For at least the past decade, there has been a concerted, nationwide movement to limit or even eliminate independent contractor status for workers in the United States. The IRS and state taxing authorities want payroll taxes not paid for contractors along with fewer tax deductions (i.e. more tax revenue) claimed by employees.
The Department of Labor and state wage and hour agencies want to be able to claim the penalties associated with unpaid overtime, missed meal and rest breaks and other violations of labor laws that only employees can bring. Workers’ compensation insurers want a larger labor pool to spread out their risk (independent contractors are not covered by a business’ workers’ compensation insurance). Trial lawyers want to be able to bring class actions for misclassification (which are not covered by insurance), as well as individual actions for harassment, discrimination and wrongful discharge, which only employees can bring.
In fact, the only ones that seem to want more independent contractors are contractors themselves, as well as the businesses that utilize their services. This is especially true in the construction industry, where businesses rely on independent contractors to provide services that are not used in a large enough quantity (or over a sustained period of time) to justify a full-time employment position. The stakes are high: for construction firms, the cost differential (i.e. savings) can be up to 20 percent of an employee's salary. For the government, it could mean the addition of hundreds of millions of dollars in revenues annually in unpaid taxes and fines.
The deck is definitely stacked in the government’s favor. In 2011, the IRS and DOL signed a Memorandum of Understanding to improve information sharing and collaboration to combat worker misclassification. As of 2018, all but nine states have signed this MOU to “protect” employees from being misclassified (and to “protect” state and federal tax revenue). Over the past decade, more than half the states have passed legislation aimed at ending misclassification with harsh punishments for companies who “willfully” misclassify employees. Several states, such as Delaware, New York, Illinois, Maine, Maryland, New Jersey and Pennsylvania have worker misclassification laws targeted directly at the construction industry.
With the federal and state governments investing millions of dollars in audits and investigations, a construction business is at a severe disadvantage already, and can no longer rely on simply “staying off the radar” of entities whose sole purpose is to find that all independent contractors are really employees. Understanding how the law and enforcement procedures are changing around independent contractor classification is therefore as important as minimizing sexual harassment in the age of Harvey Weinstein.
The rest of the nation uses the “economic realities” test, which focuses on the overall relationship between the contractor and the business, and whether the former is financially dependent on the latter. Although not a complete safe harbor for a construction business, IRS Form SS-8 can be used to request a determination from the IRS on the status of workers, to determine if they are employees or independent. Since the DOL and IRS have their MOU in place, and almost all the states have signed on, compliance with Form SS-8 can at least avoid a finding that there was a “willful” violation, which carries the most severe penalties. The IRS reviews the SS-8 on a case-by-case basis and issues a determination. A business cannot use this form for a “hypothetical” or proposed situation. A business files Form SS-8 to request a determination of the status of a worker under the “common law rules for purposes of federal employment taxes and income tax withholding.” Generally, under the common law rules, a worker is assumed to be an employee unless the IRS determines otherwise. The IRS researches each request, and may ask for further information. At the end of the process (which might take up to six months), the IRS will either:
• issue a determination letter, which is binding on the IRS; or • issue an informational letter, which is advisory but not binding.
The DOL has helpful fact sheets on explaining when an employment relationship exists:
• Employment Relationship Under the Fair Labor Standards Act; and • Get the Facts on Misclassification.
Although not as helpful as a binding determination letter from the IRS, if a business can show it actively complied with the DOL’s criteria, it can expedite an audit and minimize fines. The primary issue under the federal test is whether the business has the right to control how the work is performed. Whether the independent contractor is allowed to take on other work is an issue that, on its own, can disqualify an independent contractor. Typically, employees are given equipment, business cards and regular assignments. Workers are generally considered employees when someone else controls how and when they perform their work. In contrast, independent contractors are generally in business for themselves, obtain customers on their own from their own marketing and control how they perform services. Independent contractors provide their own equipment, and do not get paid time off or other benefits from their clients.
One of the primary problems with worker misclassification in the construction industry has been the uneven playing field in existence that makes it difficult for compliant businesses to compete with noncompliant ones. However, with the massive effort underway from multiples sources to eradicate misclassification in the construction industry, compliant firms can take solace that they are doing the prudent thing to protect themselves, and that the day of reckoning is here for their less scrupulous competitors.
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