Employee Misclassification
Improved Coordination, Outreach, and Targeting Could Better Ensure Detection and Prevention
GAO-09-717, Sep 9, 2009
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When employers improperly classify workers as independent contractors instead of employees, those workers do not receive protections and benefits to which they are entitled, and the employers may fail to pay some taxes they would otherwise be required to pay. The Department of Labor (DOL) and Internal Revenue Service (IRS) are to ensure that employers comply with several labor and tax laws related to worker classification. GAO was asked to examine the extent of misclassification; actions DOL and IRS have taken to address misclassification, including the extent to which they collaborate with each other, states, and other agencies; and options that could help address misclassification. To meet its objectives, GAO reviewed DOL, IRS, and other studies on misclassification and DOL and IRS policies and activities related to classification; interviewed officials from these agencies as well as other stakeholders; analyzed data from DOL investigations involving misclassification; and surveyed states.
The national extent of employee misclassification is unknown; however, earlier and more recent, though not as comprehensive, studies suggest that it could be a significant problem with adverse consequences. For example, for tax year 1984, IRS estimated that U.S. employers misclassified a total of 3.4 million employees, resulting in an estimated revenue loss of $1.6 billion (in 1984 dollars). DOL commissioned a study in 2000 that found that 10 percent to 30 percent of firms audited in 9 states misclassified at least some employees. Although employee misclassification itself is not a violation of law, it is often associated with labor and tax law violations. DOL's detection of misclassification generally results from its investigations of alleged violations of federal labor law, particularly complaints involving nonpayment of overtime or minimum wages. Although outreach to workers could help reduce the incidence of misclassification, DOL's work in this area is limited, and the agency rarely uses penalties in cases of misclassification. IRS enforces worker classification compliance primarily through examinations of employers but also offers settlements through which eligible employers under examination can reduce taxes they might owe if they maintain proper classification of their workers in the future. IRS provides general information on classification through its publications and fact sheets available on its Web site and targets outreach efforts to tax and payroll professionals, but generally not to workers. IRS faces challenges with these compliance efforts because of resource constraints and limits that the tax law places on IRS's classification enforcement and education activities. DOL and IRS typically do not exchange the information they collect on misclassification, in part because of certain restrictions in the tax code on IRS's ability to share tax information with federal agencies. Also, DOL agencies do not share information internally on misclassification. Few states collaborate with DOL to address misclassification, however, IRS and 34 states share information on misclassification-related audits, as permitted under the tax code. Generally, IRS and states have found collaboration to be helpful, although some states believe information sharing practices could be improved. Some states have reported successful collaboration among their own agencies, including through task forces or joint interagency initiatives to detect misclassification. Although these initiatives are relatively recent, state officials told us that they have been effective in uncovering misclassification. GAO identified various options that could help address the misclassification of employees as independent contractors. Stakeholders GAO surveyed, including labor and employer groups, did not unanimously support or oppose any of these options. However, some options received more support, including enhancing coordination between federal and state agencies, expanding outreach to workers on classification, and allowing employers to voluntarily enter IRS's settlement program.
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Status will change from "In process" to "Open," "Closed - implemented," or "Closed - not implemented" based on our follow up work.
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Recommendations for Executive Action
Recommendation: To assist in preventing and responding to employee misclassification, and to enhance understanding of classification issues by workers--especially those in low-wage industries--the Secretary of Labor should collaborate with the Commissioner of Internal Revenue to offer education and outreach to workers on classification rules and implications and related tax obligations. Such collaboration should include developing a standardized document on classification that DOL would require employers to provide to new workers.
Agency Affected: Department of Labor
Status: Closed - Implemented
Comments: The Department of Labor (DOL) agreed to explore opportunities to collaborate to offer education and outreach to workers on the topic of worker classification, including developing a standardized document that DOL would require employers to provide to new workers. WHD agreed to reach out to IRS to explore opportunities for joint outreach to workers, and IRS agreed to collaborate with DOL, make education and outreach materials available to DOL, and work with them to explore developing a standardized document on classification for DOL to provide to new workers. In September 2010, IRS reported that the Questionable Employment Tax Practices (QETP) Oversight team, made up of representatives from the IRS, the DOL, the Federation of Tax Administrators, the National Association of State Workforce Agencies, and five state workforce agencies reviewed the study recommendation and agreed to work together to improve interagency efforts with other federal and state agencies on mis-classification. Specific actions taken include:The QETP Oversight team made mis-classification and outreach a regular agenda item on its bi-monthly conference calls and will continue to develop strategies to improve mis-classification compliance. An outreach sub-team that includes members from IRS GL, SL, Communications, Employment Tax, DOL, and state workforce agencies was established to improve outreach to stakeholders.A joint IRS and Department of Labor mis-classification team was established to share information and develop strategies on mis-classification.Representatives from the IRS participated in three DOL forums that provided information on QETP and IRS Employment Tax misclassification compliance efforts to state workforce agencies.
