The Employee Misclassification Prevention Act of 2010

September 11, 2010

Employee misclassification can take place in several situations, including when a worker who should be classified as an employee of a business is illegally and improperly treated as a self-employed independent contractor. While some cases of misclassification are the result of honest mistakes or misapplication of employment laws, many businesses deliberately misclassify workers in order to avoid the taxes, benefits and other expenses that employers are legally obligated to pay for their employees.

Companies that engage in this practice save money for themselves at the expense of many:
- Their workers
- The government
- Law-abiding competitors whose profits may be lower as a result of properly fulfilling their compensation and tax obligations

Legislation proposed earlier this year would amend the Fair Labor Standards Act of 1938 to crack down on employers that engage in illegal employee misclassification. The bill, called the Employee Misclassification Prevention Act of 2010 (EMPA), contains a number of provisions designed to reduce misclassification, increase regulation of worker classification practices, and set forth specific penalties for businesses that do not maintain compliance.

Effects of Employee Misclassification on Workers

Workers who are misclassified as independent contractors are at a distinct disadvantage when compared to those who are properly classified as employees. Standard employee protections like minimum wage and overtime statutes, safety regulations and anti-discrimination laws do not apply to independent contractors. Misclassified workers are also denied basic benefits like heath care, vacation time and sick leave. In addition, businesses do not deduct taxes, 401(k), Social Security or Medicare payments from the paychecks of independent contractors.

Because employers do not pay unemployment taxes to the government for independent contractors, workers who are misclassified in this way cannot obtain unemployment benefits if they lose their jobs. Similarly, independent contractors who are injured at work are not eligible for workers' compensation benefits.

With the economy in its present state, millions of Americans are struggling either to find work or hold on to the jobs they already have. As a result, workers have relatively little bargaining power in the workplace. Because of this imbalance, there is concern among lawmakers that even those workers who know that they have been misclassified may be reluctant to speak up and challenge their classifications. Provisions of the EMPA would address that concern by establishing anti-retaliation protections for workers and requiring that businesses notify workers in writing of their status as employees or independent contractors.

Effects of Employee Misclassification on the Economy

In addition to putting workers at a disadvantage, the practice of misclassifying would-be employees as independent contractors costs the state and federal governments billions of dollars each year. The federal Government Accountability Office (GOA) estimated that employee misclassification cost the United States government $2.72 billion in revenue from Social Security, unemployment and income taxes in 2006 alone.

According to a recent congressional report, misclassification leads to revenue loss through two different avenues: Businesses evade their tax obligations by improperly classifying workers as independent contractors, while workers classified as independent contractors are less likely to pay their own taxes in full than employees who have their earnings reported by an employer. Legislators are hopeful that the EMPA will stem the flow of revenue loss through both of these avenues.

Along with protecting workers and promoting competitive fairness among businesses, another major objective of the EMPA is to narrow the tax gap and recapture revenue that the government loses due to employee misclassification.

Criticism of the EMPA

Opponents of the EMPA argue that compliance would be prohibitively expensive for many small business owners. They also contend that the legislation would burden business owners with excessive paperwork, imposing steep fines for improper recordkeeping rather than focusing directly on the problem of misclassification. United States Senator Mike Enzi (R-Wyoming) criticized this aspect of the bill, saying it could result in "nonsensical" fines to businesses for failing to notify employees that they are employees.

Under the terms proposed in EMPA, a business would pay $1,100 per person for initial misclassification of workers or recordkeeping violations. Penalties would increase to $5,000 per person for persistent or willful violations.

Not All Independent Contractors are Misclassified

While many independent contractors should rightfully be classified as employees, it is important to keep in mind that this is not true in every case. Businesses often enlist contractors to perform a variety of tasks, and not every business that does so is engaged in tax evasion, nor do they intend to break any state or federal law. The key distinction between employees and independent contractors is the extent to which the business has the right to exert control over the worker; an employer generally has the right to exert more control over an employee than a contractor, for example by dictating the hours worked and the manner in which tasks are completed.

Article provided by Marlin and Saltzman, LLP
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