GAO 

United States Government Accountability Office

Report to Congressional Requesters

EMPLOYEE 

MISCLASSIFICATION 

Improved 

Coordination, 

Outreach, and 

Targeting Could Better 

Ensure Detection and 

Prevention 

August 2009 

GAO-09-717 
What GAO Found

United States Government Accountability Office

Why GAO Did This Study

Highlights

Accountability Integrity Reliability

August 2009

EMPLOYEE MISCLASSIFICATION 

Improved Coordination, Outreach, and Targeting

Could Better Ensure Detection and Prevention 

Highlights of GAO-09-717, a report to 

congressional requesters 

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. 

What GAO Recommends

This report includes various 

recommendations to DOL and IRS 

to enhance enforcement of proper 

worker classification, improve 

outreach to workers about 

classification, and improve 

interagency coordination in 

addressing misclassification. In 

commenting on a draft of this 

report, DOL and IRS generally 

agreed with our recommendations. 

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. 

View GAO-09-717 or key components.

For more information, contact Andrew Sherrill 

at (202) 512-7215 or sherrilla@gao.gov. 
Page i GAO-09-717 

Contents 

Letter 1

Background 3 

The Current Extent of Misclassification Is Unknown, but 

Misclassification Can Be a Significant Problem with Adverse 

Consequences 10 

DOL Has Taken Limited Steps to Detect and Address 

Misclassification 15 

IRS Has Several Enforcement and Education Efforts That Focus on 

Misclassification but Faces Challenges in Undertaking These 

Efforts 20 

Collaboration among Federal Agencies Is Limited, but States 

Report Successful Collaboration to Address Misclassification 

among Their Agencies and with IRS 27 

Various Options Could Help Address Misclassification Challenges 32 

Conclusions 39 

Recommendations for Executive Action 41 

Agency Comments and Our Evaluation 42 

Appendix I Scope and Methodology 45 

Appendix II Stakeholder Views on Options to Address 

Misclassification Challenges 49 

Appendix III Comments from the Department of Labor 61 

Appendix IV Comments from the Internal Revenue Service 65 

Appendix V GAO Contacts and Staff Acknowledgments 69 

Tables 

Table 1: Differences between General Tax Responsibilities of 

Employees and Independent Contractors 5 

 Employee Misclassification 
Table 2: Key Federal and State Agencies Affected by Employee 

Misclassification 7 

Table 3: SB/SE Misclassification Examination Results by 

Examination Source, Fiscal Year 2008 21 

Table 4: Options for Addressing Employee Misclassification 33 

Table 5: Options for Addressing Employee Misclassification with 

the Greatest Level of Stakeholder Support 35 

Table 6: Options to Address Misclassification by Expressed Support, 

Opposition, or Neutrality by a Majority of Stakeholder Group 36 

Table 7: Types of Benefits and Drawbacks Stakeholders Identified 

across the 19 Options 37 

Figure 

Figure 1: Number of Misclassified Employees Identified by State 

Audits of Employers, 2000 to 2007 13 

Abbreviations 

CSP Classification Settlement Program 

DOL Department of Labor 

ETA Employment and Training Administration 

ETEP Employment Tax Examination Program 

FLSA Fair Labor Standards Act 

IRS Internal Revenue Service 

OSHA Occupational Safety and Health Administration 

QETP Questionable Employment Tax Practices 

SB/SE Small Business/Self Employed Division 

TIN taxpayer identification number 

WHD Wage and Hour Division 

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Page ii GAO-09-717 Employee Misclassification
Page 1 GAO-09-717 

United States Government Accountability Office

Washington, DC 20548 

 

August 10, 2009 

The Honorable Edward M. Kennedy 

Chairman 

Committee on Health, Education, 

 Labor, and Pensions 

United States Senate 

The Honorable Richard J. Durbin 

Chairman 

Subcommittee on Financial Services 

 and General Government 

Committee on Appropriations 

United States Senate 

The Honorable Rob Andrews 

Chairman 

Subcommittee on Health, Employment, 

 Labor, and Pensions 

Committee on Education and Labor 

House of Representatives 

The Honorable Lynn Woolsey 

Chairwoman 

Subcommittee on Workforce Protections 

Committee on Education and Labor 

House of Representatives 

In fiscal year 2007, states uncovered at least 150,000 workers who may not 

have received protections and benefits to which they were entitled 

because their employers misclassified them as independent contractors 

when they should have been classified as employees. According to the 

Bureau of Labor Statistics, approximately 10.3 million workers, or 

7.4 percent of the employed workforce, were classified as independent 

contractors in the United States in 2005, although it is not clear how many 

of these workers were misclassified. Misclassification can precipitate 

violations of labor and tax laws. Independent contractors are not covered 

by many of the labor laws that protect employees and are not eligible for 

many benefits to which employees are entitled. Misclassified employees 

may not know that they are improperly classified and may not be aware 

that they are being denied the protections and benefits to which they are 

entitled under federal and state laws. In addition, when employers 

 Employee Misclassification 
 

misclassify workers as independent contractors, they may fail to pay and 

withhold payroll taxes they would otherwise be required to pay and 

withhold, and the workers may not be aware of their tax obligations. 

No single agency is directly responsible for ensuring proper worker 

classification. Several federal agencies have responsibility, however, for 

ensuring that workers receive the benefits and protections to which they 

are entitled as employees. The Department of Labor (DOL) is responsible 

for ensuring employer compliance with several labor laws, including the 

Fair Labor Standards Act of 1938 (FLSA). Other federal agencies 

responsible for enforcing laws that provide employees—but not 

independent contractors—with benefits and protections include the Equal 

Employment Opportunity Commission and the National Labor Relations 

Board. The Internal Revenue Service (IRS) is not responsible for ensuring 

that employee protections are provided, but is responsible for ensuring 

that employers and employees pay proper payroll tax amounts and that 

employers properly withhold taxes from workers’ pay. IRS also seeks to 

provide general information to employers about worker classification. 

In response to your request, this report provides information on the 

misclassification of employees as independent contractors, including 

(1) what is known about the extent of the misclassification of employees 

as independent contractors and its associated tax and labor implications; 

(2) what actions DOL has taken to address misclassification, if any; 

(3) what actions IRS has taken to address misclassification, if any; (4) the 

extent to which DOL and IRS collaborate with each other, states, and 

other relevant agencies to prevent and address cases of employee 

misclassification; and (5) options that could help address challenges in 

preventing and responding to misclassification. 

To determine what is known about the extent of misclassification, we 

reviewed IRS’s past estimates and its plans to update its estimates of the 

revenue losses associated with misclassification; analyzed the information 

from audits that states report to DOL on the number of employers they 

determined to have misclassified employees; and reviewed 

misclassification studies conducted by states, universities, and research 

institutes. To describe actions DOL has taken to address employee 

misclassification, we examined laws, regulations, and agency policies and 

documentation; examined summary data from DOL’s Wage and Hour 

Division (WHD) on cases involving misclassification concluded during 

fiscal year 2008; reviewed select WHD misclassification case files; 

interviewed agency officials and investigators as well as employer and 

labor advocates; and surveyed states to obtain their perspectives on DOL’s 

Page 2 GAO-09-717 Employee Misclassification
 

education and outreach efforts. To describe actions IRS has taken to 

address employee misclassification, we reviewed IRS’s strategy for 

enforcing rules and regulations related to employee misclassification, 

analyzed data from IRS’s enforcement programs related to employee 

misclassification, reviewed IRS’s education and outreach activities, and 

interviewed independent contractor and labor advocates. To understand 

how DOL and IRS cooperate with each other and with states and other 

relevant agencies, we examined agency policies and procedures for 

referring cases involving misclassification, interviewed agency and state 

officials, conducted a Web-based survey of states to determine how they 

coordinate with DOL and IRS, and reviewed information from IRS’s 

Questionable Employment Tax Practices (QETP) initiative, a collaboration 

between IRS and states aimed at increasing tax compliance by employers. 

To describe options to help address misclassification, we reviewed GAO 

and other federal agency reports and recommendations and other 

organizations’ studies on misclassification of employees. We also surveyed 

relevant stakeholders to help identify such options and summarize any 

related trade-offs. 

We conducted this performance audit from August 2008 through August 

2009 in accordance with generally accepted government auditing 

standards. Those standards require that we plan and perform the audit to 

obtain sufficient, appropriate evidence to provide a reasonable basis for 

our findings and conclusions based on our audit objectives. We believe 

that the evidence obtained provides a reasonable basis for our findings 

and conclusions based on our audit objectives. For more information on 

our scope and methodology, see appendix I. 

In general, employee misclassification occurs when an employer 

improperly classifies a worker as an independent contractor instead of an 

employee.1

 As we reported in 2006, the tests used to determine whether a 

worker is an independent contractor or an employee are complex and 

differ from law to law.2

 While laws vary in their definitions of the 

Background 

 

1

In this report, we define the term employer as an entity that compensates employees, 

independent contractors, or both for services received in the course of a trade or business. 

Thus, the term does not include consumers or individuals who contract for services. While 

independent contractors may also be classified improperly as employees, this report 

focuses on the misclassification of employees as independent contractors. 

2

GAO, Employment Arrangements: Improved Outreach Could Help Ensure Proper Worker 

Classification, GAO-06-656 (Washington, D.C.: July 11, 2006). 

Page 3 GAO-09-717 Employee Misclassification
 

conditions that make a worker an employee, in general, a person is 

considered an employee if he or she is subject to another’s right to control 

the manner and means of performing the work. In contrast, independent 

contractors are individuals who obtain customers on their own to provide 

services (and who may have other employees working for them) and who 

are not subject to control over the manner by which they perform their 

services. 

Many independent contractors are classified properly, and the 

independent contractor relationship can offer advantages to both 

businesses and workers. Businesses may choose to hire independent 

contractors for reasons such as being able to easily expand or contract 

their workforces to accommodate workload fluctuations or fill temporary 

absences. Workers may choose to become independent contractors to 

have greater control over their work schedules or when they pay taxes, 

rather than have employers withhold taxes from their paychecks. 

However, employers have financial incentives to misclassify employees as 

independent contractors. While employers are generally responsible for 

matching the Social Security and Medicare tax payments their employees 

make and paying all federal unemployment taxes and a portion of or all 

state unemployment taxes, independent contractors are generally 

responsible for paying their own Social Security and Medicare tax 

liabilities and do not pay unemployment taxes because they are not 

eligible to receive unemployment insurance benefits.3

 In addition, 

businesses generally are not required to withhold the income, Social 

Security, or Medicare taxes from payments made to independent 

contractors that they are required to withhold for their employees. 

Independent contractors may also be responsible for making their own 

workers’ compensation payments, depending on their state program. The 

differences, in general terms, between the tax responsibilities of 

employees and independent contractors are summarized in table 1. 

 

3

The Federal Unemployment Tax Act (26 U.S.C. §§ 3301–3311), in combination with 53 

state-administered programs, provides for payments of unemployment compensation to 

workers who have lost their jobs. State-administered programs are subject to broad federal 

guidelines and oversight. States determine key elements of their programs, including who 

is eligible to receive state unemployment benefits and how much they receive. State 

unemployment tax revenues are held in trust by the U.S. Treasury and are used by the 

states to pay for regular, weekly unemployment benefits. Federal unemployment tax is 

used to administer the state and federal unemployment insurance programs, to administer 

the loan fund for state advances, to fund extended benefits when authorized by Congress, 

and to provide labor exchange services under the Wagner-Peyser Act. 

Page 4 GAO-09-717 Employee Misclassification
 

Table 1: Differences between General Tax Responsibilities of Employees and Independent Contractors 

Individuals classified as employees 

Individuals classified as 

independent contractors 

Type of tax 

Businesses’ general 

responsibilities 

Workers’ general 

responsibilities 

Businesses’ general 

responsibilities 

Workers’ general 

responsibilities 

Federal income taxa Withhold tax from 

employees’ pay 

Pay full amounts owed, 

generally through 

withholding 

Generally, noneb Pay full amounts 

owed, generally 

through estimated 

tax paymentsc

Social Security and Medicare 

taxesd

Withhold one half of 

taxes from employees’ 

pay and pay other half

Pay half of total 

amounts owed, 

generally through 

withholding 

None Pay full amounts 

owed, generally 

through estimated 

tax paymentsc

Federal unemployment taxePay full amount None None None 

State unemployment tax Pay full amount, 

except in certain 

statesf

None, except pay partial 

amount in certain 

statesf

None None 

Source: GAO analysis. 

Note: There are various exceptions to the general responsibilities included in this table. 

a

Most states also require payment of state income taxes. 

b

Employers are generally required to withhold taxes at a rate of 28 percent from independent 

contractors who do not provide, or provide incorrect, taxpayer identification numbers (this practice is 

known as backup withholding). 

c

For estimated tax purposes, the year is divided into four payment periods. 

d

The overall tax rates for Social Security and Medicare for 2009 are 12.4 percent and 2.9 percent of 

income, respectively. Social Security taxes are to be paid for earnings up to the established wage 

base limit ($106,800 for 2009). 

e

Employers generally are required to pay federal unemployment insurance on the first $7,000 of 

employee pay at a rate of 6.2 percent, which can be offset by a credit of up to 5.4 percent for timely 

payment of state unemployment insurance taxes, resulting in an effective rate as low as 0.8 percent. 

The rate is set to decrease to 6.0 percent in 2010. 26 U.S.C. §§ 3301, 3302. 

f

According to DOL, these states are Alaska, New Jersey, and Pennsylvania. 

While businesses may be confused about how to properly classify 

workers, some employers may misclassify employees to circumvent laws 

that restrict employers’ hiring, retention, and other labor practices, and to 

avoid providing numerous rights and privileges provided to employees by 

federal workforce protection laws. These laws include 

• FLSA, which establishes minimum wage, overtime, and child labor 

standards for employees; 

• the Americans with Disabilities Act of 1990 and the Age Discrimination in 

Employment Act of 1967, which protect employees from discrimination 

based on disability or age; 

Page 5 GAO-09-717 Employee Misclassification
 

• the Family and Medical Leave Act of 1993, which provides various 

protections for employees who need time off from their jobs because of 

medical problems or the birth or adoption of a child; and 

• the National Labor Relations Act, which guarantees the right of employees 

to organize and bargain collectively. 

Employers may also choose to misclassify their employees in order to 

avoid having to obtain proof that workers are U.S. citizens or obtain work 

visas for them. In addition, independent contractors generally do not 

qualify to participate in health and pension plans that employers may offer 

to employees. Finally, when employers misclassify employees, they may 

be able to undercut competitors because their costs are reduced. 

