Employee Misclassification: Improved Outreach Could Help Ensure Proper Worker Classification
Published: 2007-05-08T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: Some workers do not receive worker protections to which they are entitled because employers misclassify them as independent contractors when they should be classified as employees. Key worker protections include minimum hourly wage and overtime pay and access to unemployment insurance. The Department of Labor (DOL) enforces several labor laws to protect workers, including the Fair Labor Standards Act (FLSA). Misclassification can also have a negative impact on tax collection for Social Security, unemployment insurance, and other programs. This testimony draws upon a previous GAO report and focuses specifically on (1) the number and characteristics of independent contractors, (2) the workforce protections and benefits provided to employees that typically are not available to independent contractors, and (3) the actions that DOL takes to detect and address employee misclassification.
section_title: What GAO Found
paragraphs: The number of independent contractors in the total employed workforce grew from 6.7 percent in 1995 to 7.4 percent in 2005. In 2005, there were 10.3 million independent contractors. Independent contractors, in 2005, had an average age of 46 years, were almost twice as likely to be male than female, and almost two-thirds had some college or higher education. Independent contractors were employed in a wide range of industries (such as professional services and construction) and occupations (including sales and management). When employees are misclassified as independent contractors, they may be excluded from coverage under key laws designed to protect workers and may not have access to employer-provided health insurance coverage and pension plans. Moreover, misclassification of employees can affect the administration of many federal and state programs, such as payment of taxes and payments into state workers' compensation and unemployment insurance programs. Notably, the tests used to determine whether a worker is an independent contractor or an employee are complex, subjective, and differ from law to law. DOL detects and addresses misclassification of employees as independent contractors by investigating complaints, but does not always forward misclassification cases to other federal and state agencies. DOL investigators detect and address employee misclassification primarily when responding to FLSA minimum wage and overtime pay complaints. DOL procedures require officials to share information with other federal and state agencies whenever investigators find possible violations of other laws. However, the district offices GAO contacted vary in how often they forward misclassification as a possible violation of other laws. As one form of outreach to workers, DOL has an FLSA workplace poster that explains the act, but it is missing key contact information.

section_title: Letter
paragraphs: Thank you for inviting me here today to discuss the misclassification of  employees as independent contractors. Some workers do not receive  worker protections to which they are entitled because employers  misclassify them as independent contractors when they should be  classified as employees. Key worker benefits and protections include the  guarantee of workers’ rights to safe and healthful working conditions, a  minimum hourly wage and overtime pay, freedom from employment  discrimination, and access to unemployment insurance. In its last  comprehensive misclassification estimate, the Internal Revenue Service  (IRS) estimated that 15 percent of employers misclassified 3.4 million  workers as independent contractors in 1984, resulting in an estimated tax  loss of $1.6 billion (or $2.72 billion in inflation-adjusted 2006 dollars) in  Social Security tax, unemployment tax, and income tax.
The Department of Labor (DOL) enforces a wide range of labor laws that  provide protections to workers, including the Fair Labor Standards Act  (FLSA), which provides minimum wage, overtime pay, and child labor  protections. Other federal and state agencies enforce laws that provide  workers with additional workforce benefits and protections.
The information I am presenting today is based on findings from a July  2006 report, which examined various aspects of the contingent workforce.  Today, as requested, I will focus specifically on independent contractors,  one of eight categories of contingent workers included in our report. I will  discuss (1) the number and characteristics of independent contractors,   (2) the workforce protections and benefits provided to employees that  typically are not available to independent contractors, and (3) the actions  that DOL takes to detect and address employee misclassification. To  identify information on the contingent workforce, we analyzed data from  the Bureau of Labor Statistics’ (BLS) Current Population Survey (CPS),  which is used to survey people about their work and workplace benefits,  and a CPS supplement developed to collect information on the contingent  workforce; interviewed BLS officials and other researchers about  contingent worker issues; and reviewed key workforce protection laws to  determine coverage of contingent workers. To obtain information on  DOL’s efforts to detect and address employee misclassification, we  reviewed DOL documents and interviewed DOL officials and reviewed  literature and interviewed researchers about employee misclassification  issues. We performed our work in accordance with generally accepted  government auditing standards between July 2005 and June 2006.
