Gackenbach Addresses Issues Related to Employee Misclassification at National Workers' Comp Conference in Las Vegas

Julie Gackenbach, a principal with Confrere Strategies, LLC, a lobbying firm headquartered in Washington, DC, presented a lecture November 11, 2010, at the 19th Annual National Workers' Compensation and Disability Conference held at the Las Vegas Convention Center.  Ms. Gackenbach's discussion, "Reclassifying Workers: How Changes at the Federal Level Will Shake Up the Workers' Comp Industry," provided a well-organized and crisply delivered overview of the nation's problem with worker misclassification.  She also described several ongoing efforts by the federal government's executive and legislative branches to address the difficult and contentious issue.

Employee versus Self-Employed Status

Setting the overall context for the discussion, Gackenbach initially reminded the audience that for both tax and nontax purposes, workers must be classified into one of two mutually exclusive categories: employees or self-employed (the latter often referred to as independent contractors) and that employers are generally required to withhold income and FICA taxes and to pay Federal Unemployment Tax Act taxes and state unemployment compensation taxes with regard to all their employees.  While worker classification has historically been determined by utilizing a common-law test examining employer control, Gackenbach noted that there has been a tendency during the past several decades for "employers" to classify their "employees" as independent contractors.  Ms. Gackenbach highlighted a ten-year-old government study that estimated that 15 percent of businesses misclassify employees as independent contractors.  That study indicated that as many as 3.4 million workers were improperly classified, resulting in a loss of some $2.7 billion annually to the federal government.  She said that all indications are that the 15 percent figure has risen to 20 percent and that the misclassification is currently costing the federal government as much as $5 billion each year, with an additional loss of $3 billion annually to the states.

Not Just a Tax Issue

According to Gackenbach, misclassification does just result in loss of tax revenues; workers who are inappropriately designated as independent contractors receive fewer benefits such as health care insurance and workers compensation benefits.  Independent contractors also enjoy few, if any rights under the Fair Labor Standards Act, the Family and Medical Leave Act, OSHA, and the National Labor Relations Act. 

Who Is Asking the Questions?

One of the difficulties in determining the propriety of employee versus independent contractor classification is that the answer can depend upon who is asking the question.  Gackenbach indicated that under common law rules, the primary test of employee status is whether the purported employer has the right to control and direct the worker.  It is the right to control that matters—not whether control is actually exerted.  This distinction is extremely important where a skilled or experienced worker appears to be doing his or her job without supervision or interference.  Yet other tests abound.

Under the so-called "ABC" test, a test devised within the unemployment compensation context, one is determined to be an independent contractor if all the following criteria are met (otherwise, the worker is deemed to be an employee):

• The worker controls and directs the performance of the service, both from a contractual standpoint, and “in fact.”
• The service being performed is either outside the normal business of or outside the place of business of the business for which it is being performed. 
• The worker is performing services for others or clearly has an independent trade, occupation, profession or business.

Still another test is utilized by the Internal Revenue Service.  Now usually referred to as the "Twenty Factors" test, the IRS seeks to examine such factors as the level of control that the purported employer has, whether the worker must supply his or her own tools and materials, whether the worker can be fired at any time, whether the worker may quit without incurring liability, whether the worker offers his or her services out to the public, and whether the worker can suffer a loss from the enterprise.  Gackenbach indicated that the Twenty Factors Test is an outgrowth of Congressional passage years ago of § 530 of the Internal Revenue Code.  As an "off-code" provision, however, the IRS has been unable to issue regulations or advisory rulings to assist employers in determining whether they fell within safe harbors.  The Department of Treasury has sought additional legislation to give the IRS additional powers in determining independent contractor status, but Congress has never done so.

Administration's Proposal to Clarify Independent Contractor Status

If President Obama has his way, the inadequacies of the past may be resolved.  Gackenbach outlined a proposal from the Obama administration that would attempt to clarify matters and to unify the tests into one federal standard. Under the administration's plan, the IRS would be permitted to require prospective reclassification of workers who are currently misclassified and whose reclassification has been prohibited under current law.  Retained would be the reduced penalties for misclassification provided under current law, but these lower penalties for misclassification would only apply if the purported employer voluntarily reclassified its workers before being contacted by the IRS or another enforcement agency and if the purported employer had filed all required information returns (Forms 1099) reporting payments to the former independent contractors.  New enforcement would focus mainly on obtaining the proper worker classification prospectively, since in many cases the appropriate classification of workers may not have been clear.

