for federal tax purposes.
As part of this statutory classification of direct sellers as
independent contractors for tax purposes, Congress also adopted a
special tax information reporting requirement for direct salespersons.
See I.R.C. Sec. 604 lA(b). Under this special direct seller information
reporting system, each direct selling company that sells $5,000 or more
of consumer products to a direct salesperson must indicate so on a
special direct seller box on the IRS Form 1099-MISC, which is then
filed with the Internal Revenue Service and sent to the direct
salesperson. This information filing requirement also applies to a
distributor in a multi-level direct selling arrangement who is
wholesaling to direct salespeople in his or her sales organization. In
addition, the Form 1099-MISC is used to report the payment of
commissions, bonuses, and awards to direct salespeople in excess of
$600. The direct salesperson is required to provide his or her proper
taxpayer identification number to the direct selling company as part of
this process.
This statutory treatment of direct sellers as independent
contractors and the special direct seller tax information reporting
procedure constitute a clear and well-established system that has
worked effectively for Federal tax purposes for almost 25 years and has
achieved an extremely high rate of tax compliance for the direct
selling industry. Our own compliance estimates are in the 97% range.
Independent Contractor Status Generally
DSA believes it important to the nation that legitimate use of
independent contractors, in all industries, not be threatened. Based on
our own studies, people want to be independent contractors because they
like being their own bosses, working their own hours, building their
own businesses and directly relating effort to reward. Tax benefits
generally do not enter the picture for them. From the viewpoint of the
users of independent contractors, while there are some tax benefits
created by this status, there are also productivity, recruiting,
retention and tax disincentives as well. Businesses and individuals
should be able to choose within structures they wish to operate.
The current frame work, while not perfect, was developed over many
years and with input from divergent groups. The reason the 20 factors
test was developed was because of the recognition that a ``one size
fits all'' approach does not work for the diversity of industries that
properly utilize independent contractors. While, as noted before, we
believe that direct sellers are the best example of an independent
contractor, we also believe there are many other appropriate and
necessary uses for this status of workers. Anything that discourages,
prevents, or makes more difficult the appropriate use of independent
contractors would have a negative impact on business, workers, and the
broader U.S. economy.
Section 530 of the Revenue Act of 1978 was originally enacted by
Congress (and then indefinitely extended in 1982) to give a degree of
protection and certainty to those who reasonably classify workers as
independent contractors. And while we do not doubt there are abuses of
the status that is no reason to eliminate Section 530 when simple
refinements may be appropriate.
Improving Compliance
Over the years and recently, a few have advocated withholding on
independent contractors. Withholding would be counterproductive and an
unnecessary burden to the direct selling industry. As noted above,
direct selling already has a reporting requirement. Recent testimony by
the IRS on the Hill, confirms that where there is reporting there is a
high level of compliance with the tax laws. This might be an area to
consider as an alternative to withholding.
Conclusion
Industries seeking to protect the independent contractor status
have traditionally received bipartisan support in Congress. Members of
Congress have long understood the complexity of this ``classification''
issue and the need to protect this micro-entrepreneurial form of doing
business. We are concerned, however, that any attempts to address with
the issues raised by this hearing might do inadvertent harm. Until now,
Section 530 has proven to be the most inclusive, pro-independent
contractor safe harbor test that Congress could enact. Any changes to
this section of the law, whether they be designed to curb IRS abuses or
to deal with the problem of misclassifications of employees in some
industries resulting in competitive disadvantages for some firms,
should be carefully handled.
Inadvertent, unforeseen consequences handful to industries
legitimately using independent contractors must be carefully avoided.
It is a very complex, economically significant area to both
corporations and individual entrepreneurs. Experience has shown that
there are many landmines in this area, and we urge that extreme caution
be used in making any changes.
DSA appreciates the attention that both subcommittees have devoted
to this important and challenging issue. We trust that, as your
deliberations continue, the legitimate use of independent contractors
will be protected and preserved. We also respectfully urge that, should
any changes in the law take place, nothing be done to endanger the
statutory independent contractor status of direct sellers. Having been
active in these discussions for over 30 years, DSA would welcome the
opportunity to discuss compliance alternatives to withholding such
increased information reporting and the effects such alternatives would
have on our industry.
