The Washington Post – April 1, 2004; Page E03
Tales of Tax Fraud Are a Hoot, but the Penalties Are No Joke
For decades, unscrupulous construction contractors, as well as employers in other industries, have dodged paying workers compensation, unemployment insurance and other mandated payroll expenses by misclassifying workers as independent contractors. Now researchers at Harvard University are conducting a study to find out how widespread the practice is and how much it is costing in lost state and federal revenue, worker hardships and unfair competition to legitimate contractors.
While the results are expected to have significance for those on all sides of the construction labor market, general contractors have added incentive to monitor the outcome after a recent state Superior Court ruling upped their potential liability by allowing a misclassified worker of a subcontractor to sue the general contractor for damages if the worker is injured on the job site.
The study is taking place as construction union officials contend misclassification of workers in on the rise in the region and as the state’s Attorney General’s office has vowed to make prosecution of misclassification a priority in the wake of new state laws clarifying regulations.
How it works
Here’s an illustration of how misclassification works: Drywall subcontractor X has been hired to work on an area housing project. It has workers report to the job at a prescribed time and supplies them with tools, materials and direction. But X doesn’t list the workers as employees. Instead, it deems them “independent contractors,” who, among other things, must take care of their own workers compensation, unemployment insurance, social security and other workers benefits.
With no deductions and an opportunity to under-report income, the workers may get more money in their paychecks, but they lose out on overtime, health insurance and unemployment benefits if they are laid off. Company X, in turn, saves as much as 20 to 30 percept in payroll expenses it would have incurred if it paid the “independent” workers like regular employees.
So goes the “gray economy” of misclassifying workers in the construction industry, an illegal practice that industry leaders and regulators admit is tough to quantify, even tougher to enforce and could have far-reaching ramifications for workers, taxpayers and the construction industry overall.
Offloading private problems to the public purse
The study is being done by the Construction Policy Research Center, a research and public policy group that is a collaboration of the Harvard School of Public Health, the Harvard Law School’s Labor and Worklife Program, according to Elaine Bernard, executive director of the Labor and Worklife Program. The issue of misclassifying workers was brought to the program’s attention by the various groups, Bernard says, including the Boston-based N.E. Regional Council of Carpenters, who see the practice as a growing problem in the region.
From six percent to 20-25 percent of employers misclassify workers, depending on the state and the industry, says researcher Francoise Carre of the McCormack School, UMass-Boston.
While misclassification is a major concern of unions because it undermines their organization of workers, Bernard says the practice hurts those on all sides of the construction labor world. “It’s an interesting situation, where workers and companies are harmed and the government is harmed,” she says. “A number of individuals and institutions are taking advantage…by offloading the cost of their failure to comply onto everybody else.”
When companies, don’t pay their share of workers comp, Bernard notes, other companies must pickup the slack. Workers who become disillusioned with being classified as subcontractors have difficulty changing back to being classified as employees because they could be liable for back taxes, she says. And if an uninsured worker is injured, the cost of their care often gets transferred to the public purse. Bernard says. What’s more, other subcontractors bidding on the same work as those who misclassify workers are at a decided pricing disadvantage, she says.
General contractors, under which unscrupulous subcontractors may work, also have a stake in the misclassification dilemma – that got even higher with the recent court ruling, notes James Grosso, legal council for the Associated General Contractors of Mass. Labor Relations Division. Not only are they potentially liable for illegal actions on their job sites, but general contractors are also required to pay worker comp benefits to workers (misclassified or not) of subcontractors when such workers are injured on their job site and the sub has no workers comp insurance. The Sept. 14, 2004 ruling extended the general contractors’ potential liability in such cases even further when it determined that an uninsured masonry worker, Daniel Larson, is entitled to sue Burlington-based general contractor Fred Salvucci Corp. for damages even though Salvucci paid workers comp benefits for Larson’s injuries on the job. Larson was a worker for Methuen-based subcontractor Great Eastern, which did not provide workers comp insurance for him, according to the suit.
In a traditional employee relationship, Grosso says, when an employer provides workers comp insurance, that company cannot be sued by the worker for damages. While Larson was not listed as a misclassified worker in the court decision, Grosso says the ruling certainly ups general contractors’ exposure in misclassification cases.
