Contractor and Employee Misclassification Risk: New Developments in Proposed Legislation and Their Potential Impacts on Workers and Industries

For many years now, an economic problem involving the misclassification of employees has existed. The issue began primarily in the construction, agricultural and other day-labor type of industries. This trend has since migrated into big business and is having a significant impact on white collar employment, especially the IT industry.

The misclassification occurs between the W-2 and 1099 work statuses. The W-2 form notifies the IRS of an individual's employee status and takes the proper measures to cover taxes, social security and other such rights and obligations. The employer must pay payroll taxes on the employee. The 1099 form defines the individual as an independent contractor. A 1099 contractor is exempt from various tax related obligations and various means of employee protection such as the ability to bargain collectively and expect a minimum wage. In addition, the company hiring the contractor can avoid paying payroll taxes and benefits on the individual. Many companies are taking advantage of the ability to classify workers under the 1099 form in order to reduce their payroll tax and benefits burdens, but in the process risking serious damage to themselves, the employee and the federal treasury. There are major consequences for all parties when workers are misclassified under the 1099 form. This arrangement does not benefit the government. On the contrary, when employees are classified using other IRS forms besides the 1099, such as a W-2, the government receives a percentage of the worker's wages as taxes or for social security and other similar programs. When workers are filed under the 1099, these taxes are not taken out of the pay. In some cases this means that the government does not receive the tax money. 1099s are legal, but it is difficult for an employee to actually meet the standards required to qualify for the independent contractor designation. The problem is occurring because so many workers are being classified under the 1099 form illegitimately. This is costing the government money, and is also very risky for the company.

Due to the fact that the 1099 form designates the employee as an independent contractor, the company is not protected. In the long run, if the individual is not truly a contractor running their own business, the company is taking advantage of the employee and government by misclassifying the worker. In this system, the employer will make more money off of the employee for a lower cost. However, if the employee produces low quality work, or damages the company's reputation in any way, there is no protection for the company.

Companies which follow the rules and do not misclassify their workers are hurt as well. Intentional misclassification by other companies makes it more difficult for legitimate companies to afford to stay in business since their competitors are paying less for labor by misclassifying workers.

The employees themselves are also hurt by misclassification. By agreeing to become a 1099 contractor, the employer is not beholden to many laws regarding proper treatment of the employee. The potential for mistreatment can include, but is not restricted to, employees being paid less than minimum wage, being ineligible for benefits plans, workers being discriminated against or unsafe work conditions for the laborer. All of these scenarios become realistic possibilities because the 1099 form gives the government significantly less control of and information about employer-employee relations. The government is taking measures to address the damages incurred by the misclassification of employees and attempt to recover the lost tax revenue. Three acts are currently working their ways through the legislative process. These bills are the S. 2044, the SB 622 and the H.R. 6111. All three of these legislations would prevent the misclassification of employees as independent contractors under the 1099. The common thread between them is enforcement of the laws that are already in place. For the most part, the rules that designate whether or not a worker qualifies as a 1099 are suitable. The flaw is not in the guidelines, but instead in the government's ability to make sure that employers are properly identifying their employees. Therefore these acts are working to give the government the ability to crack down on misclassification of employees by targeting certain industries, increasing the information sharing between government agencies, and updating older laws regarding company record keeping.

While these acts all strive to deal with this issue of misclassification under the 1099, there are distinctions between them. The S. 2044, labeled the Independent Contractor Proper Classification Act of 2007, focuses in part on improving the government's ability to monitor the use of independent contractors by requiring employers to keep records of all 1099s for at least three years after employment. Another focal point of the act involves the way in which employers must respond to misclassification. This bill will require employers to treat independent contractors as employees if it is indeed discovered that they have been misclassified.

HR 5804 has been introduced and is in the initial phase of legislation. This bill seeks to clarify if certain individuals are to be treated as independent contractors or employees. Also referred to as the Taxpayer Responsibility, Accountability and Consistency Act of 2008, HR 5408 covers three main areas: it requires a report be sent to the IRS when a payment is made of $600 or more to a corporation, it lays out requirements and rules concerning the classification of workers as either employees or independent contractors, and, finally, HR 5408 would raise the fee for not submitting proper tax return data or comply with other information reporting criteria.

These three acts strive to solve the problem of misclassifying independent contractors. In taking care of this problem the government hopes to simultaneously protect the government, employers and employees from the potential injustices of misclassification under the 1099 form.