Thank you for your consideration of our views. We are at your
service to expand on this statement, to answer any questions you might
have or to provide additional information.
Respectfully submitted,
John Webb
Associate Legal Counsel
International Union of Bricklayers
May 17, 2007
Chairman James McDermott
Subcommittee on Income Security and Family Support
U.S. House of Representatives Committee on Ways and Means
B317 Rayburn House Office Building
Washington, DC 20515
Chairman Richard Neal
Subcommittee on Select Revenue Measures
U.S. House of Representative Committee on Ways and Means
1135 Longworth House Office Building
Washington, DC 20515
Dear Chairman McDermott and Chairman Neal:
On behalf of the nearly 100,000 members of the International Union
of Bricklayers and Allied Craftworkers (BAC), I want to deeply thank
Chairman McDermott, Ranking Member Weller, and the Subcommittee on
Income Security and Family Support as well as Chairman Neal, Ranking
Member English and the Subcommittee on Select Revenue Measures for
their decision to hold a joint hearing on the employee
misclassification crisis. As the testimony that the Subcommittee heard
on May 8, 2007 made clear, the rampant misclassification of working
Americans as independent contractors is wreaking severe and far-
reaching havoc on working families and the broader economy.
Congressional leadership is plainly necessary to effectively combat
this crisis, and we applaud the Subcommittee for taking a place in the
vanguard of those seeking to bring justice back to the American
workplace.
At the conclusion of the May 8 hearing, you solicited further
comments for consideration by the Subcommittee. In light of the fact
that the members of the Subcommittee seemed to be searching for ways
that Congress could proactively work to reduce the incidence of
employee misclassification, BAC is suggesting four key initiatives that
Congress might consider as it continues to address this critical issue.
1) Congress should immediately commission a comprehensive study to
determine the economic impact of the misclassification crisis on
federal tax revenue, the Social Security system, and Medicare and
Medicaid. In recent years, respected economists have analyzed the
effect of misclassification on the state tax revenues, workers'
compensation systems, and unemployment insurance systems in a number of
states; for example, Cornell University recently produced a study of
the cost of misclassification in New York, and a University of
Missouri-Kansas City analysis demonstrated the disastrous consequences
of misclassification in Illinois. But, remarkably, a comprehensive
study of the national cost of misclassification has not been conducted
in well over 10 years. We simply have no real idea of how big the tax
gap, Social Security gap, and Medicare/Medicaid gap caused by
misclassification of employees has become. It is almost certainly a
number of times greater than the $3.3 billion found by the last
national study, in 1995--but we need hard numbers, not guesses. We need
to ascertain the true scope of the misclassification crisis before we
can determine the best way to attack it. Moreover, understanding the
real magnitude of the misclassification crisis will allow the nation to
make better informed decisions about the future of Social Security and
Medicare. How much of the supposed Social Security crisis is really
attributable to employee/independent contractor misclassification? We
just don't know--and we ought not to be making major decisions about
the future of Social Security until we do. Congress should therefore
act swiftly to commission a comprehensive study; similar to the New
York and Illinois analyses, to evaluate the degree to which
misclassification is defunding the Federal Government, the Social
Security system, Medicare, and Medicaid.
2) Congress should budget significantly more money for Department
of Labor and Internal Revenue Service enforcement of the existing laws
governing employment status, and should allow those agencies to better
share information regarding misclassification of employees. One of the
most obvious causes of the misclassification crisis is the chronic lack
of funding for enforcement of the laws that are intended to prohibit
misclassification. The Department of Labor's Wage and Hour Division is,
along with the Internal Revenue Service, one of the primary federal
bodies charged with preventing misclassification. Yet the decade-old
$3.3 billion estimate of the tax gap created by misclassification is
nearly 20 times greater than the 2006 budget for Wage and Hour. The
agency most responsible for enforcing proper classification of
employees simply does not have the resources necessary to police the
profligate misclassification that is plaguing the United States. And
the budget priorities of recent years have not helped Wage and Hour
accomplish its mission; over the past five fiscal years, the Department
of Labor's Office of Labor-Management Standards (which is primarily
responsible for oversight of labor union finances and activities) has
received an appropriations increase three times greater than that
received by Wage and Hour.