A reliable source
Grosso says misclassification of workers isn’t a top concern of AGCM but it is a concern. He says he thinks the Harvard study is a good idea to quantify just how big a problem the practice is. Grosso says he is confident that a study of the issue by Harvard will be balanced. He says he would be “suspicious” of such a study if it were done by a less reputable researcher with links to labor unions.
The misclassification issue is a key focus of the N.E. Regional Council of Carpenters, which sees it as a growing problem in the construction labor market and seeks to publicize alleged violations by contractors. Stephen Joyce, research director for the union’s labor management program, say the practice is “rampant” and isn’t just a threat to the union but is harmful to workers, companies and taxpayers. Some contend, however, the union uses the issue in its effort to discredit contractors who aren’t committed to using union labor.
One contractor dogged by the carpenters union for allegedly using questionable subcontractors because, its owner says, it has not agreed to sign a contract with the union, is Worcester-based Cutler Associates Inc. Cutler CEO Frederic Mulligan says that, while he is not familiar with the Harvard study, he thinks it would be helpful if the issue of misclassification of workers could be clarified.
Mulligan says there’s a lot of confusion about who can be classified as an independent contractor. “The problem from my view is that it is so unclear,” he says, noting that state and federal guidelines vary. “If there were more clarity, it would benefit the companies trying to do it right,” he adds.
His company, he says, does the right thing, has never had a claim against it for misclassification and hasn’t had any violations by subcontractors on its work sites. He says some subcontractors his company uses have been cited but found innocent.
“It’s real, real easy to fall into the trap,” says William Philbrick of Greenberg, Rosenblatt, Kull & Bitsoli. The savings a company can realize from misclassifying workers as independent subcontractors can be up to 30-3 percent.
This could happen to you
Bill Philbrick, director of tax and business valuation services at Worcester-based accounting firm Greenberg, Rosenblatt, Kull & Bitsoli, agrees that the distinction between who is a valid independent contractor and an employee is a complex one about which companies need to be careful. In some cases, he says, a company may have crossed the line between using someone as an employee instead of a subcontractor and not even realize it.
For example, he notes, a general contractor who has long done business with a particular subcontractor that also works for other jobs may not realized that, if the relationship changes to the point where that subcontractor only does work for that general contractor and begins to take direction from them, they have become an employee.
Straying into misclassifying workers can have tremendous financial repercussions for companies, Philbrick says. If a company hires a worker as a subcontractor and has other employees who have tax-exempt pension and benefits plans and is found by the IRS to have misclassified that one subcontractor, the IRS could declare the benefits program invalid because it wasn’t offered to all employees. In such a case, he says, the IRS could revoke the tax-exemption status of all other employee benefits. Such a ruling could bankrupt a company, according to Philbrick.
Philbrick cautions that when it comes to independent contractors, companies should seek professional advice. “It’s real, real easy to fall into the trap,” he says. On the other hand, Philbrick says, the savings companies can enjoy from misclassifying workers as independent subcontractors are substantial, as much as 30-35 percent. “Let me put it this way, it’s very tempting,” he says.
“The problem from my view is that it is so unclear,” says Frederick Mulligan, CEO of Cutler Associates, on varying state and federal guidelines for classifying employees. “If there were more clarity, it would benefit the companies trying to do it right.”
In a nutshell
• Worker misclassification, which researchers and union officials speculate is on the rise in the region, is the practice by which companies can save between 20 and 30 percent on labor costs by listing employees as “independent contractors” rather than as employees.
• But treating an independent contractor in the same manner as employees can have significant financial repercussions, such as loss of tax benefits for pension plans and, in the case of a recent state Superior Court ruling, allowing a misclassified worker to sue the general contractor for damages if the worker is injured on the job site.
• A Harvard study is seeking to establish patterns of subcontracting practices in New England to enable researchers to estimate how much misclassification may be occurring. Researchers are using unemployment insurance data but they don’t have access to information on specific companies or individuals. The study is expected to be finished next spring.
• The state Attorney General’s office says new laws have clarified misclassification and that the office expects to prosecute more violators.