Employee misclassification: Will the last employee please turn off the lights?


Independent contractor.  Two very simple words that have a dramatic impact on businesses, workers, and government programs.  While most people have a basic understanding of the term, they often have very little understanding of the laws governing it, which vary significantly program by program and state by state.  This has lead to confusion and a common belief that any business owner can simply choose whether an individual that performs work on their behalf can be considered an employee or an independent contractor.

Broadly, this issue is known as "employee misclassification".  It hits directly at any tax or coverage that is payroll-based, from Social Security and Medicare at the federal level to unemployment and workers' compensation at the state level.  Implications spread out from there, including minimum wage and overtime laws, and even the safety of workplaces.  Some of the businesses conducting themselves this way know they are violating the law while others are unaware.  A portion of them issue 1099s, which the IRS uses to track payments to contractors, rather than the W-2 that I receive as an employee.  Others just go the old fashioned route and keep their workers off the books completely, paying them in cash "under the table".  Rather than an isolated issue, it has become an epidemic across the United States.

A study was performed at Cornell University in 2007, which looked at New York State.  In just a subset of all industries, they found over 704,000 employees misclassified as independent contractors, over 10% of the workforce.  For unemployment insurance alone, that meant over $4.2 billion in unreported wages each year, and underpayment of unemployment tax by nearly $176 million each year.  In Washington State, a report issued in 2007 found that businesses engaging in "underground economy" activity by underreporting or failing to cover workers' comp, unemployment or business taxes cost that state over $700 million per year.

When looking at all the programs impacted across the nation, the impact is in the tens of billions.  It also shifts burdens to honest and accurate employers, who are hit twice.  First, they see increasing rates for workers' compensation and unemployment, and then in competitive industries like construction, they lose bids to contractors that misclassify their employees to reduce costs.  The scope ranges from small businesses up to multi-national corporations.  In recent years a multi-national package delivery company (the one that doesn't wear brown uniforms) ended up with numerous settlements with states and the federal government for employee misclassification, to the tune of billions of dollars.

Is there a light on the horizon?  Yes.  States are starting to wake up.  Governors and legislatures have taken action to form either temporary or permanent task forces to bring agencies together and tackle the problem comprehensively.  New York produces an excellent annual report on their task force activities.  Tennessee started a new task force on action from the legislature in 2011, and North Carolina, Governor Perdue convened a broad task force earlier this year.

One critical approach, however is pulling data together.  Every single state that has convened a task force on employee misclassification has noted that.  By bringing together different views of businesses and potential employment from different perspectives, such as safety inspections, wage claims, sales tax, unemployment and workers' compensation, a more complete view of a business comes together.  Outliers can be identified, and connections between individuals built out that show the attempts at fraud, as I discussed in this earlier post.

In the efforts from Washington State's legislative task force  numerous approaches were taken, including strengthening enforcement tools, but eliminating data sharing barriers and funding targeting was critical.  They also used additional information to target education.  Simply asking new businesses if they intended to use independent contractors in addition to traditional questions about employees gained volumes of information.  Over 13,000 new businesses were forming every year that checked answered yes to that question, from all industries.  They were provided educational materials and follow-up contact that brought in millions of new revenue each year without enforcement actions.

Utilizing proper analytics and analyzing social networks can help right the ship on employee misclassification.  Segmenting employers to determine which ones need education, which need a light touch of enforcement and which are committing outright fraud creates the best opportunities for limited staffing resources to intervene.  By doing so, not only are state and federal budgets helped, but the honest businesses get a leg up on the competition.  In that way, there are still employment opportunities for the rest of us, and we won't face the need to ask the last employee to please turn off the lights.


About Author

Carl Hammersburg

Manager, Government and Healthcare Risk and Fraud

Carl Hammersburg manages the SAS Government and Healthcare Risk and Fraud team, and has been with SAS since 2012. Prior to that, he spent 20 years in anti-fraud activities for Washington State’s exclusive workers’ comp insurer, the Department of Labor and Industries. In 2004, Carl formed that agency’s comprehensive fraud program, covering tax and premium audit, claim investigation, provider fraud and collections. Data sharing and investigative partnerships with other State and Federal agencies, as well as driving public availability of information and awareness served as cornerstones to the anti-fraud activities of the program. During his stewardship, audit and investigative activities doubled and outcomes tripled, based on a focus on data mining and predictive analytics that improved efficiency and case selection. Program success under Carl’s leadership resulted in awards from two successive Governors of Washington State.

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