While some workers may agree to be misclassified as independent 

contractors in order to be paid in cash, avoid withholding of taxes, or 

prevent having to provide proof of their immigration status, other workers 

may not realize that they have been misclassified. In addition, they may 

not realize that as independent contractors, they are not protected under 

many laws designed to protect employees, and that they have obligations 

for which employees are not responsible, such as payment of their own 

taxes over the course of the year. 

Responsibility for enforcing laws that afford employee protections and 

administering programs that can be affected by employee misclassification 

issues is dispersed among a number of federal and state agencies, as 

shown in table 2. 

Page 6 GAO-09-717 Employee Misclassification
 

Table 2: Key Federal and State Agencies Affected by Employee Misclassification 

Agency 

Areas potentially affected by employee 

misclassification 

DOL • Minimum wage, overtime, and child labor 

provisions 

• Job-protection and unpaid leave 

• Safety and health protections 

IRS • Federal income and employment (payroll) taxes 

Department of Health and 

Human Services 

• Medicare benefit payments 

DOL, IRS, and the Pension 

Benefit Guaranty Corporation 

• Pension, health, and other employee benefit 

plans 

Equal Employment Opportunity 

Commission 

• Prohibitions of employment discrimination based 

on factors such as race, gender, disability, or age 

National Labor Relations Board • The right to organize and bargain collectively 

Social Security Administration • Retirement and disability coverage and payments

State agencies • Unemployment insurance benefit payments 

• State income and employment taxes 

• Workers’ compensation benefit payments 

Source: GAO analysis. 

Misclassification itself is not a violation of any federal labor law, but it can 

result in violations of federal and state laws. For example, DOL’s Wage and 

Hour Division (WHD) may cite employers that have misclassified their 

employees as independent contractors for violations of FLSA relating to 

recordkeeping (not keeping required records for these employees), 

nonpayment of the federal minimum wage, and nonpayment of overtime. It 

also assesses back wages owed to workers in cases where 

misclassification leads to nonpayment of overtime or minimum wage. IRS 

can also assess taxes and penalties on employers that it finds have 

misclassified employees. 

However, some workers who would otherwise be considered employees 

are deemed not to be employees for tax purposes. With increased IRS 

enforcement of the employment tax laws beginning in the late 1960s, 

controversies developed over whether employers had correctly classified 

certain workers as independent contractors rather than as employees. In 

some instances when IRS prevailed in reclassifying workers as employees, 

the employers became liable for portions of employees’ Social Security 

and income tax liabilities (that the employers had failed to withhold and 

remit), although the employees might have fully paid their liabilities for 

self-employment and income taxes. 

Page 7 GAO-09-717 Employee Misclassification
 

Page 8 GAO-09-717 Employee Misclassification 

In response to this problem, Congress enacted section 530 of the Revenue 

Act of 1978.4

 That provision generally allows employers to treat workers as 

not being employees for employment tax purposes regardless of the 

workers’ actual status if the employers meet three tests.5

 The employers 

must have filed all federal tax returns in a manner consistent with not 

treating the workers as employees, consistently treated similarly situated 

workers as independent contractors, and had a reasonable basis for 

treating the workers as independent contractors. Under section 530, a 

reasonable basis exists if the employer reasonably relied on (1) past IRS 

examination practice with respect to the employer,6

 (2) published rulings 

or judicial precedent, (3) long-standing recognized practices in the 

industry of which the employer is a member, or (4) any other reasonable 

basis for treating a worker as an independent contractor. Section 530 also 

prohibits IRS from issuing regulations or Revenue Rulings with respect to 

the classification of any individual for the purposes of employment taxes. 

Congress intended that this moratorium to be temporary until more 

workable rules were established, but the moratorium continues to this 

day. The provision was extended indefinitely by the Tax Equity and Fiscal 

Responsibility Act of 1982.7

Federal agencies use different tests to determine whether a worker is an 

independent contractor or an employee. IRS uses the concepts of 

behavioral control and financial control and the relationship between the 

employer and the worker to determine whether a worker is an employee,8

 

4

Pub. L. No. 95-600, 92 Stat. 2763 (Nov. 6, 1978). 

5

Section 530 does not apply in the case of certain technical workers (engineers, designers, 

drafters, computer programmers, systems analysts, or other similar skilled workers 

engaged in a similar line of work) who provide services for third parties pursuant to 

arrangements between the business for whom the technical worker works and the third 

party. Tax Reform Act of 1986, Pub. L. No. 99-514, § 1706 (Oct. 22, 1986). 

6

In 1989, we stated that Congress may want to consider repealing the limitation on IRS 

prospectively reclassifying employees who may have been misclassified. See GAO, Tax 

Administration: Information Returns Can Be Used to Identify Employers Who 

Misclassify Workers, GAO/GGD-89-107 (Washington, D.C.: Sept. 25, 1989). Based in part on 

this report, Congress modified section 530 through the Small Business Job Protection Act 

of 1996 (Pub. L. No. 104-188, August 20, 1996) to limit the past examination practice 

reasonable basis to examinations for employment tax purposes of whether a worker 

should be treated as an employee. 

7

Pub. L. No. 97-248, 96 § 269(c)(1)(C)(2), 96 Stat. 324 (Sept. 3, 1982). 

8

See IRS Publication 1779, Independent Contractor or Employee, and Publication 15-A, 

Employer’s Supplemental Tax Guide. 
 

while WHD uses six factors identified by the United States Supreme Court 

to determine employee status during investigations of FLSA violations. 

The complexity and variety of worker classification tests may also 

complicate agencies’ enforcement efforts. In addition, states use varying 

definitions of employee. For example, according to a report commissioned 

by DOL, at least 4 states follow IRS’s test, and at least 10 states use their 

own definitions. The remaining states use various definitions that rely at 

least in part on whether the employer has the right to control the worker. 

Decisions regarding employee status are sometimes determined through 

the courts. For example, in a recent decision, the United States Court of 

Appeals for the District of Columbia Circuit ruled that drivers for FedEx’s 

small package delivery unit are independent contractors, and not 

employees, and therefore do not have the right to bargain collectively. 

FedEx had sought review of the determination by the National Labor 

Relations Board that the FedEx drivers were employees and that FedEx 

had committed an unfair labor practice by refusing to bargain with the 

union certified as the collective bargaining representative of its 

Wilmington, Massachusetts drivers. In ruling that the drivers are 

independent contractors, the court noted that because FedEx Ground 

drivers can operate multiple routes, hire extra drivers, and sell their routes 

without company permission, they were not like employees of traditional 

trucking companies.9

Legislation aimed at preventing employee misclassification has been 

introduced in previous sessions of Congress. At least four bills relating to 

employee misclassification were introduced in the 110th Congress. Two of 

the bills, both titled the Employee Misclassification Prevention Act (H.R. 

6111 and S. 3648), were introduced in the House of Representatives and 

the Senate, respectively, to amend FLSA to require employers to keep 

records of independent contractors and to provide a special penalty for 

misclassification. Two other bills were aimed, in part, at amending the 

Internal Revenue Code to aid in proper classification. The Independent 

Contractor Proper Classification Act of 2007 (S. 2044) was introduced in 

the Senate to provide procedures for the proper classification of 

employees and independent contractors, including amending the tax code 

and requiring DOL and IRS to exchange information regarding cases 

involving employee misclassification. In the House of Representatives, the 

Taxpayer Responsibility, Accountability, and Consistency Act of 2008 

 

9

FedEx Home Delivery v. National Labor Relations Board, 563 F.3d 492 (D.C. Cir. 2009). 

Page 9 GAO-09-717 Employee Misclassification
 

(H.R. 5804) sought to amend the Internal Revenue Code to modify the 

rules relating to the treatment of individuals as independent contractors or 

employees, including requiring IRS to inform DOL of cases involving 

employee misclassification. However, these bills were not enacted into 

law. 

Although the national extent of employee misclassification is unknown, 

earlier national studies and more recent, though not comprehensive, 

studies suggest that employee misclassification could be a significant 

problem with adverse consequences. 

In its last comprehensive estimate of misclassification, for tax year 1984, 

IRS estimated that nationally about 15 percent of employers misclassified 

a total of 3.4 million employees as independent contractors, resulting in an 

estimated revenue loss of $1.6 billion (in 1984 dollars).10 Nearly 60 percent 

of the revenue loss was attributable to the misclassified individuals failing 

to report and pay income taxes on compensation they received as 

misclassified independent contractors. The remaining revenue loss 

stemmed from the failure of (1) employers and misclassified independent 

contractors to pay taxes for Social Security and Medicare and 

(2) employers to pay federal unemployment taxes. 

The Current Extent of 

Misclassification Is 

Unknown, but 

Misclassification Can 

Be a Significant 

Problem with Adverse 

Consequences 

For 84 percent of the workers misclassified as independent contractors in 

tax year 1984, employers reported the workers’ compensation to IRS and 

the workers, as required, on the IRS Form 1099-MISC information return.11

These workers subsequently reported most of their compensation (77 

percent) on their tax returns. In contrast, workers misclassified as 

independent contractors for whom employers did not report 

 

10The study did not include an estimate of the percentage of all independent contractors 

who were misclassified by their employers (that is, of all independent contractors, the 

percentage that should have been classified as employees). 

11Employers are generally required to report payments of $600 or more in any given year 

made to independent contractors on Form 1099-MISC, unless the independent contractors 

are incorporated. 

Page 10 GAO-09-717 Employee Misclassification
 

compensation on Form 1099-MISC reported only 29 percent of their 

compensation on their tax returns.12

Although IRS has not updated the information from its 1984 report, it plans 

to review the national extent of employee misclassification as part of a 

broader study of employment tax compliance.13 However, IRS officials 

anticipate that the results of this study will not be available until 2013, at 

the earliest. As part of its National Research Program, IRS plans to 

examine a randomly selected sample of employers’ tax returns for tax 

years 2008 to 2010. IRS employment tax officials told us they may need to 

extend the study if they have not collected sufficient data to provide 

reliable estimates. For the misclassification part of the employment tax 

compliance study, they said they hope to estimate the number of 

employers that misclassify employees, the number of employees who are 

misclassified, and the resulting loss of tax revenue. The officials also said 

they are uncertain whether IRS will be able to collect sufficient data to 

estimate the extent of misclassification within particular industries or 

geographic regions. 

A study commissioned by DOL in 2000 found that from 10 percent to 

30 percent of firms audited in nine selected states had misclassified 

employees as independent contractors.14 The study also estimated that if 

 

12In past reports, we identified various options to improve tax compliance among 

independent contractors and sole proprietors, who are included in a category of selfemployed taxpayers along with independent contractors. In 1996, we identified two 

approaches to increase tax compliance of independent contractors: (1) require businesses 

to withhold taxes from payments to independent contractors and (2) improve information 

reporting on payments made to independent contractors. See GAO, Tax Administration: 

Issues in Classifying Workers as Employees or Independent Contractors, 

GAO/T-GGD-96-130 (Washington, D.C.: June 20, 1996). In 2007, we analyzed various options 

to address tax noncompliance among sole proprietors. See GAO, Tax Gap: A Strategy for 

Reducing the Gap Should Include Options for Addressing Sole Proprietor 

Noncompliance, GAO-07-1014 (Washington, D.C.: July 13, 2007). In 2009, we made various 

recommendations to improve compliance with filing Forms 1099-MISC. See GAO, Tax Gap: 

IRS Could Do More to Promote Compliance by Third Parties with Miscellaneous Income 

Reporting Requirements, GAO-09-238 (Washington, D.C.: Jan. 28, 2009). 

13We previously attempted to estimate the extent of misclassification and the extent of 

income tax losses using compliance data that existed in 1994, but these data were not 

sufficient to produce reliable estimates. See GAO, Tax Administration: Estimates of the 

Tax Gap for Service Providers, GAO/GGD-95-59 (Washington, D.C.: Dec. 28, 1994). 

14Planmatics, Inc., Independent Contractors: Prevalence and Implications for 

Unemployment Insurance Program (Rockville, Md: U.S. Department of Labor, February 

2000). 

Page 11 GAO-09-717 Employee Misclassification
 

only 1 percent of all employees were misclassified nationally, the loss in 

overall unemployment insurance revenue because of employers’ 

underreporting of unemployment taxes across all states would be nearly 

$200 million annually. In addition, the Bureau of Labor Statistics 

periodically conducts a survey of contingent workers (defined as workers 

holding jobs that are expected to last only a limited period of time), 

including independent contractors.15 The most recent survey, conducted in 

2005, revealed that 10.3 million U.S. workers were classified as 

independent contractors—approximately 7.4 percent of all workers. 

However, the survey did not indicate how many of these workers were 

misclassified. 

State officials we interviewed told us that in their opinion, 

misclassification has generally increased over recent years. State activity 

in this area may support this view. For example, officials from New 

Hampshire’s Department of Labor said the agency recently hired four new 

investigators to focus exclusively on investigations of employee 

misclassification. Summary data states reported to DOL’s Employment 

and Training Administration, which oversees state administration of the 

unemployment insurance program, showed that from 2000 to 2007 the 

number of misclassified workers uncovered by state audits had increased 

from approximately 106,000 workers to over 150,000 workers, as shown in 

figure 1.16 While these counts reveal an upward trend, they likely 

undercount the overall number of misclassified employees, since states 

generally audit less than 2 percent of employers each year. 

 

15This survey, a supplement to the Current Population Survey, is a household survey in 

which workers are asked to self-report information about their jobs. It was conducted in 

February 1995, 1997, 1999, 2001, and 2005. 

16States may uncover misclassification during their audits of employers’ unemployment 

insurance tax payments. DOL requires states to report summary information related to 

misclassification from these audits on a quarterly basis, including the overall number of 

misclassified employees identified. We did not evaluate whether states changed their audit 

criteria over this period of time, which may explain the increase in some or all of the 

numbers of misclassified workers identified by the states. In addition, we note that during 

this period, the total number of employers audited by states increased from approximately 

114,000 to about 117,000. 

Page 12 GAO-09-717 Employee Misclassification
 

Figure 1: Number of Misclassified Employees Identified by State Audits of 

Employers, 2000 to 2007 

Number of employees

Source: GAO analysis of DOL data.

