One in seven employers misclassifies workers, state says

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More than 17,500 Minnesota employers – one in seven – illegally misclassify workers as “independent contractors,” the Legislative Auditor says in a new investigative report.

In the report and in testimony before a joint legislative committee, officials say misclassification is a growing problem that:

• Deprives the state of revenue – probably enough to wipe out the state’s projected budget deficit.
• Deprives workers of legal benefits and protections.
• Gives employers who cheat a unfair advantage over employers who obey the law.

Further, the state agencies responsible for fighting misclassification “don’t seem to communicate or coordinate,” said legislative auditor James Nobles.

“This study confirms the case that we’ve been making, that misclassification is a big problem and the state isn’t doing enough about it,” said Kyle Makarios, political director for the North Central States Regional Council of Carpenters, which has been in the forefront of fighting the problem at the Capitol.

Failure to crack down, Makarios said, means taxpayers – and contractors who play by the rules – get stuck picking up the tab for cheaters.

The report by the Office of the Legislative Auditor – the first of its kind on the extent of misclassification in Minnesota – estimates that 14 percent of employers cheat. That estimate is “conservative,” the report says, because it doesn’t factor in employers who use “independent contractors” exclusively or who operate in the shadows of the cash economy.

Cheaters tilt the field in their favor

Employers who illegally misclassify workers gain a huge competitive advantage, according to the investigative report. These employers:

• Avoid payroll and withholding taxes.
• Avoid paying unemployment insurance.
• Avoid paying workers’ compensation premiums.
• Avoid the costs of health insurance and other benefits.

Combined, they can reduce costs by more than 30 percent, Makarios said. This cost advantage makes it difficult, if not impossible, for legitimate contractors to compete, he said.

Although much of the labor movement’s focus has been in the construction industry, misclassification is widespread in many industries, the state’s report says. Other industries heavily affected include real estate, arts and entertainment, technical services, health care, and manufacturing.

Misclassification in construction overall actually is in line with employers as a whole, according to the report. But it is far worse in certain sectors: roughly 30 percent in commercial construction, residential remodeling and drywall installation; an estimated 38 percent in roofing.

Who calls the shots?

Misclassification occurs when workers who should be on the payroll as W-2 employees instead are illegally classified as 1099 “independent contractors.” It’s the difference between a worker working for a company, and a worker having a company as a customer or client.

“It’s not a matter of preference,” Nobles said. “It’s a matter of the law.”

Minnesota law contains nine requirements a worker must meet to legally qualify as an “independent contractor.” In general, if an employer controls when, where and how workers do the job, the workers are employees, not independent contractors. Under state law, independent contractors not only must call their own shots, they also generally supply their own equipment, supply the materials needed for a job, and take the risk of profit or loss. The Internal Revenue Service has similar guidelines.

New law will have an impact – in 2009

Earlier this year, the Minnesota Legislature amended state law so that construction workers claiming to be independent contractors have to prove they meet all nine state requirements. If they meet those requirements, the state will certify their status. If they don’t, they can be hired only as employees, not independent contractors.

That law takes effect in 2009; the Department of Labor and Industry now is drafting rules on how the application and certification process will work.

In the meantime, the legislative auditor’s report recommends that the Department of Revenue, Department of Employment and Economic Development, and the Department of Labor and Industry begin routinely sharing information about employers who misclassify workers. They should also better coordinate their audit and investigatory efforts, the report says.

“We don’t need to wait until 2009,” said Deborah Parker Junod, project manager for the misclassification investigation. “There are things that can be done now to coordinate enforcement efforts.”

The lack of cooperation among state agencies angered members of the Legislative Audit Commission, which received the report Nov. 28. Sen. Ann Rest (DFL-New Hope ) and Sen. Jim Metzen (DFL-South St. Paul), in particular, accused the agencies of picking and choosing which laws to enforce.

Michael Kuchta is communications coordinator for the North Central States Regional Council of Carpenters.

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