All the best-intentioned, best-crafted legislation in Washington
won't really begin to address the misclassification crisis unless there
are a sufficient number of properly funded, hard-working federal agents
available to enforce the legislation. A significant increase in funding
for the Wage and Hour Division, in conjunction with earmarks for
increased targeted auditing of dubious employers, will lead to better
enforcement of the laws prohibiting misclassification. And that is an
investment which will pay for itself. There are few appropriations that
Congress can make that are almost guaranteed to result in far more
money being returned to the Treasury--but increased funding for Wage
and Hour and for IRS misclassification enforcement efforts will have
just that result.
Another way that Congress could improve enforcement of the laws
governing employment status would be to remove any impediments barring
federal agencies from sharing information regarding the
misclassification of employees. Unless the IRS and Department of
Labor--in addition to any other agencies that might uncover evidence of
misclassification--are allowed to share that information with each
other, the government will never be able to bring the full force of its
enforcement power against those employers who have willfully chosen to
injure their workers and defraud the American people.
3) Congress should seriously consider federal legislation, similar
to that in Massachusetts and New Mexico, adopting a presumption that
workers are employees until proven otherwise. Over time, different
agencies have embraced different tests for ``independent contractor''
status, and different laws have defined ``employees'' in different
ways. Despite the fact that these multiple definitions generally vary
only in minor detail, some observers have argued that the variations
have sown confusion among employers. Although we believe that the
distinction between employees and independent contractors is usually
intuitive and simple, and although we have found that vast numbers of
misclassified workers are ``employees'' under any test and are clear
victims of misclassification, it is true that the present regulatory
framework may make the employee/independent contractor determination
more complex than it needs to be.
One approach to ameliorating this problem would be to consider
legislation--like that already adopted in Massachusetts, New Mexico,
and a number of other states--which would create a presumption under at
least some federal laws that workers are ``employees'' unless
affirmatively shown to be independent contractors. Any such
legislation, however, would need to be carefully tailored to avoid
unintended disruption of existing regulation. For that reason, BAC
suggests that Congress carefully evaluate which areas of federal
regulation would best benefit from imposition of a presumption of
employee status, and only then move forward with legislation. But we do
believe that, carefully implemented, legislation creating a presumption
of employee status would go a long way toward eliminating a great deal
of existing employee misclassification of workers as independent
contractors.
4) Congress should strongly consider amending, or even eliminating,
the ``safe harbor'' provisions of the Internal Revenue Code. Although
originally enacted in 1978 to protect the unwitting wrongful
misclassification of workers as independent contractors by an employer,
this provision has actually emboldened the underground community of
misclassifying employers and their enablers in the accounting and legal
fields. Recent changes to the law have further complicated and
protected unscrupulous employers by placing the burden on the IRS to
demonstrate deliberate misclassification. This additional burden placed
on the IRS has rendered an already underfunded enforcement effort even
less effective.
This unfortunate situation was all too clearly brought to light by
recent efforts of BAC's Chicago local leadership to involve the IRS in
the near-criminal exploitation of the safe-harbor loophole by a
residential masonry contractor. This contractor had misclassified his
entire bricklayer workforce, even though industry standards (and the
practical realities of masonry construction) require the existence of
an employer/employee relationship between a mason contractor and its
bricklayers. The IRS consistently ignored this situation until BAC's
local officers petitioned Senator Durbin for an investigation. The
Senator's investigation of the situation eventually resulted in a
serious IRS inquest into the situation--but it is unlikely the framers
of the original legislation (or the most recent revisions to the safe
harbor provision) anticipated that it would be necessary to prod the
IRS into intervention. Unfortunately, as this example indicates, the
need for prodding has become the norm rather than the exception.