Year

0

20,000

40,000

60,000

80,000

100,000

120,000

140,000

160,000

180,000

2000 2001 2002 2003 2004 2005 2006 2007

106,239 107,210

125,262 123,044

139,554

132,965

158,267

151,039

State officials, however, told us that summary data they reported to DOL’s 

Employment and Training Administration (ETA) did not include all 

misclassification identified by their investigations. For example, officials 

from one state said they did not report cases to DOL that did not meet 

ETA’s prescriptive audit criteria that mandate, among other things, 

extensive testing of an employer’s payroll records. Furthermore, the 

official pointed out that the data ETA collects do not include cases 

involving workers in the underground economy, where workers are paid in 

cash and income is not reported to states or IRS. 

Studies conducted by states, universities, and research institutes have 

been generally limited in scope—for example, confined to one state or a 

specific industry within a state. However, some of these studies have 

noted that misclassification is especially prevalent in certain industries, 

such as construction. For example, a study conducted by Harvard 

University on the extent of misclassification in the construction industry in 

Maine estimated that approximately 14 percent of construction firms 

misclassified at least some of their employees each year from 1999 to 

Page 13 GAO-09-717 Employee Misclassification
 

2002.17 Maine state officials told us that following the study, they began 

targeting construction firms for their unemployment insurance audits and 

found higher levels of misclassification—up to 45 percent of the firms 

audited misclassified at least some of their employees. 

Misclassification may undermine workers’ access to protections, such as 

unemployment insurance and workers’ compensation. For example, one 

group that advocates for workers cited an instance of a construction 

worker who fell three stories, was severely injured, and incurred hospital 

expenses of over $10,000 related to the injury. Because the worker was 

misclassified as an independent contractor, his employer did not provide 

workers’ compensation coverage for the employee. Several union officials 

told us that misclassification of workers is especially prevalent in the 

construction industry where workers are often paid entirely in cash and, 

as a result, are not noted on the employers’ records at all, either as 

employees or independent contractors. These officials told us they believe 

that some employers have been emboldened to begin operating on a cash 

basis by the ease with which they are able to misclassify their workers. 

The WHD investigation case files we reviewed provided detail on several 

instances where misclassified employees did not receive minimum wages 

or overtime pay. For example, one case involved a medical transcription 

service that hired workers—whom WHD determined had been 

misclassified as independent contractors under FLSA—to work out of 

their homes transcribing medical files they downloaded from the 

company’s computer system. When the system was not accessible, 

workers were not paid—although they were required to remain available 

until the system became operational—and, as a result, they were not paid 

the minimum wage required by FLSA. 

 

17Construction Policy Research Center, Harvard University, The Social and Economic 

Costs of Employee Misclassification in the Maine Construction Industry (Cambridge, 

Mass.: Apr. 25, 2005). This study was based on unemployment insurance audits conducted 

by the state of Maine. We did not assess the study to determine whether the methodology 

used was reliable. 

Page 14 GAO-09-717 Employee Misclassification
 

DOL’s detection of employee misclassification is generally the indirect 

result of its investigations of alleged FLSA violations, particularly 

complaints involving nonpayment of overtime or minimum wages. WHD 

officials have stated to Congress that the misclassification of an employee 

as an independent contractor is not itself a violation of FLSA or other laws 

WHD enforces. Misclassification, however, is often associated with FLSA 

violations—in particular, recordkeeping violations and the failure to pay 

overtime or minimum wages. When WHD finds FLSA violations resulting 

from misclassification, it assesses back wages owed to workers as 

appropriate. In addition, although there is no penalty for recordkeeping 

violations, WHD requires businesses to place any workers the employer 

reclassifies as employees on the company payroll records, as per FLSA 

rules. 

DOL Has Taken 

Limited Steps to 

Detect and Address 

Misclassification 

Our review of the case files also showed that WHD investigators, in the 

course of their investigations, did not consistently review documents that 

could indicate that employees had been misclassified. Specifically, 

investigators may ask employers about independent contractors or 

uncover misclassification through worker interviews, according to the 

information contained in the case files. However, they did not, as a matter 

of course, review employer records such as IRS Forms 1099-MISC that 

show payments made to independent contractors. Reviewing these 

records could aid WHD investigators in identifying workers who have 

been misclassified. Although one district director told us it is standard 

practice for investigators in his office to ask for this type of information 

during an investigation, it is not WHD policy to do so. 

Many of the experts we interviewed said that targeted investigations of 

employers or industries could increase the detection of misclassification. 

Approximately 80 percent of the investigations WHD concluded in 2008 

involving misclassification were initiated because of complaints from 

workers about possible labor violations. However, several experts we 

spoke with pointed out that some workers, such as immigrants or those in 

low-wage industries, are often less likely to file complaints with WHD.18

Thus, a lack of targeted investigations coupled with the reluctance of 

misclassified workers to complain may result in less effective enforcement 

of proper classification. WHD officials told us that their ability to conduct 

 

18Experts we spoke with explained that this reluctance sometimes stems from the fear of 

losing one’s job, employer coercion, or, in the case of immigrant workers, apprehension 

about interacting with the federal government. 

Page 15 GAO-09-717 Employee Misclassification
 

targeted investigations in recent years has been limited by reductions in 

agency resources combined with consistently high levels of worker 

complaints about possible labor law violations.19 According to WHD 

policy, the first priority of the agency’s enforcement is to respond to

complaints.

 these 

 

20

WHD conducts few investigations targeted at misclassification, though it 

has begun to place a greater focus on misclassification within existing 

agency initiatives. WHD concluded over 24,500 FLSA cases in fiscal year 

2008, and misclassification was the primary reason for the violation 

identified in 131 investigations. Most of these investigations (80 percent) 

were initiated by complaints from workers rather than being targeted by 

WHD. In the 26 investigations that were targeted by WHD,21 the agency 

identified 341 misclassified employees who were owed back wages of over 

$88,000. In the 1990s, WHD implemented initiatives to conduct targeted 

investigations within low-wage industries with a history of FLSA 

violations, such as restaurants, hotels, and nursing homes. These 

initiatives enabled WHD to detect employee misclassification to the extent 

it was prevalent in those industries. WHD officials told us that in fiscal 

year 2007, in part because of heightened congressional interest in 

misclassification, they instructed their district directors to place a special 

emphasis on those low-wage industries within their districts with a history 

of misclassifying employees. During fiscal year 2009, for example, the New 

Orleans district office planned to conduct targeted investigations of the 

19On March 25, 2009, the Secretary of Labor announced plans to hire 150 new investigators. 

WHD officials said they did not know whether this would enable them to target more 

employers for investigation. 

20GAO has recently conducted evaluations of WHD’s enforcement efforts and made 

recommendations for improvement. See GAO, Fair Labor Standards Act: Better Use of 

Available Resources and Consistent Reporting Could Improve Compliance, GAO-08-962T 

(Washington, D.C.: July 15, 2008); Department of Labor: Wage and Hour Division’s 

Complaint Intake and Investigative Processes Leave Low Wage Workers Vulnerable to 

Wage Theft, GAO-09-458T (Washington, D.C.: Mar. 25, 2009); and Department of Labor: 

Wage and Hour Division Needs Improved Investigative Processes and Ability to Suspend 

Statute of Limitations to Better Protect Workers Against Wage Theft, GAO-09-629 

(Washington, D.C.: July 23, 2009). 

21Although WHD categorized nine of these cases as targeted investigations, they actually 

stemmed from investigations based on complaints from workers. In addition, targeted 

investigations that do not result in violations are not flagged as involving employee 

misclassification in WHD’s database. Therefore, we were unable to determine the 

effectiveness of the agency’s targeting strategy. 

Page 16 GAO-09-717 Employee Misclassification
 

staffing and janitorial industries in its region, although it limited this effort 

to three investigations. 

Examples of state efforts support the potential effect of targeted 

investigations aimed at detecting misclassification. New York’s 

Department of Labor has created a task force that conducts investigations 

and audits aimed specifically at detecting misclassification. Among other 

activities, the task force conducts sweeps, or targeted investigations of 

businesses located within a certain area or within industries where 

misclassification is prevalent. In conducting investigations during 2007 and 

2008 that targeted approximately 300 businesses in the retail and 

commercial industries, the task force found that 67 percent of the 

businesses were in violation of unemployment laws, labor standards, or 

workers’ compensation laws. In addition, at the request of investigators, 

the task force scheduled follow-up audits of about half of these employers. 

As of December 2008, it had completed 54 of these audits and found in 

approximately 70 percent of them that employers had continued to 

misclassify at least some employees as independent contractors. 

In addition, the task force conducted targeted investigations of over 

600 businesses, primarily in the construction industry. It found labor 

violations in nearly half of these businesses and ordered follow-up 

investigations. Just over half of these investigations have been completed, 

resulting in nearly 7,800 employees being identified as misclassified. The 

state determined that the misclassification led to $2.2 million in unpaid 

wages, over $3.5 million in unpaid unemployment taxes and associated 

penalties, and over $1 million in penalties related to workers’ 

compensation. As a result of all investigations conducted during a 16-

month period ending December 31, 2008, the task force detected 12,300 

instances of misclassification, with approximately $12 million in 

associated unpaid wages. In contrast, in fiscal year 2008, WHD identified 

1,619 instances of misclassification nationwide during its investigations 

and assessed about $1 million in unpaid wages. 

DOL has begun to track cases of misclassification in its WHD 

investigations database. However, although DOL’s Occupational Safety 

and Health Administration (OSHA) may identify misclassification during 

its safety and health inspections, it does not record this information in its 

inspections database. In addition, in their responses to our survey, a 

majority of state workforce agencies noted that their states collect data on 

the occurrences of misclassification, but most of those states do not send 

this information to DOL. For example, an official in one state agency told 

us that in 2008 his state conducted investigations that led to the detection 

Page 17 GAO-09-717 Employee Misclassification
 

of approximately 46,000 instances of misclassification, but that DOL 

collected no information associated with those cases. Since this 

information would likely include the names of employers that 

misclassified their employees, and the industries involved, collecting it 

could enable DOL to focus its investigations more effectively on certain 

employers or industries with a known history of misclassification. 

DOL Makes Only Limited 

Use of Education or 

Penalties to Deter 

Misclassification 

Although education and outreach to workers could help reduce the 

incidence of misclassification, DOL’s work in this area is limited. The DOL 

Web site contains publications on the employment relationship under 

FLSA, some of which mention the use of independent contractors.22

However, the Web site does not provide material that focuses specifically 

on the subject of employee misclassification. In addition to publications, 

the DOL Web site provides printable workplace posters, some of which 

employers are required to display in their workplaces. However, none of 

WHD’s posters contain information on employment relationships or 

misclassification. 

DOL employees sometimes hand out to workers pamphlets that contain 

general information on workers’ rights. Also, DOL staff provides 

information materials at seminars and training sessions for employers. 

While these materials address what constitutes an employment 

relationship, they do not specifically mention misclassification. Similarly, 

WHD district directors we interviewed told us that their staffs do not 

conduct employer and worker outreach activities specifically on 

misclassification. However, some said their staffs may provide information 

about misclassification when answering questions from employers or 

workers. Finally, an OSHA official told us that the agency does not 

conduct any outreach or education directly related to misclassification, 

although officials in one region told us that workers were misclassified as 

independent contractors at over 80 percent of the construction sites they 

inspected. 

 

22Department of Labor, Wage and Hour Division, Employment Relationship Under the 

Fair Labor Standards Act, WH Publication 1297 (Washington, D.C., August 1985); “Fact 

Sheet #13: Employment Relationship Under the Fair Labor Standards Act,” 

http://www.dol.gov/esa/whd/fact-sheets-index.htm (accessed June 1, 2009); and “Fact Sheet 

#35: Joint Employment and Independent Contractors Under the Migrant and Seasonal 

Agricultural Worker Protection Act,” http://www.dol.gov/esa/whd/fact-sheets-index.htm

(accessed June 1, 2009). 

Page 18 GAO-09-717 Employee Misclassification
 

According to our survey, few states regard DOL’s efforts to educate 

workers and employers on employee misclassification to be effective. In 

fact, 16 states had no awareness of DOL education or outreach on the 

subject. Of the states that were aware of DOL’s outreach activities, only 

5 reported that they thought outreach for workers was effective, and only 

6 stated that it was effective for employers. Further, some experts we 

interviewed also expressed the view that DOL’s education and outreach 

efforts on misclassification are inadequate and that improvement is 

needed, especially for vulnerable populations. For example, some noted 

that immigrants are less likely to know their rights and are more likely to 

be misclassified than other types of workers. 

WHD district directors we interviewed noted that there are challenges 

associated with reaching vulnerable populations, such as immigrant 

workers. Some noted that many noncitizens, whether documented or not, 

are wary of government and therefore reluctant to approach DOL officials 

or attend DOL-sponsored events. Despite this challenge, the directors told 

us that their offices coordinate with immigrant population communities in 

order to educate workers on labor issues. For instance, staff from the 

Boston and New Orleans district offices told us they participate in 

presentations, information sessions, and forums with the Hispanic 

communities in their districts in coordination with the Mexican 

consulates. These activities are generally broad in scope but may include 

specific information on misclassification. 

When WHD identifies misclassification, the division does not use all 

available remedies—such as assessing financial penalties, pursuing back 

wages owed to workers who have been misclassified, and conducting 

follow-up investigations of employers that have misclassified workers—to 

penalize employers who have violated FLSA and help ensure future 

compliance. WHD levied penalties in less than 2 percent of the cases 

involving misclassification it completed in fiscal year 2008—2 of 131 

investigations. In contrast, the division levied penalties in 6 percent of the 

cases involving FLSA violations from 2000 to 2007. WHD can only levy 

penalties for violations of the minimum wage or overtime pay provisions 

of FLSA when the violations are willful or repeated, though a WHD district 

director noted that it can be difficult to prove that employers are willfully 

misclassifying employees. In addition, although WHD determined that 

there were back wages to be paid in most of these cases, we found that 

investigators did not always follow up to ensure that employees were paid 

the back wages assessed. For example, in one case we reviewed, the 

employer did not provide documented proof that she paid back wages of 

over $5,000 owed to her employees, but WHD closed the case and 

Page 19 GAO-09-717 Employee Misclassification
 

Page 20 GAO-09-717 Employee Misclassification 

recorded the back wages as paid. Further, WHD officials told us that if the 

division uncovers violations caused by misclassification, it does not 

generally conduct follow-up investigations to ensure that the employees 

are properly classified. 

