IRS, states target worker status abuse

NASHUA, N.H. – The Internal Revenue Service and 37 states are cracking down on companies that illegally try to trim payroll costs by changing employees’ status to independent contractors, The Associated Press has learned. The practice costs governments billions in lost revenue and can leave workers high and dry when they are hurt at work or are left jobless.

Many who have studied the problem believe it’s worsened during the economic downturn, fueling even 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."

But Nevada labor lawyers say they haven’t seen a surge of such cases in the Silver State, and Nevada Labor Commissioner Michael Tanchek said his department hasn’t stepped up efforts to clamp down on such cases.

"It’s a problem we see, but it’s not a problem we see a lot," Tanchek said.

Cindy Jones, administrator of the state’s Employment Security Division, said employee misclassification is an issue for several governmental agencies, but she didn’t elaborate on any additional scrutiny her agency might be applying to the topic. She said a legislative subcommittee is reviewing the issue, and she noted that President Barack Obama’s budget requests funding for states to further address misclassification.

Gregory Kamer, a partner in the local labor law firm of Kamer Zucker Abbott, said he hasn’t seen any new cases related to IRS queries on independent contractors.

That shortage of misclassification cases could come from the huge liabilities involved in misclassifying workers, Kamer said. Employers who dodge compensation expenses by misclassifying employees as contractors could subject themselves to a major lawsuit that would be far more costly than simply qualifying the worker as an employee and paying for compensation coverage.

"I believe that, in my practice, when we run into it, it’s unintentional," Kamer said. "You have the potential for all of these penalties and fines. I don’t think businesspeople want to take those chances."

But the two-year-old recession might have given some companies incentive to at least reconsider how they staff up.

The Society for Human Resource Management, representing company personnel departments nationwide, said it surveyed members in October 2008 and found 12 percent of them were moving to use more independent contractors, contingent and temporary workers because of the downturn.

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 reported finding nearly 31,500 cases of employee misclassification and nearly $390 million in unreported wages from Sept. 2007 and the end of 2009. It had ordered employers to pay more than $28 million in past-due wages, taxes and penalties.

New York’s numbers were up significantly. Its team found 12,300 misclassification cases in the 16 months ending in December 2008; by a year later it had found about 19,200 more.

— 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 state’s 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.

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, "there’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 tough and competitive economy."Some companies desire to focus on core business functions," said Kevin Hishta, an Atlanta-based 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 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.

Review-Journal writer Jennifer Robison contributed to this report.

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