In conclusion, I would once again like to commend the Committee for
its willingness to take a leadership position in combating this hidden
crisis--a crisis that so insidiously threatens the American workplace.
Your future efforts, and those of your colleagues throughout Congress,
will hopefully lead to an effective solution to the misclassification
crisis. As you proceed, BAC stands ready to assist you in any way that
we can.
Sincerely,
John J. Flynn
President
Statement of Kathy Roman, Sequim, Washington
My husband and I entered in to a contract agreement with FedEx Home
Delivery in January 2004. We were interested in starting with two
routes and growing the `business' to operate all Home Delivery routes
on the North Olympic Peninsula in Washington. The two routes covered
all of the territory we hoped to maintain receiving additional routes
within the territory as the area grew in density.
It was obvious within the first month that two trucks could not
effectively deliver the area. We were told to add another truck and
driver at OUR cost. We added this truck and driver operating at a loss
until eight months later we received a third route. There is no
language in the contract as to when or if new routes are added.
With the third route it became obvious that the current methodology
of have one truck shuttle up the packages for the other two routes was
hurting productivity. What originally took 30 minutes to hand off
packages was taking 90 minutes. Also, the shuttle truck was delivering
packages before meeting the other two trucks making the other two
routes wait longer for packages. I came up with different feasibility
options to solve the methodology issues and was told ``No'' to every
option I came up with. FedEx was not interested in allowing me to solve
my problems in a cost effective manner. The only solution they would
entertain was us adding another truck and driver at my expense with no
guarantee of receiving new routes. Actually, they said the odds of
getting a new route were pretty slim.
After one year of attempting to run my business in collaboration
with FedEx it became obvious that I had absolutely no control over my
business, my routes, my drivers, or my expenses. The contract states
that a driver must delivery a minimum of 7.5 hours each day but it does
not have a maximum delivery day. Our average work day is 12 hours and
there is not an option of taking less packages to deliver less hours.
The only option is to add another truck and driver at my expense. But
be certain the truck passes their scrutiny. It took three months to get
a bigger truck approved for an existing route. It can take a month to
get a new driver approved. Only half of the drivers I find pass FedEx
approval. The driver that bought one of my routes was not approved at
first. It took six months to get him approved to take over the route. I
can not accept single parents as drivers because daycare centers are
not open enough hours for the parent to complete the day's work.
This is not self employment, this is slave labor. This is the worst
of both. If I can not make decisions, then I am an employee. If I am an
employee, then I have protections on my work day.
We have been in this three years and we still can not make
decisions regarding the routes. We have tried to sell the routes but
those that qualify financially do not meet FedEx approval. I have too
much financially invested to just dump the routes and if FedEx ever
decides to just take them away, as they threaten all the time, I will
have to file bankruptcy.
Statement of National Association of Home Builders
Introduction
The 235,000 members of the National Association of Home Builders
(NAHB) appreciate the opportunity to submit this statement for the
House Ways and Means Committee, Subcommittee on Select Revenue Measures
and Subcommittee on Income Security and Family Support regarding the
effects of misclassifying workers as independent contractors. This
issue is of great importance to the home building industry, which
thrives on the efficiency and entrepreneurship that comes from both
home builders and their workers being able to freely choose the form of
their business relationship. At the same time, entrepreneurship only
succeeds when all participants in the market play by the same rules and
one entity cannot have an unfair advantage over others. NAHB supports
enforcement of the current rules on the classification of workers, but
would also support clarification of those rules to improve compliance
across all industries.
This statement focuses on the economics surrounding the decision by
home builders to contract with independent contractors as well as the
motivations for employees to act as independent contractors. Further,
it examines present law rules for the classification of workers and how
they ensure a fair and equal marketplace for business. Finally, the
statement identifies some potential enhancements to the current law
that could improve compliance.
Economics of Independent Contracting
There are important business-related reasons why a home builder
would want to use an independent contractor as part of a home
construction project. Economic theory dictates that firms employ labor
in-house only when the costs of doing so are less than the cost of
contracting with another firm. In general, labor costs are lower for
businesses that specialize in a particular activity compared to a
business that attempts to do all tasks in-house. Consequently, it may
be more efficient to contract with a business consisting of dedicated
specialists than housing a single or few employees within the firm.