IRS’s misclassification enforcement strategy relies on identifying and 

examining employers that have potentially misclassified employees. IRS 

primarily identifies employers to examine for potential misclassification 

through four sources: 

• The Determination of Worker Status (Form SS-8) Program, in which 

workers or employers request that IRS determine whether a specific 

worker is an employee or an independent contractor for purposes of 

federal employment tax and income tax withholding through the 

submission of Form SS-8.23 IRS examines some of the employers it 

determines to have misclassified workers through the SS-8 program. 

• The Employment Tax Examination Program (ETEP), in which IRS uses 

specific criteria to identify for examination employers that have a high 

likelihood of having misclassified employees. 

• General employment tax examinations, meaning examinations of tax 

returns that are started because of separate employment tax issue that 

lead to examinations of classification issues. 

• The Questionable Employment Tax Practices (QETP) program, through 

which IRS and states share information on worker classification-related 

examinations and other questionable employment tax issues. IRS 

examines some employers that states have determined to have 

misclassified employees. 

IRS’s Small Business/Self Employed Division (SB/SE) conducts the 

majority of IRS’s misclassification-related examinations. It made 

applicable assessments (taxes and penalties) in 71 percent of such 

examinations that it closed during fiscal year 2008, resulting in a total of 

almost $64 million in assessments, as shown in table 3. A description of 

the four programs though which IRS primarily generates misclassificationrelated examinations follows table 3. Also following table 3 is a 

description of IRS’s Classification Settlement Program (CSP), which 

 

23IRS Form SS-8, Determination of Worker Status for Purposes of Federal Employment 

Taxes and Income Tax Withholding. 

IRS Has Several 

Enforcement and 

Education Efforts 

That Focus on 

Misclassification but 

Faces Challenges in 

Undertaking These 

Efforts 
 

enables qualifying employers under examination for misclassificationrelated issues to lower their misclassification-related tax liabilities if they 

agree to properly classify their workers in the future. 

Table 3: SB/SE Misclassification Examination Results by Examination Source, Fiscal Year 2008

Examination source 

SS-8 ETEP 

General 

examinations QETP

All 

programs

Number of closed examinationsa38 221 690 232 1,181

Percentage of all closed examinations by referral source 3 19 58 20 100

Number of closed examinations with assessments 30 127 522 165 844

Percentage of closed examinations with assessmentsb79 57 76 71 71

Total assessments (dollars in millions)c$1.1 $11.8 $40.9 $9.8 $63.5

Average assessment per examination $28,191 $53,378 $59,225 $42,314 $53,810

Source: GAO analysis of IRS data. 

Notes: We could not isolate the assessments made for taxpayers with CSP agreements because 

before fiscal year 2009, IRS did not separately track the outcomes of such examinations. For a 

qualifying taxpayer who enters into a CSP agreement, IRS records the dollar amount of the 

settlement as the assessment amount, not the dollar amount that would otherwise have been 

assessed for the taxpayer. IRS conducts examinations of taxpayers who do not comply with the terms 

of their CSP agreements, and assessments from such cases are included in table 3. 

a

In fiscal year 2008, SB/SE conducted all of IRS’s examinations based on ETEP and QETP, all but 

one of IRS’s examinations based on SS-8 referrals, and the majority of IRS’s misclassification-related 

examinations based on general examinations. Examinations completed in fiscal year 2008 cover tax 

returns from previous tax years. 

b

A portion of the examinations that resulted in no assessments were closed because the taxpayers in 

question qualified for protection under section 530 of the Revenue Act of 1978, but IRS does not track 

the number of cases that are closed for this reason. 

c

Total assessments for each examination source do not sum to the total assessments for all programs 

because of rounding. Assessment amounts may include tax liabilities related to other employment tax 

issues that were assessed to the same taxpayer concurrently, as well as any penalties. Total 

assessments reflect the amounts that examiners recommended rather than the amounts collected by 

IRS. Taxpayers may challenge IRS’s recommended assessments. 

Through its SS-8 program, IRS provides workers or employers that file 

Forms SS-8 with its determination on the correct classification of the 

workers in question. IRS also uses the program to identify employers that 

may have misclassified employees and therefore would be fruitful to 

examine. In fiscal year 2008, 72 percent of all Form SS-8 requests filed 

resulted in IRS determinations that the workers in question were 

employees, 25 percent were closed without any advice given, and 

3 percent resulted in determinations that the workers in question were 

Page 21 GAO-09-717 Employee Misclassification
 

independent contractors or had other results.24 IRS’s SS-8 unit makes these 

determinations, in part, using information workers or employers provide 

on Forms SS-8.25 After making classification determinations, IRS sends 

letters to employers to provide them with guidance on how to voluntarily 

amend their tax returns to comply with the determinations. IRS’s SS-8 unit 

then uses specific criteria to determine which cases it should refer for 

examination, including the amount of compensation the worker in 

question earned, the number of similar workers hired by the employer, and 

whether the case likely involves fraud. The majority of employers the SS-8 

unit determined to have misclassified employees are very small 

businesses, which generally are not referred because examining such 

businesses is generally not cost effective. As a result, IRS officials 

estimated that for recent tax years, only an average of 2 percent to 

3 percent of employers it identified to have misclassified employees 

through SS-8 determinations were referred for examination, and an even 

smaller percentage resulted in examinations.26

For ETEP, IRS uses a computer matching program to identify annually 

employers that potentially misclassified employees. The match criteria 

include employers that reported paying compensation to workers (on 

Form 1099-MISC), the amount of compensation the workers reported on 

their tax returns, and the portion of the workers’ total income that was 

 

24According to IRS employment tax officials, the SS-8 unit closes about 20 percent of cases 

it receives each year without a determination for various reasons. For example, IRS may 

need to contact employers in order to make a determination for Form SS-8 requests filed by 

workers, and some workers withdraw their SS-8 requests because of fear of retaliation 

from their employers. To avoid duplication, the SS-8 unit does not make a determination in 

cases where IRS is examining the employer. In addition, a case is closed if the associated 

Form SS-8 is incomplete and IRS is unable to contact the applicant. 

25About 90 percent of Form SS-8 requests are filed by workers. 

26IRS examines an even smaller percentage of all Forms SS-8 filed. For example, IRS closed 

39 examinations of employers that it identified through SS-8 determinations in fiscal year 

2008 out of the almost 12,000 such requests filed. This amount was an increase from the 

average of 6,000 Form SS-8 requests that were filed annually for fiscal years 2005 through 

2007. This increase was prompted, in part, by a new IRS form (Form 8919) that informs 

workers who think they may have been misclassified that they can file a Form SS-8 to 

obtain a determination from IRS. 

Page 22 GAO-09-717 Employee Misclassification
 

paid by the employers.27 IRS uses these criteria to identify employers to 

examine with the greatest potential for tax assessments. IRS officials told 

us that generally IRS examines about 1 percent to 3 percent of the 

employers it identifies annually through ETEP to have potentially 

misclassified employees. IRS does not examine some employers that it 

determines based on the ETEP match to have potentially misclassified 

employees, such as those that no longer appear to be in business; appear 

to have legitimate reasons for meeting the ETEP selection criteria, such as 

employers who compensate real estate agents, who are statutorily defined 

as independent contractors; or are protected by section 530. For tax year 

2006, IRS identified over 33,000 employers through ETEP.28 In fiscal year 

2008, IRS examined 221 employers it identified through ETEP, as reflected 

in table 3. 

Over half (58 percent) of the misclassification-related examinations of 

employers that SB/SE conducted in fiscal year 2008 arose through the 

course of IRS examining employers for other types of employment tax 

noncompliance. IRS examiners in all divisions are trained about 

misclassification issues, but the depth of training depends upon the 

division and group in which the examiners work. 

According to IRS employment tax officials, QETP, initiated in December 

2007, has proven to be a useful source of timely leads on potential 

misclassification cases. QETP is a collaborative initiative between IRS 

and, currently, 34 participating states through which IRS and state 

workforce agencies share information on misclassification examinations. 

IRS employment tax officials told us that the examination information that 

states provide through QETP is especially useful to the agency because it 

 

27In a 1989 report, we recommended that IRS match independent contractors’ information 

returns with their tax returns to more systematically identify employers that are 

misclassifying employees as independent contractors. One scenario we discussed in the 

report involved identifying independent contractors with incomes of more than $10,000 to 

identify contractors who received all of their income from one employer. See 

GAO/GGD-89-107. IRS’s use of this matching process during the review led it to assess 

$9.9 million in additional taxes and penalties against 67 employers found to have 

misclassified workers. 

28ETEP match data for tax year 2006 were the most recent data available at the time that 

we did our work. 

Page 23 GAO-09-717 Employee Misclassification
 

is timely, making it easier for IRS to contact and collect money from 

noncompliant employers.29

In addition to its programs that generate misclassification examinations, 

IRS uses CSP to offer settlements to employers that it is examining for 

misclassification. Through CSP, which IRS initiated in 1996, employers 

under examination that meet certain criteria can lower their 

misclassification-related assessments if they agree to correctly classify 

their workers in the future and pay proper employment taxes.30 As of 

November 2008, IRS had entered into about 2,800 settlement agreements, 

of which about 2,500 involved SB/SE. Employment tax officials in this IRS 

division estimated that their CSP agreements signed through the end of 

2006 have resulted in at least approximately $76 million in taxes 

voluntarily reported by participating employers without further IRS 

intervention.31 Of employers that entered into agreements through the end 

of 2006, IRS determined that 64 percent appear to be in compliance with 

their agreements. IRS has not been able to determine, through a review of 

filing histories, whether the remaining 36 percent of employers have 

complied with their CSP agreements. IRS would need to examine these 

employers to determine if they are in compliance with their agreements. 

IRS Uses Various Methods 

to Educate Taxpayers 

about Proper 

Classification 

IRS provides extensive general information on its Web site on worker 

classification issues for employers and workers, including flyers, IRS 

forms, fact sheets, a Web cast, and a training manual providing in-depth 

information on how IRS examiners determine a worker’s correct 

classification. IRS also held a national phone forum on worker 

classification determinations in May 2009 targeted at tax professionals and 

small business employers and organizations. IRS officials noted that a key 

IRS worker classification Web page was recently linked to IRS’s main page 

and was viewed nearly 800,000 times in fiscal year 2008. 

 

29IRS officials reported that some QETP audit referrals it receives contain extraneous 

information or are provided in a format that is difficult to use. However, IRS officials have 

worked with at least one state workforce agency to help the state tailor the information it 

forwards to IRS. 

30For example, employers must have filed all required information returns for their workers 

to be eligible to participate in CSP. 

31IRS calculated this figure by first noting the dollar amount of each CSP agreement, 

multiplying the dollar amount for each agreement by the number of tax years since the 

taxpayer signed the agreement, and summing the values of all CSP agreements that had 

been signed since CSP was initiated. 

Page 24 GAO-09-717 Employee Misclassification
 

IRS’s outreach strategies include the use of handouts, e-mail lists, and 

industry newsletters. In 2008, IRS began conducting worker classification 

workshops. IRS employment tax officials said that IRS targets these 

workshops toward persons working as payroll professionals, who are 

most likely to handle workers’ pay paperwork, and paid tax return 

preparers. IRS does not generally conduct outreach on classification 

issues for workers. 

IRS Faces Challenges in 

Enforcing Compliance 

with and Educating 

Taxpayers about 

Classification Regulations 

IRS’s programs aimed at enforcing proper worker classification and 

educating taxpayers about this issue face three main challenges. First, 

because misclassification is a complex issue, addressing proper 

classification can be labor intensive for the IRS officials involved. For 

example, in determining whether workers are employees or independent 

contractors, IRS examiners must look to the common law, which can be a 

complex process.32 The examiners must collect and weigh evidence on the 

related common law factors to determine what is relevant for classifying 

each relationship between the respective businesses and the workers in 

question. 

Second, given competing agency priorities, IRS has limited resources to 

allocate to these programs. With regard to enforcement, it has resources to 

examine only a small percentage of the potential misclassification cases it 

detects. As shown in table 3, SB/SE completed examinations of less than 

1,200 employers in 2008, a very small number when compared to the 

millions of small business and self-employed taxpayers in the United 

States. IRS focuses its examinations on employers with potential for large 

assessments or cases that likely affect a number of workers. To encourage 

voluntary compliance, IRS sends SS-8 determination letters to employers, 

and has also sent “soft notices” to employers it determined had not 

reclassified their workers after receiving these letters. However, IRS 

officials told us that SS-8 determination letters and soft notices can be 

 

32For employment tax purposes, the Internal Revenue Code incorporates the common law 

definition of an employee. 26 U.S.C. § 3121(d)(2). The Department of the Treasury’s 

regulations state that an employee-employer relationship generally exists when the 

business has a right to control and direct the worker not only as to the result to be 

accomplished but also as to the details and means by which that result is accomplished. 

26 C.F.R. §§ 31.3121(d)-1(c); 31.3306(i)-1; 31.3401(c)-1. IRS’s Revenue Ruling 87-41 contains 

a list of 20 factors or elements that IRS examiners can use to determine whether a worker 

is an employee under the common law. IRS examination training materials characterize 

these 20 factors as being based on three concepts: behavioral control, financial control, and 

the relationship between the employer and the worker. 

Page 25 GAO-09-717 Employee Misclassification
 

ineffective if the letter or the notice signals that IRS will not further pursue 

the noncompliant employers. For example, according to these officials, 

only about 20 percent of employers that are sent SS-8 determination letters 

but that are not selected for examination voluntarily comply with IRS’s 

classification determination. With regard to education, IRS uses indirect 

methods to reach the millions of businesses across the United States, such 

as sending correspondence to a large list of contacts in various industries 

and posting information in industry newsletters. According to IRS 

employment tax officials, information on misclassification is generally 

passed down two or three levels in order to reach employers. 

Third, according to IRS officials we interviewed, section 530 is both a 

major reason that it cannot examine many of the suspected cases of 

misclassification it identifies and an impediment to its ability to educate 

taxpayers on misclassification issues, as discussed below. 