Recommendation: To assist in preventing and responding to employee misclassification, and to identify promising practices in addressing misclassification and use agency resources most effectively, the the Secretary of Labor and the Commissioner of Internal Revenue should establish a joint interagency effort with other federal and state agencies to address the misclassification of employees as independent contractors. Because tax data may provide useful leads on noncompliance, the task force should determine to what extent tax information would assist other agencies and, if it would be sufficiently helpful, seek a legislative change through the Department of the Treasury to allow for sharing of tax information with appropriate privacy protections.
Agency Affected: Department of the Treasury: Internal Revenue Service
Status: Closed - Implemented
Comments: IRS expressed support for this recommendation, stating that coordination between departments and agencies at the federal and state levels is an effective way to encourage voluntary compliance and agreed to work with DOL to explore developing a joint effort, subject to disclosure rules under section 6103 of the Internal Revenue Code and other privacy rules. In FY2011, IRS notified GAO that DOL and IRS have evaluated the potential benefits of tax information that can be shared and is seeking to identify new and enhanced partnering arrangements, subject to disclosure rules under IRS Section 6103, as well as privacy rules under 5 U.S.C. 522a. A procedure has been put in place to allow referrals to easily flow from DOL to the IRS. A MOU to facilitate additional exchanges of information is under development and is expected to be completed in 2011.
Recommendation: To assist in preventing and responding to employee misclassification, and to increase proper worker classification, the Commissioner of Internal Revenue should extend the Classification Settlement Program (CSP) to include employers that volunteer to prospectively reclassify their misclassified employees, and as part of this extension test whether sending notices describing the program to potentially noncompliant employers would be cost effective. Employers to which IRS would send notices could include those referred for examination but who may not be examined because of higher priorities, resource limitations, or other reasons.
Agency Affected: Department of the Treasury: Internal Revenue Service
Status: Open
Comments: In 2009, IRS said it would consider expanding the Classification Settlement Program (CSP) to employers not under examination and commented that if it decides to expand the program, it will consider all options, including issuing notices and soft letters and soliciting volunteers through outreach and education. GAO appreciates these efforts and continues to believe that extending the CSP to include employers that volunteer to prospectively reclassify their misclassified employees would be an effective way to increase proper worker classification and that it would be useful to test whether sending notices would be a cost-effective feature of an expanded program. A team of representatives from IRS, DOL, and SSA reviewed the CSP process in conjunction with the Voluntary Closing Agreement (VCA) process. The purpose is of the team is to determine whether to develop a VCA similar to the CSP such that employers who are not under audit can self-correct their treatment of workers. The team prepared recommendations for the Small Business/Self-Employed Commissioner's consideration that include that the expansion of the CSP program is appropriate. The recommendations are currently under review by Counsel. Implementation of the recommendations will be dependent upon any legal and other obstacles identified.
Recommendation: To assist in preventing and responding to employee misclassification, and to identify promising practices in addressing misclassification and use agency resources most effectively, the the Secretary of Labor and the Commissioner of Internal Revenue should establish a joint interagency effort with other federal and state agencies to address the misclassification of employees as independent contractors. Because tax data may provide useful leads on noncompliance, the task force should determine to what extent tax information would assist other agencies and, if it would be sufficiently helpful, seek a legislative change through the Department of the Treasury to allow for sharing of tax information with appropriate privacy protections.
