[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

Pursuant to clause 2(e)(4) of Rule XI of the Rules of the House, public 
hearing records of the Committee on Ways and Means are also published 
in electronic form. The printed hearing record remains the official 
version. Because electronic submissions are used to prepare both 
printed and electronic versions of the hearing record, the process of 
converting between various electronic formats may introduce 
unintentional errors or omissions. Such occurrences are inherent in the 
current publication process and should diminish as the process is 
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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.
      

DETAILS FOR SUBMISSION OF WRITTEN COMMENTS:

      
    Please Note: Any person(s) and/or organization(s) wishing to submit 
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FORMATTING REQUIREMENTS:

      
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noted above.

                                 

    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.
---------------------------------------------------------------------------
    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%
ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½
------------------------------------------------------------------------------------------------------------------
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\
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \20\ NH Employment Security Appeal Tribunal, Decision of Appeal 
Tribunal, Docket No. 06-0463 6016-06.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
          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).
---------------------------------------------------------------------------
          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.
---------------------------------------------------------------------------
          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\
---------------------------------------------------------------------------
    \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\
---------------------------------------------------------------------------
    \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).
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \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\
---------------------------------------------------------------------------
    \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).
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    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.

---------------------------------------------------------------------------
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.
---------------------------------------------------------------------------
    \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.

---------------------------------------------------------------------------
        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.

---------------------------------------------------------------------------
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\
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    \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).
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \56\ Planmatics, 94.
    \57\ Planmatics, 95.

---------------------------------------------------------------------------
        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.

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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\
---------------------------------------------------------------------------
    \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\
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \2\ Builders' Economics Council Survey: Special Analysis. May 2005.

---------------------------------------------------------------------------
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.
---------------------------------------------------------------------------
    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.

                                 
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