Renewed Focus on Worker Classification
President Obama's interest in strengthening the middle class and reducing the tax gap bring attention to worker classification problems and solutions.
August 26, 2010
Proper classification of workers as employees or independent contractors is a decade’s old problem. "Section 530" of the Revenue Act of 1978 which was intended to provide temporary relief while Congress studied solutions, is still with us. The work world of 1978 is not the same as that of today. Today, new work arrangements and job descriptions raise new challenges in worker classification. For example, today, a telecommuting, "knowledge" worker is able to work with little supervision and easily able to perform work for multiple employers from their home.
President Obama has brought attention to workplace flexibility. In March 2010, the White House sponsored the Forum for Workplace Flexibility. A report for the forum by the Council of Economic Advisers, Work-Life Balance and the Economics of Workplace Flexibility (PDF), concluded:
"encouraging more firms to consider adopting flexible practices can potentially boost productivity, improve moral, and benefit the U.S. economy. Especially at this time as the U.S. rebuilds after the Great Recession, it is critical for the 21st century U.S. workplace to be organized for the 21st century workforce."
While the work-life balance report did not address tax considerations of the changed workforce and how desired workplace flexibility might challenge existing worker classification rules, other White House initiatives have included worker classification. This article discusses and critiques these worker classification proposals.
In 2009, President Obama established the White House Task Force on the Middle Class, chaired by Vice President Biden (White House press release, January 30, 2009; task force website). The task force's annual report (February 2010 (PDF)) includes an explanation of actions to be taken to protect workers and create middle class jobs. Such actions include a Department of Labor (DOL) initiative to prevent misclassification and a legislative proposal from Treasury (pages v – vi, 21 – 22).
The report explains that proper worker classification prevents workers from deprivation of benefits and legal protections (such as workers' compensation, unemployment insurance and safe workplace) and better ensures proper tax compliance. In addition, "misclassification gives unfair advantages in the marketplace to employers who misclassify their workers" (page 22).
Department of Labor
On June 17, 2010, the Senate Committee on Health, Education, Labor and Pensions (HELP) held a hearing entitled "Leveling the Playing Field: Protecting Workers and Businesses Affected by Misclassification." In testimony at the hearing, DOL Deputy Secretary Seth D. Harris explained the need to improve worker classification to protect workers and compliant employers and to encourage proper classification. He noted that under some laws administered by the DOL, such as the Fair Labor Standards Act (FLSA), there is no penalty imposed on employers who misclassify workers.
In describing the Administration's efforts to improve worker classification, Harris stated:
"The rules governing employers’ decisions about whether to respect employees’ rights under our nation’s employment laws must change, and they must change now. We must restore a level playing field for responsible employers and employees and ensure that workers benefit from the protections Congress intended them to have."
Harris noted that the Administration's 2011 budget called for $25 million to fund a DOL initiative to improve enforcement of worker classification laws. Activities include providing better guidance to service recipients and workers, and information sharing among federal and state government agencies to improve enforcement of labor laws. One new compliance strategy is “Plan/Prevent/Protect.” Under consideration as part of this strategy is to require employers to "perform a written analysis of the worker’s status applying the “economic realities” test" (applicable under the FLSA) and making that analysis available to any worker or DOL investigator who might ask for it. DOL believes that the added transparency created by such a requirement would reduce misclassification.The DOL testimony also noted the department's support of S. 3254 (111th Congress), the Employee Misclassification Prevention Act. This proposal would add penalties for employer violation of FLSA and require employers to notify workers in writing whether they have been classified as an employee or a contractor.
Administration's Tax Proposal
The Administration's list of revenue proposals for FY 2011 (the "Greenbook" (PDF)) includes a tax gap measure to "increase certainty with respect to worker classification" (pages 107 – 109). Key elements of this proposal are explained next.
No doubt, worker classification is a problem area, as Congress and others have noted for decades. The lack of clear and consistent rules lead to confusion, added costs for workers and service recipients, and a portion of the tax gap. Some of the problems would be addressed by the Administration's proposal, but not all. Described below are some additional points to consider in improving worker classification rules:
The Joint Committee on Taxation has published an analysis of the Administration's FY2011 revenue proposals that includes comments on the worker classification proposal. [Description of Revenue Provisions Contained in The President's Fiscal Year 2011 Budget Proposal, JCS-2-10, August 16, 2010, page 427 - 446.]
Looking ForwardThe worker classification problem is longstanding and well-studied. Yet, it gets little attention in active tax legislation. Its placement in the Administration's revenue proposals helps remind everyone that the classification issue is still with us. There are many reasons that justify finally fixing this problem area, including fairness to workers and businesses, reducing the tax gap and simplifying the law. One more reason to address classification is the lurking possibility of a value-added tax (VAT) to help reduce the deficit and debt. Under a VAT, payments to contractors are not taxable, while wages are taxable. Without effective worker classification rules, a VAT would have one more challenge in its administration.
|Additional Resources on Worker Classification||Independent Contractor (Self-Employed) or Employee? (IRS website)|
|Employee Misclassification: Improved Coordination, Outreach and Targeting Could Better Ensure Detection and Prevention (GAO-09-717, August 10, 2009)|
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Annette Nellen, CPA, Esq., is a tax professor and director of the MST Program at San José State University. Nellen is an active member of the tax sections of the ABA and AICPA. She serves on the AICPA’s Individual Income Taxation Technical Resource Panel. She has several reports on tax reform and a blog.