The Department of the Treasury and the IRS would be permitted to issue generally applicable guidance on the proper classification of workers.  Treasury and the IRS would be directed to issue guidance interpreting common law in a neutral manner, recognizing that many workers are, in fact, not employees.  Treasury and the IRS would develop guidance that would provide safe harbors and/or rebuttable presumptions for firms.  Gackenbach added that priority for the development of guidance would be given to industries and jobs where application of the common law test has been particularly problematic, where there has been a history of worker misclassification, or where there have been failures to report compensation paid.

Federal Legislative Proposals

In addition to plans by the executive branch of government, two separate legislative proposals to handle the worker misclassification issue have been introduced in Congress.  H.R. 3408/S. 2882, entitled the Taxpayer Responsibility, Accountability, and Consistency Act of 2009 was introduced in the House by Representative Jim McDermott and in the Senate by Senator John Kerry.  Gackenbach indicated that the bill would

• modify the three "statutory standards" (reasonable basis, substantive consistency, reporting consistency) under § 530 (discussed above);
• place the burden of proof of entitlement to safe harbor relief upon the employer;
• require the Secretary of the Treasury to issue an annual report on worker misclassification;
• require that any worker designated as an independent contractor receive a document describing the protections and benefits that were not being afforded him or her because of the independent contractor status and advise of procedures to seek legal determination, if the status, was disputed; and
• provide for various tax return requirements and penalties.

Separate legislation, H.R. 5107/S. 3254, entitled the Misclassification Prevention Act, has been introduced in the House by Representative Lynn Woolsey and Senator Sherrod Brown.  Gackenbach highlighted these bills provisions.  In short, the legislation would:

• require firms to maintain records of non-employees who perform labor or services, including through a corporation;
• require notice to each new employee or non-employee regarding his or her classification;
• provide for double liquidated damages for maximum hour, minimum wage, and notice of classification violations; and
• condition unemployment assistance on each state's establishment of administrative penalties—at the state level—for misclassifying workers.

Other Federal and State Proposals

Gackenbach advised that other legislative proposals, both at the federal and state levels, had been introduced to deal with specific issues related to employee misclassification.  For example, President Obama's FY 2011 budget proposed $25 million for a Department of Labor initiative to work with the IRS to address misclassification.  As many as 100 new federal investigators would be employed to review the classification of workers. 

The states have established initiatives of their own.  Gackenbach mentioned that Connecticut had increased the penalty for misclassifying workers by specifying that each day of the violation was a separate offense for purposes of the $300 per violation civil penalty.  New York has created a presumption that all construction workers are employees unless they meet specific criteria. 

Final Thoughts Regarding Workers' Compensation Issues

Gackenbach observed that none of the proposed legislation described in her lecture had been enacted.  She indicated that the Health Care debate had consumed a great deal of legislative capital.  She added that most experts see passage of the bills, or anything like them, as unlikely.  She said she's not so sure they are correct, that the deepening deficit has legislators on both sides of the aisle looking for revenue sources, and that politicians of every cloth think that additional revenues could be generated by closing up some of the loopholes in employee misclassification. 

Additional pressures at the state level may result in further tightening of the rules related to independent contractors.  The National Conference of Insurance Legislators has formed a subcommittee to move forward with an Employee Misclassification Workers' Compensation Coverage Model Act.  The draft model, based upon Florida and Wisconsin statutes, targets transparency, disclosure, and accountability in workers' compensation insurance.  Gackenbach indicated might special legislation, at the state level, might first be directed at the trucking and messenger/carrier industries and then to construction.  It should be noted that the NCOIL Annual Meeting is currently being held in New Orleans.  Some sort of announcement about the conference's plans may well be imminent.

  This article was written by Thomas A. Robinson.