• Before examining each potential misclassification case, IRS examiners 

must verify whether the employer in question qualifies for section 530 

protection.33 This verification process can be time and labor intensive, 

because examiners must determine whether the employers in question 

meet the three tests for section 530 protection.34

• Section 530 also restricts IRS’s ability to issue regulations and Revenue 

Rulings with respect to the classification of any individual for purposes of 

employment taxes. Because of this limitation, IRS restricts the educational 

information it issues to informal general guidance and SS-8 determinations 

and rulings, which provide recommendations on how to classify specific 

workers. However, as noted previously, applying the classification rules 

can be complex. IRS employment tax officials told us that businesses 

regularly request IRS’s guidance on how to classify workers. In 

accordance with section 530, IRS officials do not answer such inquiries 

but instead recommend that the businesses file Form SS-8 requests, which 

take time for the businesses to file and for IRS to process. Representatives 

 

33IRS has interpreted the Small Business Job Protection Act of 1996, which added 

subsection (e) to section 530, as requiring the first step in examining any case involving 

employment tax obligations of an employer with respect to workers to be determining 

whether the business meets the requirements of section 530. Pub. L. No. 104-188, § 1122, 

110 Stat. 1755, 1766 (Aug. 20, 1996), codified at 26 U.S.C. § 3401 note. 

34As previously mentioned, in order to receive section 530 protection, employers must have 

filed all federal tax returns in a manner consistent with not treating the workers in question 

as employees, consistently treated similarly situated workers as independent contractors, 

and had a reasonable basis for treating the workers as independent contractors. 

Page 26 GAO-09-717 Employee Misclassification
 

of worker, business, and paid tax return preparer groups pointed to a great 

deal of confusion about proper worker classification. In an interview, 

representatives of IRS’s Taxpayer Advocate Service told us that IRS should 

have the ability to issue guidance on the rules it enforces, in the interest of 

effective tax administration. 

DOL and IRS typically do not exchange the information they collect on 

misclassification, and DOL does not share information internally. 

However, when an employee is misclassified there is a potential for 

violations of both tax and labor laws, and sharing information could 

enable multiple agencies to address the consequences of misclassification. 

For example, WHD does not always send information on cases involving 

misclassification to other federal and state agencies, although WHD’s 

policies and procedures direct it to share such information with other 

federal and state agencies. WHD officials said they may not provide 

referrals to states or other federal agencies because the definition of an 

employee varies by statute and the division does not want its investigators 

to interpret statutes outside its jurisdiction. WHD officials told us there 

were no legal limitations on sharing information from an investigation, 

although they said they were reluctant to share information on open cases 

because they did not want to compromise their investigations. 

Collaboration among 

Federal Agencies Is 

Limited, but States 

Report Successful 

Collaboration to 

Address 

Misclassification 

among Their Agencies 

and with IRS 

Although WHD has a memorandum of understanding stating that it will 

share information with IRS, WHD officials said they are concerned about 

referring cases to IRS because they fear that employers would be reluctant 

to cooperate with the division if they knew that it refers cases to IRS. 

However, in these cases, WHD could obtain a subpoena to compel the 

employer to provide WHD with records. Similarly, WHD depends on 

complaints from workers to drive much of its workload and locate 

employers that are in violation of the laws under its purview. According to 

these officials, if workers who were not paying taxes properly knew that 

WHD shared information with IRS about its investigations, they might be 

less likely to file complaints or cooperate during investigations. 

In cases where WHD refers a case involving misclassification to states or 

other federal agencies, or to other divisions within DOL, it does not track 

these referrals centrally. Therefore, officials do not know how often or to 

whom cases are referred. In addition, officials are not able to ensure that 

cases are referred consistently across offices. Some district offices, 

however, keep track of the forms used to make such referrals. The 

referrals are usually made by the district offices, which maintain records 

Page 27 GAO-09-717 Employee Misclassification
 

of the referrals in their files and send the originals to the agencies to which 

WHD has referred the cases. 

OSHA may uncover misclassification during its inspections of potential 

health and safety violations but generally does not refer these cases to 

WHD or IRS. OSHA officials told us that although they have a number of 

memorandums of understanding with other agencies and divisions within 

DOL, these pertain to issues such as child labor and migrant workers and 

not to misclassification. However, we found that OSHA has a 

memorandum of understanding with WHD dating from 1990 that states 

that, in order to secure the highest level of compliance with labor laws, the 

agencies will exchange information and referrals where appropriate. This 

agreement also states that both agencies will report the results of any 

referrals to the other agency and will establish a system to monitor the 

progress of actions taken on referrals. However, while OSHA tracks 

referrals and results in its database, WHD has not established such a 

system. 

ETA, which oversees unemployment insurance, collects only summary 

data from states on the number of employees they have found to be 

misclassified during unemployment insurance audits. While DOL funds the 

administration of state unemployment insurance programs, states are 

responsible for all tax collection, benefit payment, and investigations and 

audits. Therefore, officials told us that detailed employer or employeespecific information is available only at the state level, and ETA is unable 

to refer potential misclassification cases to WHD. Moreover, since state 

agencies are administrators of their own programs, officials told us that 

ETA does not investigate instances of misclassification that occur in state 

unemployment insurance programs. 

Other federal agencies with jurisdiction over laws affected by 

misclassification told us that they do not work with DOL or track cases 

involving misclassification. Officials from the National Labor Relations 

Board, which enforces the right of employees to bargain collectively, told 

us that the agency does not work with DOL. Equal Employment 

Opportunity Commission officials said that they have not worked with 

DOL in any substantial way, although they do have a memorandum of 

understanding with DOL. 

According to officials, IRS does not share misclassification-related 

information with DOL and shares only limited information with other 

federal agencies. In general, IRS is prohibited from sharing taxpayer 

information with other agencies per section 6103 of the Internal Revenue 

Page 28 GAO-09-717 Employee Misclassification
 

Code.35 IRS and the Social Security Administration have memorandums of 

understanding in place to facilitate information sharing on employment 

tax cases and issues, but they do not regularly share information on 

misclassification, according to IRS employment tax officials. However, the 

officials told us that the two agencies are creating a joint employment tax 

task team, and noted that the Social Security Administration can use IRS 

employment tax information to ensure that misclassified workers are 

given Social Security credit for wages earned. Contracting officers from 

several federal agencies we interviewed said that they saw relatively high 

volumes of potential misclassification among workers on federal 

construction contracts, and that the payroll information they collect could 

be of value to IRS. However, many of these agencies did not have 

information sharing relationships with IRS. 

DOL Generally Does Not 

Work with States, but IRS 

Shares Information with 

Them 

Less than 25 percent of states collaborate with DOL to identify employee 

misclassification. In responding to our survey, 12 states said that they have 

some type of collaborative arrangement with DOL in this area. These 

arrangements may include sending information to DOL, receiving 

information from DOL, and conducting joint investigations with DOL of 

cases involving potential misclassification. Approximately 56 percent of 

states we surveyed said that they collect data on misclassification beyond 

the summary unemployment insurance audit data they are required to 

report to DOL’s ETA on a quarterly basis. Although this information could 

be useful to DOL in pursuing potential FLSA violations stemming from 

misclassification, state officials we interviewed said that they are not 

required to report it to DOL. For example, officials told us that they do not 

report information on employees who were misclassified but paid in cash 

and whose wages were not reported to IRS or state revenue agencies. DOL 

could use information on these employees to target investigations of 

possible FLSA violations, such as improper payment of overtime. 

IRS and state workforce agencies share information on misclassification 

as part of QETP. IRS, DOL, and state workforce agencies collaborated to 

create QETP in September 2005. In its first year, 5 states participated and 

additional states have been added over time. Currently, IRS and workforce 

 

3526 U.S.C. § 6103. The protection of taxpayer information is commonly thought to be 

critical to voluntary compliance with the tax code and necessary to protect taxpayer 

privacy. There are statutory exceptions to the general prohibition, such as those permitting 

the sharing of certain information with state tax officials and the Social Security 

Administration. 26 U.S.C. § 6102(d),(l)(1). 

Page 29 GAO-09-717 Employee Misclassification
 

agencies from 34 states share information on audits involving 

misclassification as part of QETP.36 IRS employment tax officials 

remarked that QETP sends an important message to employers and 

workers that IRS and states are working together on compliance issues. 

According to the IRS officials, the state agencies audit employers to 

determine whether they have classified workers correctly and paid state 

unemployment taxes as appropriate. We surveyed participating s

agencies, and most respondents reported that audit information IRS 

tate 

provided was helpful. 

und to have 

akes 

these 

agencies we surveyed reported receiving this information from IRS.38

r 

om 

and 

 

In addition to sharing audit reports for employers that were fo

misclassified their employees, IRS also shares other types of 

misclassification-related data with some states. Nineteen of the state 

workforce agencies we surveyed reported that they receive Form 1099-

MISC data from IRS.37 The state agencies may use these data to identify

potential cases of misclassification. According to IRS employment tax 

officials, IRS also shares the worker classification determinations it m

through its SS-8 program with some state agencies; IRS issues 

determinations following employers’ or workers’ requests for 

determinations of employment status. Fourteen of the state workforce

Some state workforce agencies surveyed noted that IRS’s QETP 

information sharing and communication practices could be improved. Fo

example, two states commented that the information they receive fr

IRS is somewhat dated. Some states that participated in our survey 

reported frustration over not receiving requested information from IRS or 

difficulty contacting IRS officials. IRS officials with whom we spoke were 

aware that some states were not receiving QETP referrals, and stated that 

IRS was in the process of centralizing its QETP administration in order to

rectify the problem. They also said that IRS is in the process of clearing 

out a backlog of referrals from states. According to IRS employment tax 

officials, IRS has completed the centralization of QETP administration 

taken steps to clear the backlog of referrals from states. Finally, some 

36Seven additional state agencies reported that they were working with IRS to become 

QETP members. 

37According to IRS officials, as of April 2009, 22 state workforce agencies were enrolled in 

the process to receive Form 1099-MISC data extracts. 

38According to IRS officials, as of May 2009, 31 states were enrolled in a process to receive 

information from classification determinations. 

Page 30 GAO-09-717 Employee Misclassification
 

states we surveyed also reported several key barriers to effectively using 

information provided by IRS. These included resource limitations w

their own agencies, data system incompatibilities, and difficulties 

ithin 

complying with IRS’s legal requirements for safeguarding taxpayer data. 

s’ 

 as the cost 

stances, to ban violators from 

obtaining state public works contracts. 

the 

int 

or 

ed in 

cy approach 

and cross-agency coordination to deal with misclassification. 

, 

st 

akes 

ucracy involved in 

tracking cases and enforcing compliance together. 

 Are 

 Enforcement 

Agencies 

Some states have made efforts to address misclassification and have 

reported successful collaboration among their own agencies. States are 

particularly concerned because of misclassification’s impact on worker

compensation programs and unemployment tax revenue, among other 

programs. In addition, states may incur additional costs, such

of providing health care to uninsured workers, as a result of 

misclassification. Some states have passed legislation related to 

misclassification. For example, Massachusetts passed legislation that 

standardizes the definition of an employee and penalizes employers for

misclassification, regardless of whether it was intentional. The statute

authorizes the state Attorney General to impose substantial civil and 

criminal penalties and, in certain circum

Some States

Identifying 

Misclassification through

Collaborative Initiatives 

Involving Their Revenue, 

Labor, and

Several states have recently created interagency initiatives or joint task 

forces aimed at detecting misclassification, often by executive order of 

states’ governors. These task forces share information across revenue, 

labor, and enforcement agencies. For example, the New York State Jo

Enforcement Task Force on Employee Misclassification, which was 

formed in September 2007, is led by the New York Department of Lab

and includes revenue agencies, other enforcement agencies, and the 

Attorney General’s office. Since its inception, the task force has engag

joint enforcement sweeps, coordinated assignments, and systematic 

referrals and data sharing between state agencies. New York state officials 

told us that they now consider it customary to use a multiagen

However, some of these state task forces have encountered challenges

particularly in coordination among state agencies. The agencies mu

overcome or ease restrictions on sharing information outside their 

jurisdictions, which may require state legislative action. State officials we

interviewed cited other challenges, such as the fact that the lead agency 

does not have oversight authority over task force members, which m

it difficult to direct their efforts; the limited resources of many state 

agencies; and dealing with the added layers of burea

Page 31 GAO-09-717 Employee Misclassification
 

While these task forces are relatively recent innovations, state officials 

told us that they have already been effective in uncovering 

misclassification. New York state officials told us that the state uncovers 

many more misclassified employees through task force activities than 

solely through the unemployment insurance audits required by DOL. The 

state estimated that in just over a year’s time, its misclassification task 

force uncovered 12,300 instances of employee misclassification and, as 

noted earlier, $157 million in unreported wages. The task force’s 

enforcement activities also resulted in over $12 million in workers’ back 

wages being assessed against employers. 

As far back as 1977, we have analyzed options for addressing tax 

noncompliance arising from employee misclassification. In 1977, we 

recommended a specific definition to clarify who should be considered an 

independent contractor, and in 1979, we concluded that some form of tax 

withholding could be warranted to reduce tax noncompliance among selfemployed workers.39 In 1992, we offered options to improve independent 

contractor tax compliance, such as ensuring that their taxpayer 

identification numbers (TIN) are valid, informing them of their 

classification status and tax obligations, and closing gaps in the payments 

that are required to be reported on Form 1099-MISC.40 For this report, we 

explored current options to address the challenges raised by employee 

misclassification, some of which are similar to the options we analyzed in 

these prior reports. 

Various Options 

Could Help Address 

Misclassification 

Challenges 

We identified 19 options to address the challenges raised by employee 

misclassification by reviewing literature and speaking with various groups, 

including those representing (1) labor and advocacy, (2) independent 

contractors and small businesses, and (3) tax professionals.41 These 

 

39GAO, Tax Treatment of Employees and Self-Employed Persons by the Internal Revenue 

Service: Problems and Solutions, GAO/GGD-77-88 (Washington, D.C.: Nov. 21, 1977) and 

Compliance Problems of Independent Contractors, Testimony 109909 (Washington, D.C.: 

July 17, 1979). 

40GAO, Tax Administration: Approaches for Improving Independent Contractor 

Compliance, GAO/GGD-92-108 (Washington, D.C.: July 23, 1992). Other options dealt with 

improving information reporting on payments made for services to independent 

contractors, including incentives to file Form 1099-MISC, and requiring more information 

to be reported on tax returns about the payments made for services. 

41For a more detailed discussion of our methodology in selecting options to include in this 

report, see app. I. 

