IRS, States Target Employers’ Use of Independent Contractors

March 7, 2010

The Internal Revenue Service and 37 states are cracking down on companies that try to trim payroll costs by illegally classifying workers as independent contractors, rather than as full employees, The Associated Press has learned. The practice costs governments billions in lost revenue, can leave workers without workers compensation if they are injured while working, and without benefits if they lose their job.

Many believe the problem has worsened during the economic downturn, fueling more aggressive recovery efforts by states.

“I think the economic downturn has had a serious impact … has exacerbated the problem,” said Vermont Rep. Warren Kitzmiller, who chaired a panel that recently reported on the issue. “Businesses are looking to trim costs in every way they can, and some are coming very close to shading the legal with the illegal on that question.”

For a growing number of companies, including Target, FedEx Ground and Comcast, cutting costs means removing workers from the payroll or bringing on new workers – sometimes through intermediary companies – without making them full employees.

The Society for Human Resource Management said it surveyed companies in October 2008 and found 12 percent were moving to use more independent contractors, contingent and temporary workers because of the recession.

By designating workers as “independent contractors,” businesses can save as much as 30 percent of payroll, avoiding unemployment insurance and workers’ compensation costs, as well as the employer’s share of payroll withholding.

The practice also deprives states of sorely needed income as rising jobless rates strain their budgets.

The federal Government Accountability Office estimated that employee misclassification resulted in the underpayment of $2.72 billion in Social Security taxes, unemployment insurance taxes and income taxes in 2006.

The IRS said it would begin a three-year study of the issue this month. State crackdowns include:

  • Florida: A 2008 statewide grand jury found some construction contractors conspired with check-cashing stores to fake payments to a bogus subcontractor, cash the checks themselves and pay workers cash, under the table.
  • New York: A multi-agency team reported finding nearly 31,500 cases of employee misclassification and nearly $390 million in unreported wages from Sept. 2007 and the end of 2009. New York’s numbers were up significantly.
  • California: Orange County prosecutors said last year they would seek $38 million from a couple for fraud for failing to pay premiums and submitting claims for 42 injured but uninsured workers at their construction companies.

Matthew Capece, an officer with the United Brotherhood of Carpenters and Joiners of America, called the states’ efforts encouraging. “We’re beginning to see the state and federal government fighting back and taking more interest,” Capece said. But “[t]here’s a lot of road left to travel to fix this.”

Companies say using independent contractors helps them keep costs down and stay flexible in an increasingly competitive economy.

“Some companies desire to focus on core business functions,” said Kevin Hishta, an Atlanta lawyer who represents employers in labor relations matters. “They may feel they do not have the expertise to handle a particular function or that it would be more efficiently handled by others.” He offered as an example “a carpet manufacturer who decides ‘I really don’t need to be in the installation business.”‘

Experts say the abuse extends through various industries: low-skilled makers of shipping pallets in California, home health providers , even dancers in some Massachusetts strip clubs. Several states said the practice is most prevalent in construction.

FedEx Ground has been sued more than 45 times for classifying drivers as independents.The company maintains its drivers are small-business owners, who can own multiple routes and expand their business as they wish. Court rulings have been split.

Cable TV giant Comcast and retailer Target have been sued for allegedly hiring intermediaries that deny benefits to workers. Plaintiffs include janitors who worked in Target stores in Texas and cable TV installers in Massachusetts. Both firms maintain the workers suing were never employees of theirs.

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