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Employee Misclassification Costing Government Billions

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Employees in certain industries, including construction are being taken advantage of from a financial standpoint by their employers.

A June report released by the Economic Policy Institute sheds light on an alarming trend in America known as employee misclassification that is rampant within industries that rely heavily on a chain of subcontractors such as construction and trucking.

Between 10 and 20 percent of employers nationwide, misclassify at least one worker as an independent contractor. According to the report, this trend is likely to have increased in recent years.

Employee misclassification occurs when a company treats someone who should be classified as a direct hire as a self-employed, independent contractor.

Francoise Carre, who authored the report, calls this practice fraud and says it violates tax and employment laws.

The company committing employee misclassification usually does so with the intent to not pay insurance premiums and payroll taxes. This fraudulent act forces the independent contractor to pay the full amount of Social Security and Medicare (FICA) tax while being ineligible to receive minimum wage, overtime, and any company benefits such as retirement or health care.

Additionally, by misclassifying an employee, a business can get away with hiring illegal aliens because they are not required to check on the immigration status of independent contractors. Oftentimes, these workers are paid in cash and pay no taxes.

This unscrupulous activity costs the local, state, and federal governments billions each year in lost revenue.

In southern states, misclassification within just the construction industry is costing hundreds of millions of dollars. Carre cites annual losses of $400 million in Florida, $467 million in North Carolina, and $1.2 billion in Texas.

A 1984 IRS study found 15 percent of employers engaged in the misclassification of 3.4 million workers, which resulted in an estimated loss of $1.6 billion in FICA tax. If adjusted to inflation for the year 2014, the loss in FICA taxes would be an estimated $3.5 billion.

Due to a loophole in the Revenue Act of 1978 known as Safe Harbor, companies can legally misclassify employees and get away with it because the Internal Revenue Service is not allowed to seek back taxes or order the change of status for workers.

Any company can be granted Safe Harbor if they show misclassification is a common industry problem or if the business is doing it on a reasonable basis.

Besides costing taxpayers billions of dollars, this problem also erodes labor standards.

Carre claims misclassification is a threat to labor because it “has a chilling effect on a worker’s ability to raise concerns about or bargain for, improvements in either the terms of employment (pay, work hours, etc.) or working conditions. In union environments, if misclassification occurs it may undermine compliance with the terms of a bargaining agreement.”

Furthermore, she points out that misclassification is a tool used by employers to end the threat of bargaining power over wages and working conditions.