Employee or independent contractor? White House budget depends on the answer

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At least seven billion dollars… that's the amount President Barack Obama has penciled into his 2010 budget to be collected in the next ten years, from firms that misclassify workers, according to a recent report in The New York Times describing the Obama budget. Toward that end, the Obama administration has announced it will target 6,000 firms for special audit, with an emphasis on worker classification. This move, they say, is intended to help close the tax gap.

How big is the problem of worker misclassification? The Labor Department estimates that up to 30 percent of companies misclassify their workers, and another federal study showed that 3.4 million individuals who should have been included on payrolls were not.

Many states have already begun their own crackdowns, by stiffening the penalties companies will face for misclassifying workers. Here are a few examples.

In Ohio alone, state Attorney General Richard Cordray says that misclassification has cost the state:

  • About $35 million per year in unemployment insurance taxes
  • Roughly $103 million in workers compensation premiums
  • Up to $223 million in income tax.

Cordray told The New York Times",Misclassification is bad for business, government, and labor. Law-abiding businesses are in many ways the biggest fans of increased enforcement. Misclassifying can mean a 20 or 30 percent cost difference per worker."

Last November, the Illinois Department of Labor fined a home improvement company $328,500 for paying 18 employees as contractors. Officials said the company coerced the workers to incorporate themselves as a way to avoid problems.

Last April, California, attorney general Jerry Brown won a $13 million judgment against two companies that paid 300 janitors as independent contractors when they should have been employees. Currently he's seeking $4.3 million from a construction company that he says, is also guilty of misclassification.

Paying workers as contractors instead of as employees not only allows companies to avoid paying unemployment tax, workers compensation, and their share of Medicare and Social Security taxes, but it also allows them to skirt laws governing such items as minimum wage, overtime, and antidiscrimination.

"This denies many workers their basic rights and protections and means less revenues to the Treasury and a competitive advantage for employers who misclassify", Jared Bernstein told The New York Times. Bernstein is the executive director of Vice President Joe Biden's Middle Class Task Force, which helped create the Obama administration's campaign on this issue. "The last thing you want is to give a competitive advantage to employers who are breaking the rules."

Opposing voices

Some on both sides, employers and workers, are bristling at the increased scrutiny. With the economy still sluggish, most individuals are grateful to have paying work of any kind. They know that businesses are struggling to keep their doors open and they hesitate to rock what could be the only boat available. There's no question that businesses have to obey the law regarding worker classification and the appropriate employment laws. Still there are voices of opposition to the government's crusade to penalize businesses.

Randel K. Johnson is the senior vice president of the United States Chamber of Commerce. The Chamber has been a loud voice in support of businesses and always an advocate of abiding by the laws governing businesses. But Johnson questions the motives behind what is being called the biggest crackdown on worker classification in history.

"The goal of raising money is not a proper rationale for reclassifying who falls on what side of the line", Johnson told The New York Times. "The laws are unclear in this area, and legitimate clarification is one thing. But if it's just a way to justify enforcing very unclear laws against employers who can have a legitimate disagreement with the Labor Department or IRS, then we're concerned."

Others see Obama's crackdown as a favor or payback to unions which helped put him in the Oval Office. Worker misclassification is an issue that organized labor has been vocal about. Dean Zerbe, national managing director of AlliantGroup, a tax advisory firm to small and mid-size businesses, told The Wall Street Journal online that Obama's proposal would bolster unions by broadening the number of employees who would be able to organize.

"Is it a legitimate issue? Yes, but it's not right to cudgel small businesses to please the union bosses", Zerbe said.

Businesses of course are required to follow existing employment laws, to ensure fair treatment and protection of workers, and to prevent a scofflaw company from having an unfair advantage over a law-abiding competitor. While the problem is complex, it's not hard to see both sides. Now that money is tight and jobs are disappearing every day, it might be tempting to try to slide under the radar of scrutiny in order to hang on until times get better. And because of the ailing economy, workers might be willing to cooperate with companies that are providing them an income even if the workers aren't getting everything the law requires.

On the other hand, government is facing unfathomable deficits and is trying to pull in revenue from every corner… like turning up the heat on businesses that are struggling to stay open by any means possible. Government needs the money, but it's conceivable that penalties plus the cost of compliance could cause more businesses to fold, which would mean more jobs lost and ultimately, income tax revenue to the government will decrease.

A less rational voice of opposition

Also weighing in against the government's historical treatment of independent contractors and self-employed individuals – among other things -- was Joe Stack. He's the tax protestor, who, just last week, expressed his frustration by flying his light plane into an Austin, Texas IRS building. In the 3,000 word manifesto he posted online before crashing his plane, Stack ranted about many issues he considered unfair, including a provision in 1986 tax reform law which, he said, unfairly targeted software engineers, like himself. That law excluded engineers and computer workers who were hired through third party recruiters, from certain business-friendly tax provisions. As a result, Stack and those in similar situations had to pay back payroll taxes if the tax agency determined they were really employees.

In his rant he lashed out at Congress, saying, they "could only have been more blunt if they would have came [sic] out and directly declared me a criminal and non-citizen slave." He wrote that he spent countless hours, and $5,000 of his own money fighting to change the law.

In a more recent incident, Stack said that an IRS audit zinged him for failing to report $12,700 earned by his wife.

Decades of feeling like a victim of the tax system led him first to post his manifesto online. After that, he set his house on fire with his wife and daughter inside, and then ended his own misery by flying his plane into an IRS building, killing one person and injuring others. Read the full story in the related article below",Deadly tax protest in Texas."

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