Page 32 GAO-09-717 Employee Misclassification
 

options would require either legislative or administrative actions. Table 4 

lists the 19 options. The list is not ranked in any order, but rather is 

grouped in seven broad categories.42

Table 4: Options for Addressing Employee Misclassification 

A. Clarify the employee/independent contractor definition and expand worker 

rights 

1. Clarify the distinction between employees and independent contractors under 

federal law 

2. Allow workers to challenge a classification determination in U.S. Tax Court 

3. Ensure that workers have adequate legal protection against retaliation from filing a 

Form SS-8 

4. Define misclassification as a violation under FLSA 

B. Revise section 530 of the Revenue Act of 1978

5. Narrow the definition of “a long-standing recognized practice of a significant 

segment of the industry” so that fewer firms qualify for this reasonable basis for the 

section 530 safe harbor provision 

6. Lift the ban on IRS/Treasury issuing regulations or revenue rulings clarifying the 

employment status of individuals for purposes of employment taxes 

C. Provide additional education and outreach 

7. Require service recipientsa to provide standardized documents to workers that 

explain their classification rights and tax obligations 

8. Expand IRS outreach to service recipient, worker, and tax advisor groups to educate 

them about classification rules and related tax obligations, targeting groups IRS 

deems to be “at risk” 

9. Create an online classification system, using factors similar to those used in the SS8 determination process, to guide service recipients and workers on classification 

determinations 

10. Increase the use of IRS notices to service recipients in industries with a potentially 

high incidence of misclassification to educate them about classification rules and 

ask them to review their classification practices 

 

42The list also does not include options that we have recently analyzed or recommended in 

prior reports that are indirectly related to worker misclassification, such as information 

reporting on payments made to independent contractors. For example, in GAO-09-238 we 

made various recommendations to improve compliance with filing Forms 1099-MISC, and 

in GAO-07-1014 we analyzed various options to address tax noncompliance among sole 

proprietors, a group of taxpayers that includes independent contractors. 

Page 33 GAO-09-717 Employee Misclassification
 

D. Withhold taxes for independent contractors 

11. Require service recipients to withhold taxes for independent contractors whose TINs 

IRS cannot verify or who IRS has determined are not fully tax compliant 

12. Require universal tax withholding for payments made to independent contractors, 

using tax rates that are relatively low (e.g., 1 percent to 5 percent of payment 

amounts) 

13. Require service recipients to withhold taxes from payments made to independent 

contractors who request withholding in writing 

E. Collect data on misclassification and independent contractors 

14. Measure the extent of misclassification and related impacts on tax revenues at the 

national level 

15. Require each independent contractor to apply for a separate business TIN 

F. Enhance IRS compliance programs 

16. Expand IRS’s CSP to include service recipients that voluntarily contact IRS about 

their misclassified workers 

17. Require service recipients to submit Forms SS-8 for all newly retained independent 

contractors 

G. Enhance coordination and information sharing 

18. Enhance coordination between IRS, DOL, and other federal agencies to share data 

and address misclassification 

19. Enhance coordination between IRS, states, and selected local governments to 

share data and address misclassification 

Source: GAO analysis of literature reviews and interviews with affected stakeholders. 

a

By “service recipients,” we mean businesses and other entities that receive services from 

independent contractors or employees in the course of a trade or business, not including consumers 

or individuals who seek services for their homes or personal use. 

We asked 11 external stakeholders to provide input on these 19 options, 

including (1) the extent to which they supported or opposed each option 

and (2) the benefits and drawbacks of each option (see app. II for a 

summary of these benefits and drawbacks for each option).43 These 

stakeholders included 4 groups that represent the views of small 

businesses, independent contractors, and those who hire them (i.e., 

independent contractor groups); 4 groups that represent the views of 

organized labor (i.e., labor groups); 2 groups that represent the tax 

 

43We identified these 11 stakeholder groups from the original 19 that we interviewed early 

in our study. We selected the 11 based on those that provided specific ideas and comments 

on the options in our first round of interviews and that expressed willingness to respond to 

our written data collection instrument. 

Page 34 GAO-09-717 Employee Misclassification
 

preparation and advice community; and 1 federal agency that uses 

contractors. We received responses from 9 of these groups.44

No Option Had Unanimous 

Support or Opposition 

Stakeholders did not unanimously support or oppose any of the 19 

options. Although views were mixed, stakeholders generally expressed 

support for the options more frequently than they expressed opposition. 

For example, at least seven of the nine responding stakeholders supported 

three options (see table 5). 

Table 5: Options for Addressing Employee Misclassification with the Greatest Level 

of Stakeholder Support 

Ensure that workers have adequate legal protection against retaliation from filing a Form 

SS-8 (option 3) 

Require service recipients to provide standardized documents to workers that explain 

their classification rights and tax obligations (option 7) 

Increase the use of IRS notices to service recipients in industries with a potentially high 

incidence of misclassification to educate them about classification rules and ask them to 

review their classification practices (option 10) 

Source: GAO analyses of stakeholder responses to questions about 19 options. 

Note: Options included in this table were supported by seven or eight stakeholders out of the nine 

from which we received input on the 19 options. 

In contrast, five of nine stakeholders opposed one option—narrowing the 

definition of “a long-standing recognized practice of a significant segment of 

the industry” under section 530 of the Revenue Act (option 5). While all 

three independent contractor groups opposed this idea on the grounds that 

the protection was important, two labor groups that opposed the option did 

so because it only narrowed rather than eliminated this protection. 

Labor Groups and Others 

Were Generally More 

Supportive of Options 

Than Independent 

Contractor Groups 

In general, labor groups, a group representing tax preparers, and a federal 

agency that hires contractors tended to be more supportive of the 

19 options than independent contractor groups. We analyzed whether the 

majority of stakeholders in each group—that is, over half of them—stated that 

they supported, opposed, or were neutral on the 19 options. Table 6 shows that 

a majority of the labor group respondents (i.e., at least 3 of the 4) supported 9 

options and opposed none. Similarly, the tax professional group and the federal 

 

44We did not receive responses from one of the paid tax return preparer groups and one of 

the independent contractor groups. 

Page 35 GAO-09-717 Employee Misclassification
 

agency both supported 10 options and opposed none. In contrast, a majority of 

the independent contractor respondents (i.e., at least 2 of the 3) supported 7 

options and opposed 8. A blank cell in the table indicates that the stakeholders 

for the group lacked a majority view on the option. 

Table 6: Options to Address Misclassification by Expressed Support, Opposition, or Neutrality by a Majority of Stakeholder Group 

Options Labor groups 

Independent 

contractor groups Other groupsa

1. Clarify the distinction between employees and independent 

contractors within federal law 

Support Support 

2. Allow workers to challenge determinations in Tax Court Support Oppose Support 

3. Ensure that workers have protection for filing a Form SS-8 Support Support Support 

4. Define misclassification as a violation under FLSA Support Oppose 

5. Narrow the definition of “a long-standing recognized practice of a 

significant segment of the industry” 

Oppose Support 

6. Lift the ban on IRS clarifying employment status Support Oppose 

7. Require service recipients to give workers documents that explain 

classification 

Support Support 

8. Expand IRS outreach Support Support 

9. Create an online classification system Oppose Support 

10. Increase the use of IRS notices Support Support Support 

11. Require service recipients to withhold taxes for certain independent 

contractors 

Neutral Oppose Support 

12. Require universal tax withholding for payments made to 

independent contractors 

Oppose 

13. Require service recipients to withhold taxes at independent 

contractor request 

Neutral Support 

14. Measure the extent of misclassification at the national level Support Neutral 

15. Require each independent contractor to apply for a separate 

business TIN 

Support 

16. Expand IRS’s CSP Support 

17. Require service recipients to submit Forms SS-8 for newly retained 

independent contractors 

Oppose Support 

18. Enhance coordination between IRS, DOL, and other federal agencies Support Neutral 

19. Enhance coordination between IRS, states, and selected local 

governments 

Support Neutral 

Source: GAO analyses of stakeholder responses to questions about 19 options. 

Note: “Support” indicates that over half of the respondents in the group generally or strongly supported the 

option. “Oppose” indicates that over half of the respondents in the group generally or strongly opposed the 

option. “Neutral” indicates that over half the group was neutral on the option or had no opinion. A blank cell 

indicates that the option lacked a consensus opinion by a majority of stakeholders. 

a

Other groups included a group representing tax professionals and a federal agency that hires 

contractors. 

Page 36 GAO-09-717 Employee Misclassification
 

Stakeholders Identified 

Various Benefits and 

Drawbacks to the Options 

We asked stakeholders what they perceived to be the benefits and 

drawbacks of each option. We did not follow up on these responses to 

clarify and understand the basis for the stakeholders’ perceptions on 

benefits and drawbacks. As a result, absent other relevant data, these 

responses did not allow us to uniformly assess whether the benefits 

outweighed the drawbacks for each option, or vice versa. Table 7 lists 

examples of types of benefits and drawbacks identified across all the 

options. 

Table 7: Types of Benefits and Drawbacks Stakeholders Identified across the 

19 Options 

Examples of types of benefits 

identified 

Examples of types of drawbacks 

identified 

Improved tax compliance Higher financial costs/burdens for 

businesses 

Greater equity/justice for workers Inequities among those using independent 

contractors 

More consistency/uniformity in classifying Economic disruption/upheaval 

More education/understanding More litigation 

More attention/visibility Political opposition 

More worker protection Less freedom of choice 

Less misclassification Deter use of independent contractors 

Less manipulation of classification rules More manipulation of classification rules 

Source: GAO analyses of stakeholder responses to questions about 19 options. 

We found that some of the stakeholders had different perceptions of 

whether an outcome for an option would be beneficial. For example, some 

respondents said that creating an online classification system could help 

reduce confusion over classification rules and unintentional 

misclassification. However, other respondents stated that such a system 

would produce inconsistent determinations and could be manipulated to 

achieve desired classification determinations. Similarly, some 

stakeholders said that requiring a separate TIN for independent 

contractors could increase voluntary tax compliance or help facilitate IRS 

compliance and enforcement efforts. However, others expressed the 

opinion that a separate TIN could be conducive to tax fraud or 

manipulation of the classification system. Finally, some perceived that 

expanding CSP to include employers that volunteer to disclose their 

misclassified employees would benefit such employers by reducing their 

financial exposure while others viewed this same outcome as allowing 

Page 37 GAO-09-717 Employee Misclassification
 

them to escape financial sanctions for misclassifying. (See app. II for 

summaries of the types of benefits and drawbacks for each option.) 

We also asked IRS officials to share their insights on the benefits and 

drawbacks of the options from a tax administration perspective. Some of 

their insights included the following: 

• Expanding CSP to include employers that voluntarily ask to participate 

could help reduce employee misclassification, although allowing voluntary 

participation raises issues of equity and may create a safe harbor from 

examination. For example, this expansion could bring into compliance 

employers that voluntarily disclose that they have misclassified employees 

but would reduce the financial sanctions they face for having done so. IRS 

employment tax officials said that they recently created a team to explore 

these and other issues related to such an expansion and that they hope to 

start soliciting comments on a proposal from across IRS starting in 

summer 2009. 

• “Soft” (i.e., non enforcement) notices to educate employers that appear to 

be misclassifying employees and to encourage them to correct their 

classifications might not be effective unless IRS is able to follow up with 

employers that do not change their classification behavior. Notices also 

are more effective if they are sent strategically rather than using a 

“shotgun” approach. Furthermore, sending notices to employers in certain 

industries without sufficient justification for targeting them likely would 

create a backlash that IRS would have to manage. 

• Expanded information sharing with other federal agencies generally can 

help IRS to be more effective at enforcing proper worker classification. 

However, section 6103 protections against improper disclosure of tax data 

generally hamper such sharing and one-way information sharing can 

create resentment among other agencies. 

• Creating standardized documents on worker rights and tax obligations can 

impose burdens on businesses, although such burdens could be reduced 

by requiring employers to provide such documents only to newly hired or 

retained workers rather than to all workers. Also, IRS may not currently 

have the authority to require employers to provide such documents to 

workers. 

• Requiring a separate TIN for each independent contractor could help 

compliance but would impose some costs on businesses and IRS to 

reprogram its computers. 

Page 38 GAO-09-717 Employee Misclassification
 

• Requiring Forms SS-8 for all newly retained independent contractors 

would create tremendous costs for IRS, and it may not be able to review 

the forms quickly enough to affect some independent contractors who 

employers retain on a short-term basis. 

• An online classification system that uses factors like those that IRS uses to 

make Form SS-8 determinations could provide guidance to those unsure 

about classifying workers. However, the system should not be used to 

make classification determinations because those entering the data could 

manipulate their entries to receive a desired outcome. 

Some of the identified options relate to goals, objectives, and strategies in 

IRS’s Strategic Plan for 2009-2013. For example, IRS’s plan envisions 

placing more emphasis on providing more targeted and timely guidance 

and outreach on how to voluntarily comply and creating opportunities for 

taxpayers to proactively resolve tax disputes as soon as possible as part of 

its goal to improve service to make voluntary compliance easier. To 

enforce the law to ensure that everyone meets their tax obligations, IRS 

plans to strengthen its partnerships with other government agencies to 

leverage resources in a way that allows quick identification and pursuit of 

emerging tax schemes through education as well as enforcement. IRS also 

seeks to expand its enforcement approaches by allowing for alternative 

treatment of potential noncompliance. These approaches include 

expanding the use of soft notices to educate taxpayers and to encourage 

them to self-correct to avoid traditional enforcement contacts, such as 

examinations, as well as expanding incentives and opportunities for 

taxpayers to voluntarily self-correct noncompliant behavior. 

Misclassification can have a significant impact on federal and state 

programs, businesses, and misclassified employees. It can reduce revenue 

that supports such programs as Social Security, Medicare, unemployment 

insurance, and workers’ compensation. Further, employers with 

responsible business practices may be undercut by competitors who 

misclassify employees to reduce their costs, for example, by not paying 

payroll taxes or providing benefits to workers. Employers may also exploit 

vulnerable workers, including low-wage workers and immigrants, who are 

unfamiliar with laws pertaining to employment relationships, including 

laws designed to protect workers. For example, misclassified workers may 

not be paid properly for overtime or may not know that their employers 

are not paying worker’s compensation premiums. 

Conclusions 

Page 39 GAO-09-717 Employee Misclassification
 

Although misclassification is a predictor of labor law violations, and 

although state examples show that targeting misclassification is an 

effective way to uncover violations, DOL is not taking advantage of this 

opportunity by looking for misclassification in its targeted investigations. 