This effect is also known as economies of scale and is likely to occur
in industries associated with large fixed costs, low marginal costs and
learning-by-doing, such as residential construction or the technology
sector.
In addition to certain professional duties, such as management and
administration, home building requires a large number of specialized
tasks. The Census identifies some of these roles, including but by no
means limited to: construction supervisor, brick mason, carpenter,
flooring contractor, cement worker, general laborer, pile driver,
engineer, drywaller, electrician, glazier, insulation contractor,
painter, paperhanger, pipe plumber, plaster contractor, rebar worker,
roofer, metalworker, quality inspector, fencer, hazmat removal
contractor, and septic and sewer specialist.
For a small home builder, who may only construct a few homes a
year, there is not sufficient internal demand to justify hiring an
employee for each of these specialized roles. For example, the total
internal demand for an electrician may only be for one-half of a
position per year. Consequently, it makes more economic sense to
contract with an electrician who acts as an independent contractor.
This contractor will likely own his own equipment, provide for his own
training, and contract with other businesses. He may also employ his
own staff. Therefore, working with an independent contractor has the
potential for significant efficiency gains. Proposals that would
artificially alter the decision between hiring an employee and working
with an independent contractor would increase overall construction
costs and therefore result in higher prices for home buyers.
Furthermore, there are advantages for specialty trade workers to
adopt independent contractor status. Data from the Census Bureau's
Survey of Population demonstrates that independent contractors in the
construction industry tend to be higher skilled than their employed
counterparts. Not surprisingly given the demand issue discussed above,
self-employed construction trades workers are more common in rural
areas and smaller cities, where home building occurs at a smaller
scale. Finally, independent contractor status affords the opportunity
of growth and expansion, whereby a successful contractor hires his own
staff to meet the increasing needs of his business. Indeed, many
contracting business begin operation as a self-employed independent
trade worker.\1\
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\1\ For more information, consult ``Construction Workers: Settling
In.'' Michael Carliner. Housing Economics, October 2003; and ``Self
Employment in Construction.'' Elliot Eisenberg. Housing Economics,
January, 2001.
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The result of the economic setting described above is a vibrant
subcontractor market within the residential construction industry. NAHB
survey data indicate that 80% of home builders subcontract at least
three-quarters of their total work. The average home builder uses 24
subcontractors for the construction of a single-family home. For
example, 53% of home builders subcontract their sales operations.\2\
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\2\ Builders' Economics Council Survey: Special Analysis. May 2005.
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Present Law Rules
The prevailing tax and regulatory system reflects the economic
importance of allowing businesses to determine how services are
provided. Under present law, the determination of whether a specialist
is an independent contractor or an employee is made by a facts and
circumstances evaluation. This evaluation examines the nature of the
work completed, the means and control of the work, and the
circumstances under which the work is performed, among other factors.
Internal Revenue Service Ruling 87-41 provides 20 such factors that may
be considered in performing this evaluation. These factors include
training, payment by job/time status, tool/material provision, and
whether the specialist works for more than one business. Further,
Section 530 of the Revenue Act of 1978 allows a business to treat a
worker as an independent contractor if the IRS or past industry
practice has accorded such status to similar workers in the past.
Section 530 is an important policy tool for ensuring that inappropriate
tax policy considerations do not interfere with efficient market
operation and established business practice.
NAHB supports enforcement of these present law rules. Businesses or
individuals that are in violation of these rules, either through
wrongful misclassification of workers or through failure to pay taxes
in full, can achieve an unfair competitive advantage in the
marketplace. This hurts law abiding businesses and individuals in the
industry.
Policy Recommendations
Nonetheless, the present law system is complex and potentially
confusing. In some cases, misclassification of employees can occur due
to unfamiliarity with the rules. This is due in part to the nature of
the facts and circumstances test that is available to businesses.
