IRS, States Target Employer Abuse of Classification 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 even more aggressive recovery efforts by states.

“I think the economic downturn has had a serious impact,” 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.

By designating workers as “independent contractors,” businesses can save as much as 30 percent of payroll — avoiding unemployment insurance and workers’ compensation payments, 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 nation’s unemployment rate in January was 9.7 percent.

Typically, unless workers fight for and win a ruling that they should have been treated as full employees, they aren’t able to collect workers’ compensation for the injury or unemployment benefits when left jobless. The federal Government Accountability Office estimated that employee misclassification resulted in the underpayment of an estimated $2.72 billion in Social Security taxes, unemployment insurance taxes and income taxes in 2006, the last year for which figures are available.

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

  • New York: A multi-agency team found nearly 31,500 cases of employee misclassification and nearly $390 million in unreported wages from Sept. 2007 and the end of 2009. It ordered employers to pay more than $28 million in past-due wages, taxes and penalties.
  • California: Orange County prosecutors said last year they would seek $38 million from a couple for workers’ compensation fraud for failing to pay premiums and submitting claims for 42 injured but uninsured workers at their construction companies.
  • 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.
  • Ohio: The Bureau of Workers’ Compensation ruled last year that a former state attorney general’s top aide improperly classified all four employees at his Youngstown construction firm; on appeal only two were found misclassified. The state won’t say how much he owes in restitution.

Experts say independent contractor abuse extends through a broad swath of 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.

Even some insurance agents believe they are being targeted. Last fall, the National Association of Professional Allstate Agents (NAPAA) published and distributed a petition to the IRS questioning whether Allstate has acted appropriately after converting the majority of its sales force from employee to independent contractor status in 2000.

The group says it has not, claiming the company has benefited from a tax-advantaged status but does not treat agents as true independent contractors. The agents contend they are stuck in a sort of limbo, somewhere between a company employee and an independent contractor, because of the limitations Allstate places on the agents’ operations. Those restrictions include what and where Allstate agents can sell, according to Jim Fish, NAPAA executive director and a former Allstate agent.

Allstate spokesperson Laura Strykowski told Insurance Journal, however, that the company’s independent contractor agent policy has been confirmed in numerous courts, and the National Labor Relations Board and the IRS have confirmed its legitimacy.

Some other brand-name companies have been sued for alleged employee misclassification. FedEx Ground, a subsidiary of Memphis-based FedEx Corp., has been sued more than 45 times for classifying package delivery drivers as independent contractors. 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. And FedEx rival UPS is close to settling a misclassification suit in California, said a lawyer in the case.

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

Associated Press reports contributed to this story.

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