As a result, employers may continue to misclassify employees without 

consequences and workers may remain unprotected by labor laws and not 

receive benefits to which they are entitled. Furthermore, because DOL 

conducts limited education and outreach on misclassification, many 

workers have insufficient information on employment relationships and 

may not understand their employment status and rights. In addition, 

vulnerable populations, including low-wage workers and immigrants, may 

not know they are misclassified and, as result, may not receive the 

protections and benefits to which they are entitled. By not regularly 

sharing information on cases involving misclassification, federal and state 

agencies are also losing opportunities to protect workers and to make the 

most effective use of their resources. Also, because DOL is not working 

with states active in this area to identify misclassification, it is not using its 

resources most effectively by establishing a collaborative effort between 

federal and state agencies to address misclassification. 

Many of the IRS-related options we analyzed to address misclassification 

were generally perceived to have merit as means to address 

misclassification, but all have some drawbacks, according to those 

stakeholders we surveyed. Although several options had support from 

many of those who provided input, we had no reliable measure of the 

extent of misclassification and did not have sufficient information to 

weigh the benefits compared to the drawbacks of the options given the 

scope of our work. Even so, qualitative information provided by the 

stakeholders can help policymakers and tax administrators judge whether 

any of the options merit pursuit. 

Likewise, some actions have potential to address misclassification in a 

cost-effective manner while also adhering to IRS’s strategic vision for the 

next few years. For example, IRS and DOL can do more to educate 

employers and workers. Given that most complaints come from workers, 

further educating them about the consequences of misclassification may 

be especially useful. Developing a standard document on classification 

rights and related tax obligations that all new workers would either be 

given by employers or referred to on agencies’ Web sites would be 

particularly well targeted. Similarly, IRS could build on its existing state 

contacts to resolve current concerns with the QETP initiative, which 

mutually benefits both federal and state parties. Regularly collaborating 

with participating states can help ensure that issues are addressed by both 

Page 40 GAO-09-717 Employee Misclassification
 

IRS and states in a timely manner. Finally, expanding CSP to allow for 

voluntary self-correction of classification decisions could prompt 

compliance among employers that IRS is unlikely to pursue through 

enforcement because of limited resources. Soft notices targeted to 

employers that appear to be misclassifying would give them a chance to 

self correct before IRS decides whether to examine them and should be 

tested to determine their effectiveness. 

We are making six recommendations to the Secretary of Labor and the 

Commissioner of Internal Revenue to assist in preventing and responding 

to employee misclassification. 

Recommendations for 

Executive Action 

• To increase its detection of FLSA and other labor law violations, we 

recommend that the Secretary of Labor direct the WHD Administrator to 

increase the division’s focus on misclassification of employees as 

independent contractors during targeted investigations. 

• To enhance efforts to protect workers and make the most effective use of 

their resources, we recommend that the Secretary of Labor direct the 

WHD Administrator and the Assistant Secretary for 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. 

• To identify promising practices in addressing misclassification and use 

agency resources most effectively, we recommend that the Secretary of 

Labor and the Commissioner of Internal Revenue 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. 

• To enhance understanding of classification issues by workers—especially 

those in low-wage industries—we recommend that the Secretary of Labor 

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. 

Page 41 GAO-09-717 Employee Misclassification
 

• To maximize the effectiveness of the relatively new QETP initiative, we 

recommend that the Commissioner of Internal Revenue 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. 

• To increase proper worker classification, we recommend that the 

Commissioner of Internal Revenue extend the 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. 

In their comments on a draft of this report, both DOL and IRS generally 

agreed with our recommendations, and either agreed to implement or to 

take steps consistent with our recommendations, such as exploring their 

implementation. WHD, OSHA, and IRS provided written comments on the 

draft, which are reprinted in their entirety in appendixes III (DOL 

comments from WHD and OSHA) and IV (IRS comments). In addition, 

ETA provided technical comments, which we incorporated. 

Agency Comments 

and Our Evaluation 

DOL agreed with our recommendation to increase WHD’s focus on 

misclassification of employees as independent contractors during targeted 

investigations. WHD commented that it would reexamine its training 

documents and field guidance to ensure that employee classification was 

addressed during all stages of an investigation. In addition, WHD agreed to 

focus on increasing compliance for workers in industries where 

misclassification is prevalent. 

DOL also agreed that there is value in sharing information on cases 

involving the misclassification of employees as independent contractors 

between WHD and OSHA and with state agencies. WHD and OSHA stated 

that they are both committed to working closely together to exchange 

information and improve protections afforded workers. 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 their comments, the agencies expressed support for our 

recommendation to establish a joint interagency effort to address 

Page 42 GAO-09-717 Employee Misclassification
 

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. Similarly, 

IRS stated 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 the Secretary of Labor to explore 

developing a joint effort, subject to disclosure rules under section 6103 of 

the Internal Revenue Code and other privacy rules. 

In addition, DOL and IRS 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 the Secretary of Labor, make education and 

outreach materials available to DOL, and work with the Secretary of Labor 

to explore developing a standardized document on classification for DOL 

to provide to new workers. 

Finally, 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. IRS also said it would consider expanding the 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. We 

appreciate that IRS will consider these actions and continue 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. 

As we agreed with your offices, unless you publicly announce the contents 

of this report earlier, we plan no further distribution of it until 30 days 

from the date of this letter. At that time, we will send copies of this report 

to the Secretary of Labor, the Commissioner of Internal Revenue, and 

relevant congressional committees. The report is also available at no 

charge on GAO’s Web site at http://www.gao.gov. 

Page 43 GAO-09-717 Employee Misclassification
 

Please contact Andrew Sherrill at (202) 512-7215 or sherrilla@gao.gov or 

Michael Brostek at (202) 512-9110 or brostekm@gao.gov if you or your 

staffs have any questions about this report. Contact points for our Offices 

of Congressional Relations and Public Affairs may be found on the last 

page of this report. Key contributors to this report are listed in appendix V. 

Andrew Sherrill Michael Brostek 

Director, Education, Workforce Director, Tax Issues 

and Income Security Strategic Issues Team 

Page 44 GAO-09-717 Employee Misclassification
Appendix I: Scope and Methodology Appendix I: Scope and Methodology 

To determine what is known about the extent of the misclassification of 

employees as independent contractors and its associated tax and labor 

implications, we reviewed studies on misclassification conducted by the 

Internal Revenue Service (IRS), the Department of Labor (DOL), and 

others. We reviewed IRS’s estimate on the extent of misclassification and 

the associated revenue loss for tax year 1984. We also interviewed IRS 

officials responsible for planning an update to that estimate. From DOL, 

we reviewed a study it commissioned in 2000 on the extent of 

misclassification. We also analyzed the information states report to it 

regarding their findings of misclassification during their audits of 

employers.1

 We analyzed summary data that the states reported for the 

years 2000 to 2007. These data included the number of employers in each 

state, the number of audits completed, and the number of misclassified 

employees identified during these audits. We also reviewed 

misclassification studies conducted by states, universities, and research 

institutes. Finally, we interviewed officials from federal and state agencies 

to obtain their views on misclassification and its consequences for 

workers. 

To describe actions taken by DOL to address employee misclassification, 

we examined DOL policies and documentation, including DOL’s Wage and 

Hour Division’s (WHD) Field Operations Handbook and the Occupational 

Safety and Health Administration’s Field Operations Manual. We 

interviewed agency officials at the national and district levels, as well as 

several investigators from WHD, and spoke with employer and labor 

advocates to obtain their perspectives on DOL’s efforts. In some cases, we 

relied on interviews conducted for a previous closely related GAO 

testimony, issued in July 2008.2

 We also obtained and analyzed WHD data 

on cases involving misclassification concluded during fiscal year 2008. We 

could not obtain data for other time periods because WHD did not flag 

cases to indicate whether they involved misclassification before fiscal year 

2008. We assessed the reliability of the data and determined them to be 

sufficiently reliable for the purposes of this report. However, because DOL 

only flagged cases as involving misclassification when it was the primary 

reason for Fair Labor Standards Act (FLSA) violations, and because WHD 

officials told us that not all investigators understood how to properly flag 

these cases, this information may be incomplete. 

 

1

All states, the District of Columbia, and Puerto Rico are required to report information 

regarding their unemployment insurance audits to DOL on a quarterly basis. 

2

GAO-08-962T. 

Page 45 GAO-09-717 Employee Misclassification 
Appendix I: Scope and Methodology 

In total, we examined data for 131 cases involving 1,619 misclassified 

employees who were denied payment for overtime or were paid less than 

minimum wage. Using these data from the WHD database, we 

judgmentally selected 26 case files to review. We selected cases based on 

factors such as the number of employees misclassified, the total amount of 

back wages computed, whether a single employee was owed over $10,000 

in back wages, whether civil money penalties were assessed, and whether 

the case resulted from a complaint or was directed by the agency. We 

conducted reviews of 13 case files in the WHD New Orleans and Boston 

offices and requested copies of the remaining selected case files from 

WHD. Because we judgmentally selected these files, our findings from the 

reviews of case files are not projectable to all WHD cases. 

To obtain information on state coordination with DOL and IRS, state 

perspectives on DOL’s education and outreach efforts, and whether states 

collect data on cases involving misclassification, we conducted a Webbased survey of unemployment insurance directors in all states, the 

District of Columbia, and Puerto Rico. We administered two versions of 

this survey: one for states participating in the Questionable Employment 

Tax Practices (QETP) program and one for states that do not participate in 

the QETP program. After we drafted the questionnaire, we asked for 

comments from a knowledgeable official at the National Association of 

State Workforce Agencies as well as from an independent GAO survey 

professional. 

We conducted two pretests of the survey, one with a state participating in 

the QETP program and one with a state that does not participate in the 

QETP program, to check that (1) the questions were clear and 

unambiguous, (2) terminology was used correctly, (3) the questionnaire 

did not place an undue burden on agency officials, (4) the information 

could feasibly be obtained, and (5) the survey was comprehensive and 

unbiased. We received responses from all 32 states on the survey for QETP 

participants, for a response rate of 100 percent. We did not receive a 

response from 1 state on the survey for states that do not participate in 

QETP, for a response rate of 95 percent. We were unable to contact the 

official in Puerto Rico within the study’s time period. Finally, we 

interviewed officials in 4 states to obtain more information about their 

efforts to address misclassification and, where applicable, reviewed 

documentation on these efforts. 

To describe actions IRS takes to address employee misclassification, we 

interviewed officials from the employment tax group within IRS’s Small 

Business/Self Employed Division (SB/SE), which conducts the majority of 

Page 46 GAO-09-717 Employee Misclassification
Appendix I: Scope and Methodology 

IRS misclassification-related examinations. We also obtained data on 

SB/SE examinations of worker misclassification for tax year 2008 

generated from four sources: (1) the Determination of Worker Status 

(Form SS-8) program, (2) the Employment Tax Examination Program 

(ETEP), (3) QETP, and (4) general IRS employment tax examinations, 

including cases referred from other divisions within IRS. SB/SE conducted 

all IRS misclassification examinations generated by ETEP and QETP, over 

97 percent of the examinations generated by the SS-8 program, and the 

majority of general examinations IRS conducted during fiscal year 2008. 

We also obtained data from IRS’s Classification Settlement Program. We 

assessed the reliability of these IRS data sources and found them to be 

sufficiently reliable for the purposes of this report. To obtain information 

on IRS’s education and outreach activities that address misclassification, 

we interviewed officials from the employment tax group within SB/SE, 

interviewed independent contractor and labor advocates, and reviewed 

educational materials on classification IRS makes available on its Web 

site. 

To understand how DOL and IRS cooperate with each other and with 

states and other relevant agencies, we examined agency policies and 

procedures for sharing information on misclassification and referring 

cases involving misclassification, and interviewed agency and state 

officials. We also reviewed information IRS provided on its arrangements 

with states through the QETP program. 

To describe options that could help address challenges in preventing and 

responding to misclassification, we reviewed GAO and other federal 

agency reports and recommendations and other organizations’ studies on 

misclassification of employees. We also interviewed 19 relevant 

stakeholders representing various groups, including (1) labor and 

advocacy groups, (2) groups that represent small businesses and 

independent contractors, (3) groups that represent tax professionals, 

(4) authors who have published on misclassification issues, and (5) federal 

agencies, to help identify options and summarize any associated trade-offs. 

Based on those discussions, we identified 19 options to include in this 

report. We originally identified over 100 options but reduced the list to 

19 options that directly addressed misclassification challenges and issues, 

were not already being implemented, and were distinct from each other. In 

addition, we did not include other options that we have recently analyzed 

or recommended in prior reports on misclassification or that are indirectly 

related to worker misclassification, such as for information reporting on 

payments made to independent contractors. 

Page 47 GAO-09-717 Employee Misclassification
Appendix I: Scope and Methodology 

We surveyed 11 stakeholders for their views on the 19 options we 

identified, asking them to state their level of support or opposition to the 

options and what they perceived to be the strengths and drawbacks of 

each option. These stakeholders included 4 groups that represent the 

views of small businesses, independent contractors, and those who hire 

them (i.e., independent contractor groups); 4 groups that represent the 

views of organized labor (i.e., labor groups); 2 groups that represented the 

tax preparation and advice community; and 1 federal agency that uses 

contractors. We received responses from 9 of these groups.3

 We analyzed 

the responses we received in order to present summary information in the 

report. 

We conducted this performance audit from August 2008 through July 2009 

in accordance with generally accepted government auditing standards. 

Those standards require that we plan and perform the audit to obtain 

sufficient, appropriate evidence to provide a reasonable basis for our 

findings and conclusions based on our audit objectives. We believe that 

the evidence obtained provides a reasonable basis for our findings and 

conclusions based on our audit objectives. 

 

3

We did not receive survey responses from one of the groups representing the tax 

preparation and advice community and one of the independent contractor groups. 

Page 48 GAO-09-717 Employee Misclassification
Appendix II: Stakeholder Views on Options to Appendix II: Stakeholder Views on Options to Address Misclassification Challenges 

Address Misclassification Challenges 

We identified 19 options to address challenges involved with preventing 

and responding to worker misclassification by reviewing related literature 

and interviewing knowledgeable persons about misclassification. As we 

identified these options, we asked these stakeholders for their views on 

the options, including what they considered to be the benefits and 

drawbacks of each. These stakeholders included IRS officials and 

representatives of organizations representing workers, independent 

contractors, tax professionals, and a federal agency that hires contractors. 

The following is a summary of the options and their perceived associated 

benefits and drawbacks. Neither the list of options nor the list of their 

perceived associated benefits and drawbacks is exhaustive. Some of the 

options are concepts rather than fully developed proposals with details of 

how they would be implemented. Additional detail could bring more 

benefits and drawbacks to light. The benefits and drawbacks are not 

weighted and are not listed in order of importance or by frequency of 

mention. Options should not be judged by the number of benefits and 

drawbacks. Some of the options overlap, covering more than one problem, 

while other options only deal with specific aspects of a problem. 