Section 530 is useful because it establishes a safe harbor, thereby
providing certainty to potential employers. NAHB recommends that
compliance in this area could be improved by establishing additional
safe harbors for common scenarios involving subcontractors that provide
specialized services to businesses. Further, additional education
efforts by the appropriate tax authorities concerning the benefits and
responsibilities of being an independent contractor would be helpful.
This would be useful for individuals who are new to the experience of
being a subcontractor, and thus would prevent surprises concerning tax
treatment at the end of the year.
However, NAHB opposes any attempt to legislate the particular
circumstances under which professionals must be defined as employees or
independent contractors. Such efforts would be damaging to the
marketplace, particularly as they would be driven by tax policy
considerations and not the economics of the marketplace. Furthermore,
such policies would be complex and administratively difficult to
enforce. Consider the example of a specialist who theoretically would
be required by statute to be classified as an employee, despite the
fact that the specialist may work for several employers in a given
year. Each employer would be required to withhold payroll taxes for
FICA purposes, but no accounting could be made for withholding made by
other employers. This would create an administratively difficult task
to resolve for both the IRS and the employers, which would result in
higher business costs and cash flow challenges. Indeed, this example
illustrates one of the merits of the existing system.
As a general principle, NAHB opposes tax proposals and policies
that impose increased administrative burdens on businesses that play by
the rules. For example, increasing information reporting requirements
beyond present law rules would increase paperwork burdens on business,
and small business in particular. Indeed, such small businesses are
those firms that, due to the economics of utilizing specialists, rely
on independent contractors the most and thus would shoulder the largest
burden from increased paperwork requirements.
Conclusion
The classification of workers as either employees or independent
contractors is important for all small businesses, but it is especially
so for home builders. NAHB supports maintaining the efficiency and
flexibility of the marketplace by continuing to allow employers to
classify their workers as independent contractors, as merited. At the
same time, we support enforcement of present law to ensure a level
playing field for all small businesses. NAHB looks forward to working
with the Committee and the Congress to achieve both of these goals.
Statement of Richard A. Samp
The ``independent contractor'' model of conducting business affairs
is coming under increasing assault from government regulators, labor
activists, and plaintiffs' attorneys, who often view the model as an
impediment to maximization of tax revenues and to increased
unionization of workforces. Such objections are generally wrong-headed
and overlook the key role that independent contractors play in driving
economic growth and business innovation.
But the free enterprise community is often its own worst enemy in
the battle to preserve the independent contractor model. All too often,
businesses are tempted to skirt the law by classifying individuals as
``independent contractors'' who quite clearly are employees. By doing
so, businesses do not merely gain an unfair cost advantage over rivals.
They also strengthen the hand of those who, if given the chance, would
do away with the independent contractor model completely.
Why Independent Contractors?
When most of a person's time is devoted to providing services to a
single entity or another individual, that person arguably is an
``employee'' and thus subject to numerous federal and state laws--e.g.,
mandatory income tax withholding, minimum wage and overtime laws,
employee and employer FICA, workers' compensation, and unemployment
insurance. But there are many reasons why such individuals, if they
genuinely operate independently, ought to be treated not as employees
but as self-employed independent contractors.
Chief among those reasons is the entrepreneurial spirit that comes
with being one's own boss. Those who operate their own businesses and
whose incomes are dependent on how successfully they perform have much
more incentive than do employees both to work hard and to find
innovative ways to perform more efficiently. Allowing companies to farm
out work to independent contractors rather than hire additional
employees allows those companies to operate more efficiently as well.
Companies that employ independent contractors can avoid being required
to develop in-house expertise in performing specialized tasks and can
instead concentrate on undertaking the core functions they do best.
Companies can also use independent contractors to increase their
flexibility in varying production output in response to fluctuating
market demand.
How Much Independence Is Enough?
In general, the law permits an individual to be classified as an
independent contractor if he or she controls most of the details
regarding how and where work is to be performed. There will always be
cases that are fairly close to the line that separates employees and
independent contractors. In close cases, the analysis can get rather
complicated, with administrative agencies applying variants of the
infamous ``twenty factor test.'' One can easily have sympathy for
companies involved in those close cases; huge amounts of money are
often riding on the outcome, yet they often lack clear guidance
regarding how those providing services must be classified.
