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Legislative Update

In the cut-throat competition of the construction industry, contractors are always looking for an edge. When the difference between winning and losing a bid is a fraction of a percent of the project’s price tag, some resort to less than legal means to gain that edge. One of those means is growing in frequency all over the country: the misclassification of employees as independent contractors.

Employee misclassification can be a huge advantage for the cheaters. Fortunately, the problem is being discussed in government hearing rooms and solutions are receiving votes in legislative chambers all over the country.

In testimony before Congress last year, the U.S. Government Accountability Office stated that the number of U.S. workers treated as independent contractors increased 25 percent in just 10 years. It is now estimated that there are more than 10 million independent contractors working in the United States, more than 2 million of whom work in the construction industry.

Simply calling someone an independent contractor, however, does not necessarily make them one. The Internal Revenue Service (IRS) as far back as 1984 estimated that more than 3 million workers given 1099 forms instead of W-2s were actually employees. Given the growth in independent contractor designations it is very safe to assume that the number of misclassified workers has also grown significantly.

The major incentive for illegal misclassification of construction workers is simple: money. Employers who treat workers as independent contractors save tremendous amounts of money. They avoid paying the employer portion of FICA and Medicare taxes and any employer-provided pensions and health insurance. They don’t pay unemployment insurance taxes on these workers or include them in their workers’ compensation premiums. And since most labor laws protect only employees, independent contractors don’t have the right to join a union, don’t have OSHA protections and don’t even have minimum wage or overtime pay requirements.

All told, it is estimated that misclassification can allow employers to cut payroll costs by 30 percent. This advantage becomes even greater when one figures that many of these costs are shifted to contractors who play by the rules by way of higher rates on UI taxes.

Fortunately, states are beginning to wise up to and crack down on the 1099 scheme, particularly in the construction industry, in part because it’s in their best financial interest.

It is estimated that “non-traditional” workers, like independent contractors, are more likely to underreport their income and, thus, avoid paying income taxes. According to IRS estimates, independent contractors report less than 70 percent of their income while workers receiving W-2s report 99 percent of their wages.

States all over the country and the U.S. Congress are either studying the issue of misclassification or pursuing legislation of their own. That trend of legislative activity has strong roots here in the Midwest.

Kansas passed one of the first laws in the country cracking down on misclassification in 2006. After just six months, the enforcement of this law proved so successful that Governor Kathleen Sebelius increased funding for it, and the Kansas Department of Labor created an entire unit devoted to misclassification.

One of the most comprehensive laws in the nation went into effect in 2008 in Illinois, and it is proving to be the model for many states.

Illinois’ Employee Classification Act assumes all construction workers, on both government and private sector work, are employees of a contractor and creates a simple, three-part test determining legitimate independent contractors. Violators could be fined up to $1,500 per worker per day for first offenses. Penalties for repeat offenders increase to a maximum of $2,500 and include a prohibition from getting state projects for 4 years. The law also takes steps to allow state agencies with an interest in the classification issue to share information.

The Indiana House of Representatives passed HB 1269 earlier this year with bi-partisan support. It is based largely on the Illinois law and is now pending in the Senate Committee on Pensions and Labor. The Nebraska Senate’s Business and Labor Committee has made LB 1016, the Proper Employee Classification Act, one of its two priority bills this session. The state senate in Missouri is considering SB 929 which would penalize worker misclassifications by construction contractors.

Iowa Governor Chet Culver called for independent contractor reform in his “Condition of the State” speech in January. House File 2026 and House Study Bill 717 would do just that for the construction industry with language similar to Illinois’ Employee Classification Act. One major difference, however, is the addition of provisions linking the issue to illegal immigration. HF 2026 also makes it illegal for employers to knowingly hire undocumented workers. HSB 717 requires employers to verify the identity of new employees by copying their Iowa drivers’ licenses or non-operators’ id cards.

In early March, HSB 717 passed to the full House from the Labor Committee where HF 2026 remains as of this writing.

In our nation’s Capitol, the 1099 issue has been the subject of several hearings over the last year. Illinois Senators Barack Obama and Dick Durbin took what they learned and introduced the Independent Contractor Proper Classification Act of 2007. Its focus is the closure of a tax loophole in Section 530 of the Internal Revenue Code, called the “Safe Harbor” provision.

“Safe Harbor” essentially allows employers who misclassify workers to continue to do so if they misclassify similar workers, or if misclassification is common within their industry. It also prevents the IRS from penalizing many employers that misclassify, from requiring those employers to change their classification of their workers and prohibits the IRS from writing rules to guide employers on proper classification of workers. The ICPCA of 2007 closes the Safe Harbor loophole.

Other legislation is expected to be introduced on the federal level in the coming weeks and governors and state legislatures are taking actions to correct the misclassification problem. Wherever they may be, Midwest Region Laborers and contractors will work together through Midwest Region LECET to ensure that the playing field is level for everyone.