A. Clarify the employee/independent contractor definition and 

expand worker rights 

1. Clarify the distinction between employees and independent 

contractors under federal law by unifying multiple definitions, limiting 

the number of factors used to make determinations, and making the 

factors more conclusive 

Benefits: 

• Could reduce manipulation of classification rules 

• Could improve equity and efficiency of classification rules 

• Could improve worker protection if an expansive definition is adopted 

• Could improve objectivity of rules/reduce confusion 

Page 49 GAO-09-717 Employee Misclassification 
Appendix II: Stakeholder Views on Options to 

Address Misclassification Challenges 

Drawbacks: 

• Lobbying and political compromises could weaken the definition 

• Lobbying and political compromises could lead to a more restrictive 

definition 

• Could lead to increased litigation if a new definition has no history or 

precedent 

• Could create transitional costs and upheavals in working relationships 

• Could deter use of independent contractors 

• A “one-size-fits-all” approach may cause imbalances and more 

problems than it solves in certain industries 

• IRS and government agencies could incur costs to administer a new 

definition 

• Could sidetrack key anti-abuse reforms 

• No need to harmonize definitions since courts work well in doing so 

• Could encourage more employers to engage in fraud 

2. Allow workers to challenge classification determinations in U.S. Tax 

Court 

Benefits: 

• Could increase equity and protections for workers 

• Could reduce incentives for misclassification 

Drawbacks: 

• Could result in more or unnecessary litigation 

• Would be unfair to businesses 

• Could deter use of independent contractors 

• Too narrow to limit challenges to just Tax Court and just workers 

Page 50 GAO-09-717 Employee Misclassification
Appendix II: Stakeholder Views on Options to 

Address Misclassification Challenges 

3. Ensure that workers have adequate legal protection from retaliation 

for filing a Form SS-8 

Benefits: 

• Could help reduce misclassification/improve misclassification 

compliance 

• Could help improve worker protection and justice 

Drawbacks: 

• Could result in more litigation 

• Limits ability of employers to end contractual relationships as needed 

• Could reduce use of independent contactors 

• Not necessary because retaliation is rare and independent contractors 

can protect themselves through a contract 

• Does not include worker protection for other actions to challenge 

misclassification 

4. Define misclassification as a violation under FLSA 

Benefits: 

• Could help increase voluntary compliance 

• Would allow federal agencies, including DOL, to take greater 

enforcement actions 

Drawbacks: 

• Could increase costly lawsuits for businesses 

• Could deter use of independent contractors 

• Unfair to penalize businesses and contractors for confusing and 

subjective regulations 

Page 51 GAO-09-717 Employee Misclassification
Appendix II: Stakeholder Views on Options to 

Address Misclassification Challenges 

B. Revise section 530 of the Revenue Act of 1978 

5. Narrow the definition of “a long-standing recognized practice of a 

significant segment of the industry” so that fewer firms qualify under 

this reasonable basis for the section 530 safe harbor 

Benefits: 

• Could reduce incentive to misclassify and increase voluntary 

compliance 

• Could reduce confusion 

• Could help reduce tax gap related to misclassification 

Drawbacks: 

• Opens the door to eroding the protection of section 530 

• Could create inequities among those who use independent contactors 

• Could lead to economic disruption or upheaval in some industries 

• Ignores unique issues that some industries possess 

• Unnecessary because current definition can be hard to meet 

• Only narrows rather than eliminates “industry practice” 

6. Lift the ban on IRS/Treasury regulations or revenue rulings clarifying 

the employment status of individuals for purposes of employment 

taxes 

Benefits: 

• Could reduce requests for individual classification determinations and 

associated costs 

• More consistent application of the rules 

• Could increase voluntary compliance 

• Could allow IRS to more effectively prevent misclassification and 

enforce classification 

• Could improve understanding and reduce confusion over classification 

Page 52 GAO-09-717 Employee Misclassification
Appendix II: Stakeholder Views on Options to 

Address Misclassification Challenges 

Drawbacks: 

• No need because existing case law is sufficient 

• IRS favors employee status 

• Could erode section 530 protection 

• Could increase litigation and lobbying costs 

• IRS cannot fix the classification problem without congressional 

guidance 

• A national standard would not affect state definitions 

• Could disrupt working relationships 

• Political influences could slant the new guidance 

C. Provide additional education and outreach 

7. Require service recipients to provide standardized documents to 

workers that explain their classification rights and tax obligations 

Benefits: 

• Could increase voluntary compliance 

• Could help reduce misclassification by reducing errors 

• Could help educate workers about classification 

Drawbacks: 

• Could discriminate against some independent contractors 

• Relies on employers instead of IRS to inform workers 

• Could be ineffective if workers cannot understand the documents 

• Employers would incur costs and burdens 

Page 53 GAO-09-717 Employee Misclassification
Appendix II: Stakeholder Views on Options to 

Address Misclassification Challenges 

8. Expand IRS outreach to service recipient, worker, and tax advisor 

groups to educate them about classification rules and related tax 

obligations, targeting groups IRS deems to be “at risk” 

Benefits: 

• Could increase voluntary compliance 

• Could improve uniformity of classifications 

• Could reduce misclassification by reducing errors 

Drawbacks: 

• Could deter use of independent contractors 

• Could divert IRS resources from enforcement 

• Does not target tax advisors who facilitate misclassification 

• Could lead to unfair targeting of business groups 

• Could lead to independent contractors suing their clients 

9. Create an online classification system, using factors similar to those 

used in the SS-8 determination process, to guide service recipients and 

workers on classification determinations 

Benefits: 

• Uses electronic instead of paper-based processes 

• Could minimize the need for SS-8 determinations 

• Could provide more information to workers and service recipients 

• Could streamline decision making on classifications 

• Could reduce confusion and unintentional misclassification 

Drawbacks: 

• IRS would incur costs to develop system 

• Still relies on subjective weighting of evidence and is likely to produce 

inconsistent determinations 

• Not all workers have access to computers 

• Could be manipulated by employers to attain desired classification 

Page 54 GAO-09-717 Employee Misclassification
Appendix II: Stakeholder Views on Options to 

Address Misclassification Challenges 

10. Increase the use of IRS notices to service recipients in industries with a 

potentially high incidence of misclassification to educate them about the 

classification rules and ask them to review their classification practices 

Benefits: 

• Could increase voluntary compliance 

• Could improve understanding of correct classification 

Drawbacks: 

• IRS would incur costs to develop and mail notices 

• Could be ineffective if not combined with IRS enforcement 

• Could expose employers to more litigation 

• Could create adversarial relationships between employers and workers 

• Could be unfair to targeted industries 

D. Withhold taxes for independent contractors 

11. Require service recipients to withhold taxes, with rates at an adequate 

level to induce compliance, for independent contractors whose 

taxpayer identification numbers (TIN) cannot be verified or if notified 

by IRS during the TIN verification process that the contractors are not 

fully tax compliant 

Benefits: 

• Could identify more misclassification 

• Could help improve voluntary filing and tax compliance by having 

taxes paid up front 

Drawbacks: 

• Would impose costs and burdens on employers 

• Does not hold employers financially accountable for misclassification 

• TIN verification is not effective 

• Could face political opposition 

• Discriminates against independent contractors 

• Could result in withholding errors 

Page 55 GAO-09-717 Employee Misclassification
Appendix II: Stakeholder Views on Options to 

Address Misclassification Challenges 

12. Require universal tax withholding for payments made to independent 

contractors using tax rates that are relatively low (e.g., 1 percent to 5 

percent of payment amounts) 

Benefits: 

• Would make payments to workers more visible 

• Could increase voluntary filing and tax compliance by having taxes 

paid up front 

• Could help identify misclassification 

• Such low rates would not be burdensome to independent contractors 

Drawbacks: 

• Would impose costs and burdens on employers and workers 

• Could expose employers to underwithholding penalties 

• Does not hold employers financially accountable for misclassification 

• Could deter use of independent contractors 

• Does not recognize that profit margins vary widely across businesses 

• Could be used to intimidate undocumented workers 

• Withholding amounts could be too high or withholding rate could be 

too low 

• Could lead to increased “off-the-books” payments for services 

13. Require service recipients to withhold taxes from payments made to 

independent contractors who request withholding in writing 

Benefits: 

• Could increase voluntary filing and tax compliance by having taxes 

paid up front 

• Would be practical because withholding is voluntary 

• Could help independent contractors meet their tax obligations 

• Could make misclassification easier to identify and less likely to occur 

Page 56 GAO-09-717 Employee Misclassification
Appendix II: Stakeholder Views on Options to 

Address Misclassification Challenges 

Drawbacks: 

• Could increase employers’ costs and exposure to penalties for 

withholding errors 

• Could deter use of independent contractors 

• Does not hold employers financially accountable for misclassification 

• Would need additional remedies for workers if employer did not remit 

taxes to IRS 

E. Collect data on misclassification and independent contractors 

14. Measure the extent of misclassification and related impacts on tax 

revenues at the national level 

Benefits: 

• Could raise awareness of misclassification 

• Would provide data to support any reform efforts 

• Could help IRS more effectively address misclassification 

• Could improve understanding of correct classification 

Drawbacks: 

• Timely estimates could be costly 

• May not be successful 

• Could take a while and delay needed reforms 

15. Require each independent contractor to apply for a separate business 

TIN 

Benefits: 

• Could increase voluntary compliance 

• Reinforces business status and obligations of independent contractors 

• Could facilitate IRS compliance and enforcement efforts 

• Could prompt workers to think about their desired status 

Page 57 GAO-09-717 Employee Misclassification
Appendix II: Stakeholder Views on Options to 

Address Misclassification Challenges 

Drawbacks: 

• IRS would incur costs 

• Would impose burdens on independent contractors to apply 

• Could be harmful to some industries 

• Employers could use it to force workers into independent contractor 

status or to justify their independent contractor classifications 

F. Enhance IRS compliance programs 

16. Expand IRS’s Classification Settlement Program (CSP) to allow for 

CSP treatment for service recipients that voluntarily contact IRS about 

their misclassified workers before any contact from IRS about 

potential misclassification 

Benefits: 

• Would reduce the financial exposure of participating employers 

• Could increase voluntary compliance 

• Would not unnecessarily burden employers 

Drawbacks: 

• IRS would incur costs to expand program 

• Unfairly rewards intentional misclassification 

• Could create section 530 protection or allow other manipulation of 

classification rules for some employers 

17. Require service recipients to submit Forms SS-8 for all newly retained 

independent contractors 

Benefits: 

• Could increase voluntary compliance/reduce misclassification 

• Shifts burden of proof to the independent contractor 

• Provides IRS more information about independent contractors for 

compliance and enforcement 

Page 58 GAO-09-717 Employee Misclassification
Appendix II: Stakeholder Views on Options to 

Address Misclassification Challenges 

Drawbacks: 

• Current SS-8 process does not sufficiently protect workers or 

investigate employers 

• Would impose burdens and costs on employers and independent 

contractors 

• Could severely slow down the contracting process 

• Could deter use of independent contractors 

• Could allow for more manipulation of classification rules unless the 

rules are clarified and IRS more vigorously investigates employers 

• Does not address IRS’s bias for employee status 

• IRS’s costs would be significant 

G. Enhance coordination and information sharing 

18. Enhance coordination between IRS, DOL, and other federal agencies 

to share data and address misclassification 

Benefits: 

• Could increase voluntary compliance 

• Could deter intentional misclassification 

• Could make federal enforcement more efficient 

• Could improve consistency across federal agencies 

Drawbacks: 

• IRS may not be able to use all the information that it receives 

• Could deter some workers from reporting misclassification, especially 

if it leads to questions about their immigration status 

• Could result in loss of privacy for individuals affected by the 

information sharing 

• Could be hampered by differences in agency definitions of employee 

status 

Page 59 GAO-09-717 Employee Misclassification
Appendix II: Stakeholder Views on Options to 

Address Misclassification Challenges 

19. Enhance coordination between IRS, states, and selected local 

governments to share data and address misclassification 

Benefits: 

• Could help increase voluntary compliance 

• Could improve federal agency efficiency and effectiveness 

Drawbacks: 

• IRS may not be able to use all the information it receives 

• Could deter some workers from reporting misclassification 

• Could result in loss of privacy for individuals affected by the 

information sharing 

• Could be hampered by different definitions of employee status 

• Having too many government agencies involved could hamper action 

and allow employers to manipulate rules 

Page 60 GAO-09-717 Employee Misclassification
Appendix III: Comments from the Department Appendix III: Comments from the of Labor 

Department of Labor 

Page 61 GAO-09-717 Employee Misclassification 
Appendix III: Comments from the Department 

of Labor 

Page 62 GAO-09-717 Employee Misclassification
Appendix III: Comments from the Department 

of Labor 

Page 63 GAO-09-717 Employee Misclassification
Appendix III: Comments from the Department 

of Labor 

Page 64 GAO-09-717 Employee Misclassification
Appendix IV: Comments from the Internal Appendix IV: Comments from the Internal Revenue Service 

Revenue Service 

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Appendix IV: Comments from the Internal 

Revenue Service 

Page 66 GAO-09-717 Employee Misclassification
Appendix IV: Comments from the Internal 

Revenue Service 

Page 67 GAO-09-717 Employee Misclassification
Appendix IV: Comments from the Internal 

Revenue Service 

Page 68 GAO-09-717 Employee Misclassification
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ppendix V: GAO Contacts and Staff

cknowledgments 

Page 69 GAO-09-717 

Appendix V: GAO Contacts and Staff 

Acknowledgments 

 Employee Misclassification 

Andrew Sherrill, (202) 512-7215 or sherrilla@gao.gov GAO Contacts 

Michael Brostek, (202) 512-9110 or brostekm@gao.gov

In addition to the contacts named above, Revae Moran, Acting Director; 

Tom Short, Assistant Director; Amy Sweet, Analyst-in-Charge; Jeff Arkin, 

Analyst-in-Charge; Susan Bernstein; Jessica Bryant-Bertail; Scott Charlton; 

Doreen Feldman; Jennifer Gravelle; Maura Hardy; David Perkins; Ellen 

Phelps Ranen; Albert Sim; Andrew J. Stephens; and Gregory Wilmoth 

made key contributions to this report. 

Acknowledgments 

(130880) 
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