Nonetheless, in most instances the analysis is relatively
straightforward, and it should be fairly obvious to a company whether
it is controlling how and where the service provider performs his work,
and thus whether he must be classified as an employee. An insurance or
real estate agent who establishes her own working hours and meets with
customers of her choosing on her own schedule quite obviously can be
classified as an independent contractor, notwithstanding that all of
her work is performed for a single insurance or real estate company.
Conversely, individuals hired by Attorney General-designate Zoe Baird
and Supreme Court Justice Stephen Breyer to perform assigned domestic
chores within their households during assigned time periods quite
obviously should have been classified as employees. Many of the
classification controversies have arisen not because the outcome was
debatable, but because one side or the other was over-reaching.
Over-Reaching Employers
Companies that should know better have succumbed to financial
temptation and have classified as independent contractors many
individuals who, based on extensive control over how and when they
work, should properly be deemed employees. By so doing, companies are
threatening the viability of the entire independent contractor model by
providing regulators with the ammunition they need to justify efforts
to expand the definition of ``employee.''
Perhaps the area most rife with employer abuse is the construction
industry. Sometimes, it seems that virtually everyone present on a
construction site is designated an independent contractor, even though
the construction foreman is telling workers precisely what tasks are to
be performed in what order and in what time frames. A recent study by
the Construction Policy Research Center, affiliated with Harvard
University, found that as many as 1 in 4 construction companies in
Massachusetts have misclassified employees as independent contractors,
and the prevalence of misclassification is on the rise. See Francoise
Carre and Randall Wilson, The Social and Economic Costs of Employee
Misclassification in Construction (Dec. 2004). Such worker
misclassification can relieve employers of considerable employment tax
responsibilities. It can also work to the advantage of workers, who
realize that the absence of tax withholding on their wages can
facilitate under-reporting of income \1\ as well as employment of
undocumented aliens. But worker misclassification significantly
disadvantages other law-abiding employers, who pay their taxes yet must
compete with the scofflaws. It also impacts the public at large, which
endures underfunding of such programs as workers' compensation funds
designed to compensate workers injured on the job.
---------------------------------------------------------------------------
\1\ The Internal Revenue Service estimates that taxpayers pay tax
on less than one-half of the income for which the IRS receives little
or no reporting information, such as payments made to independent
contractors.
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Other industries with serious misclassification problems include
limousine companies and delivery services. When the service that an
individual provides to a company consists of driving a vehicle to
benefit the company's customers, that individual should almost surely
be deemed an employee when the company (as is often the case) retains
significant control over when and how the individual performs his
services. For example, if a limousine driver wears a company uniform;
must service customers designated by the company within a time frame
set forth by the company; drives a vehicle meeting detailed company
specifications; performs virtually all of his services for that
company; and must abide by a detailed set of operating procedures,
there is virtually no basis for classifying the driver as an
independent contractor. Yet numerous limousine companies that have
adopted such working conditions nonetheless misclassify their employees
in that manner.
One package delivery company that finds itself facing adverse
administrative and court judgments regarding misclassification of
employees is Federal Express, which classifies drivers in its Ground
and Home Delivery divisions as independent contractors. FedEx faces at
least 36 class-action lawsuits filed by drivers who claim they really
are employees; those suits have been consolidated before a Federal
court multi-district litigation panel in Indiana. In December 2005, a
Los Angeles County Superior Court judge ruled, following a nine-week
trial, that FedEx had violated California law by improperly classifying
a group of drivers. The court ruled that the drivers were employees and
ordered FedEx to pay them $5.3 million, given FedEx's substantial
control over the drivers' work activities--including requiring drivers
to comply with detailed work procedures, wear uniforms and drive trucks
displaying company logos, work a minimum number of hours, deliver all
packages assigned to them, and perform virtually all of their work for
FedEx. The California court judgment is echoed by rulings from the
National Labor Relations Board Region 22 (November 2004), Region 4
(June 2005), and Region 1 (January 2006) that FedEx drivers were
misclassified as independent contractors and should be deemed
employees.
