This week, there have been a couple of big stories involving independent contractors -- more specifically, the classification of workers as independent contractors rather than employees (and vice versa). These stories show that worker classification is still a very hot topic, perhaps even more so in the current economic climate.
First, it was reported this week that President Obama's proposed budget includes a $25 million effort to stop the misclassification of employees as independent contractors, with funding for 100 new enforcement positions at the IRS. The Labor Department estimates that up to 30% of businesses misclassify employees as contractors, according to an article in the New York Times.
This move isn't so surprising when you consider the economy -- and the money a company can save by classifying workers as contractors, who aren't entitled to benefits, overtime, workers' compensation coverage, or unemployment if they are let go. I've even heard stories of employees being laid off, then brought back months later as independent contractors to do essentially the same work.
According to a study cited in Inc., about half of the jobs that have been created during the current economic recovery are "contingent," which means they are held not by employees but by temps and contractors. Used properly, contingent workers give companies the flexibility to ramp up quickly for a particular project, using professionals with experience and expertise, then pare back down just as quickly (and with very little legal exposure) once the project is done. Used improperly, turning employees into contingent workers exploits the employees, hurts morale and cohesion in the workplace, depletes state and federal tax coffers, and ultimately leaves workers at far greater risk of hitting bottom -- with no unemployment to protect them -- if the work runs out.
And speaking of hitting bottom and tax coffers, there was a second story about contractors this week. Apparently, the man who crashed a plane into an IRS office in Austin, Texas, yesterday was particularly angry about a provision of the Tax Code involving worker classification. The Times reported that the man's suicide note cited a 1986 law that made it more difficult for companies to classify certain workers who provide technical services as independent contractors. (The pilot of the plane was a computer software engineer.) The law ("Section 1706") essentially takes away certain defenses for these companies if they are audited for misclassification: Other companies can point to past industry practice, court rulings, and similar evidence to show that they had a reasonable basis for classifying workers as contractors, but those defenses aren't available for these technical services workers. The Times cites critics of the law, who say that it has prevented technical workers from becoming wealthy entrepeneurs and stymied technological innovation. The Times also reports that the law was passed essentialy as a way to raise tax revenue.
Taken together, these two stories show the tension underlying worker classification: Workers are supposed to be classified according to the work they do, but the amount of money at stake seems to cloud everyone's judgment. And, the financial interests of private business and the government are decidedly at odds here. Generally speaking, when workers are classified as contractors, companies save money and the government loses money. When workers are classified as employees, companies pay more and the government collects more.
While the financial incentives on both sides of the equation are therefore strong (and opposing), they are not supposed to be decisive. The law says that workers are to be classified according to what they do: Is their work essential to the employer's business? Does it require special training, skills, tools? Considering a long list of factors, do the workers truly look like independent business people, who can be expected to bargain at arm's length with the employer and cover their own costs of doing business? Or do they look more like employees, who have less bargaining power and may therefore need some protection against discrimination, on-the-job injuries, potentially oppressive working conditionsg, and job loss? With both business and government going broke, however, these fundamental policy considerations seem to have taken a back seat to financial concerns.
To get the legal lowdown on how to avoid misclassifying a worker, read Working With Independent Contractors, by Stephen Fishman (Nolo).