Agency Affected: Department of Labor
Status: Closed - Implemented
Comments: In 2009, the Department of Labor (DOL) expressed support for establishing a joint interagency effort to address misclassification. DOL stated that a joint effort between DOL and IRS may prove useful in WHD's efforts to enforce wage and hour laws, and that WHD would participate in any such interdepartmental effort. In 2010, DOL reported that the President's Fiscal Year 2011 budget proposes $25 million for a DOL initiative that will include close cooperation with its partners in the Internal Revenue Service (IRS) to address worker misclassification. DOL will work with Congressional leadership to enact legislation that will address worker misclassification under the Fair Labor Standards Act. The President's 2011 Budget also includes a proposal to help employers and the IRS clarify the status of workers for employment tax purposes, so that the incidence of (and in some instances, the excuses for) misclassification will be reduced. IRS reported that the Questionable Employment Tax Practices (QETP) Oversight team, made up of representatives from the IRS, the DOL, the Federation of Tax Administrators, the National Association of State Workforce Agencies, and five state workforce agencies reviewed the study recommendation and agreed to work together to improve interagency efforts with other federal and state agencies on misclassification. Specific actions taken include:The QETP Oversight team made misclassification and outreach a regular agenda item on its bi-monthly conference calls and will continue to develop strategies to improve misclassification compliance. An outreach sub-team that includes members from IRS GL, SL, Communications, Employment Tax, DOL, and state workforce agencies was established to improve outreach to stakeholders.A joint IRS and Department of Labor misclassification team was established to share information and develop strategies on misclassification.Representatives from the IRS participated in three DOL forums that provided information on QETP and IRS Employment Tax misclassification compliance efforts to state workforce agencies.
Recommendation: To assist in preventing and responding to employee misclassification, and to enhance efforts to protect workers and make the most effective use of their resources, the Secretary of Labor should direct the WHD Administrator and the Assistant Secretary for Occupational Safety and Health Administration (OSHA) to ensure that information on cases involving the misclassification of employees as independent contractors is shared between the two entities and that cases outside their jurisdiction are referred to states and other relevant agencies, as required.
Agency Affected: Department of Labor
Status: Open
Comments: DOL agreed with this recommendation in 2009, noting that there is value in sharing information on cases involving the misclassification of employees as independent contractors between Wage and Hour Division (WHD) and OSHA and with state agencies. In addition, WHD said that it would assess its current referral processes to ensure that they adequately provided for referrals to other agencies in cases related to employee misclassification. In 2010, WHD reported that it is participating in a Joint DOL misclassification initiative with OSHA. In FY11, the agency did not provide an update on its efforts.
Recommendation: To assist in preventing and responding to employee misclassification, and to increase its detection of Fair Labor Standards Act (FLSA) and other labor law violations, the Secretary of Labor should direct the Wage and Hour Division (WHD) Administrator to increase the division's focus on misclassification of employees as independent contractors during targeted investigations.
Agency Affected: Department of Labor
Status: Open
Comments: In 2010, Wage and Hour Division (WHD) reported that it will reexamine its training materials and field guidance documents to ensure that all investigative staff are aware of the potential for employer misclassification of workers as independent contractors, that procedures are clearly articulated, and that investigators address employers' classification practices during all stages of an investigation. In addition, WHD's performance planning priorities for FY 2011 will include criteria related to increasing compliance on behalf of workers employed in industries that are characterized by frequent incidences of independent contractor misclassification. WHD has also requested and received from the Solicitor's Office legal advice addressing misclassifications in specific industries. The President's Fiscal Year 2011 budget proposes $25 million for a DOL initiative to support increased enforcement in industries in which misclassification is prevalent. The agency did not provide an update in FY2011.
Recommendation: To assist in preventing and responding to employee misclassification, and to maximize the effectiveness of the relatively new Questionable Employment Tax Practices (QETP) initiative, the Commissioner of Internal Revenue should create a forum for regularly collaborating with participating states to identify and address data sharing issues, such as ensuring clear points of contact within IRS for states and expeditious sharing of data.
Agency Affected: Department of the Treasury: Internal Revenue Service
Status: Closed - Implemented
Comments: In 2009, IRS agreed to work with state workforce agencies participating in QETP to establish a forum to identify and address data sharing and IRS points of contact issues using its Enterprise Wide Employment Tax Program. In August 2009, the QETP Oversight Committee established the Outreach Sub-team which includes members representing State Workforce Agencies participating in the QETP and IRS. The Oversight team meets bi-monthly and will address, as a regular agenda item, issues regarding expeditious data sharing and IRS points of contact.