In general, a company that engages large numbers of individuals to
provide services for the company on a full-time basis should seriously
consider whether those individuals should be classified as employees,
particularly when they provide a service that is a core component of
the company's operations. In such situations, the company very often
out of necessity will prescribe large segments of the individuals' day-
to-day activities--in which case the individuals almost surely should
be classified as employees. Unless the individual brings some special
``skill set'' to the table (e.g., a licensed insurance or real estate
agent or an IT professional) such that the individual could easily
transfer his services to another company at a moment's notice, a
company that classifies such an individual as an independent contractor
has little good-faith grounds for doing so. Such individuals cannot
legitimately be deemed ``entrepreneurs'' if they are not building up a
business that provides, or even realistically could provide, services
to those other than the company's customers.
There are, of course, numerous reasons other than increased taxes
why companies would want to keep to a minimum the number of
``employees'' on their books. For example, while governments impose
regulations on the business community that in some cases can
legitimately be categorized as onerous, statutes often waive those
regulations for companies with fewer than a specified number of
employees. But if a regulation is overly burdensome, the response of
the business community ought to be to unite to seek a change in the
regulation, not to adopt questionable worker classification policies to
reduce a company's claimed employee roll as a means of evading the
regulation.
Over-Reaching Regulators
But over-reaching is hardly limited to the business community.
Government regulators have considerable financial and bureaucratic
incentives to expand the definition of ``employees'' as far as courts
and legislators will permit them. If regulators succeed in having those
formerly classified as ``independent contractors'' reclassified as
``employees,'' revenues derived from a variety of taxes and fees
(income tax, FICA, unemployment) will rise sharply. Tax collectors are
well aware that non-reporting of income is far higher among independent
contractors, who generally are not subject to nearly as many reporting
and withholding requirements as are employees. Regulators' natural
inclination to expand the definition of ``employees'' is egged on by
labor unions (who understand that employees are easier to organize than
are independent contractors) and by lawyers (who view litigation
regarding alleged misclassification of employees as a growth
opportunity for the trial bar).
All too frequently, such over-reaching leads to truly unfortunate
enforcement actions and litigation, such as Fleece on Earth v. Vermont
Department of Labor, a case pending before the Vermont Supreme Court.
The case involves a small country store in Vermont (Fleece on Earth, or
``Fleece'') that sells home-made sweaters. The sweaters are knitted by
(usually elderly) women working in their own homes on their own
schedules and at their own pace. The only store to whom the women sell
is Fleece; the store pays the women on a per-sweater basis. Given the
considerable control the women exercise over their own work schedules,
Fleece quite understandably has classified them as independent
contractors. The Vermont Department of Labor, apparently seeking to
position itself as the champion of elderly workers being ``exploited''
by the business community, sees things differently. It claims that the
knitters should be deemed ``employees'' and has assessed Fleece for
unpaid taxes, unemployment, and workers' compensation. Fleece has
appealed that assessment to the Vermont Supreme Court.
In seeking to expand what constitutes an ``employee,'' the Vermont
Department of Labor appears to be oblivious to the needs of the
business community or the economic value of encouraging entrepreneurial
activity. It apparently did not occur to regulators that knitters might
well decide not to engage in their craft if deprived of the flexibility
to decide when and how often to work. Moreover, if the assessment is
upheld, it is difficult to see how any individual performing services
for a single company in Vermont could ever be deemed an independent
contractor.
Conclusion
The existence of employer abuses has provided ammunition to those
who are pushing state regulators and legislatures to crack down on use
of the independent contractor model. Unless the free enterprise
community can get its own house in order, we can expect to see more
businesses like Fleece on Earth being threatened with financial ruin by
over-reaching regulators. Given the tremendous entrepreneurial
contribution that truly independent contractors make to the American
economy, the business community needs to do all it can to ensure that
the independent contractor model survives.