In summary, the number of independent contractors in the total employed  workforce grew from 6.7 percent in 1995 to 7.4 percent in 2005. In 2005,  there were 10.3 million independent contractors. Independent  contractors, in 2005, had an average age of 46 years, were almost twice as  likely to be male than female, and almost two-thirds had some college or  higher education. Independent contractors were employed in a wide range  of industries (such as professional services and construction) and  occupations (including sales and management). The tests used to  determine whether a worker is an independent contractor or an employee  are complex, subjective, and differ from law to law. Nevertheless, when  employees are misclassified as independent contractors, they may be  excluded from coverage under key laws designed to protect workers and  may not have access to employer-provided health insurance coverage and  pension plans. Moreover, misclassification of employees can affect the  administration of many federal and state programs, such as payment of  taxes and payments into state workers’ compensation and unemployment  insurance programs. Finally, DOL detects and addresses misclassification  of employees as independent contractors by investigating complaints, but  does not always forward misclassification cases to other federal and state  agencies. DOL investigators detect and address employee misclassification  primarily when responding to FLSA minimum wage and overtime pay  complaints. DOL procedures require officials to share information with  other federal and state agencies whenever investigators find possible  violations of other laws. However, the district offices GAO contacted vary  in how often they forward misclassification as a possible violation of other  laws. As one form of outreach to workers, DOL has an FLSA workplace  poster that explains the act, but is missing key contact information. GAO  recommended in its July 2006 report that DOL revise the workplace poster  to include additional contact information that would facilitate the  reporting of potential employee misclassification complaints, and evaluate  the extent to which misclassification cases identified through  investigations are referred to the appropriate federal or state agency, and  take action to make improvements as necessary. DOL generally agreed  with both recommendations.
subsections: section_title: Background
paragraphs: The term “contingent work” can be defined in many ways to refer to a  variety of nonstandard work arrangements. Broadly defined, “contingent  work” refers to work arrangements that are not long-term, year-round, full- time employment with a single employer. For example, an employer may  hire workers when there is an immediate and limited demand for their  services, without any offer of permanent or even long-term employment.  Independent contractors, temporary workers, and part-time workers are  examples of contingent workers. Specifically, independent contractors can  be seen as individuals who obtain customers on their own to provide a  product or service (and who may have other employees working for  them), such as maids, realtors, child care providers, and management  consultants.
Research has shown that employers use contingent work arrangements for  a variety of reasons. Employers may hire contingent workers to  accommodate workload fluctuations, fill temporary absences, meet  employees’ requests for part-time hours, screen workers for permanent  positions, and save on wage and benefit costs, among other reasons.  Previous analyses of data from the CPS Contingent Work Supplement have  indicated that workers also take temporary and other contingent jobs for a  variety of personal and economic reasons. For example, workers in  various types of contingent jobs indicated that they (1) preferred a flexible  schedule to accommodate their school, family, or other obligations;   (2) needed additional income; (3) could not find a more permanent job; or  (4) hoped the job would lead to permanent employment. Studies using  data from the BLS National Longitudinal Survey of Youth show that events  such as the birth of a child or a change in marital status affect the  likelihood of entering different types of employment arrangements and  prompt some workers to enter contingent work arrangements.
Concerns arise when employers misclassify workers as independent  contractors, who are excluded from certain worker protections. Employee  misclassification occurs when an employer improperly classifies a worker  as an independent contractor when the worker should be classified as an  employee. In 2000, we reported that because most key workforce  protection laws cover only workers who are employees, independent  contractors and certain other contingent workers, such as self-employed  workers, are, by definition, not covered.
DOL may encounter employee misclassification while enforcing worker  protection laws. DOL’s mission is to promote the welfare of job seekers,  workers, and retirees in the United States by improving their working  conditions, advancing their opportunities for profitable employment,  protecting their retirement and health care benefits, helping employers  find workers, strengthening free collective bargaining, and tracking  changes in employment, prices, and other national economic  measurements. In carrying out this mission, DOL enforces a variety of  worker protection laws, including those guaranteeing workers’ rights to  safe and healthful working conditions, a minimum hourly wage and  overtime pay, freedom from employment discrimination, and  unemployment insurance.
In particular, DOL’s Employment Standards Administration’s (ESA) Wage  and Hour Division enforces FLSA. The Wage and Hour Division—with  staff located in 5 regional and 72 district, area, and field offices throughout  the country—conducts investigations of employers who have $500,000 or  more in annual sales volume. In addition, the division conducts outreach  efforts for employers and workers to ensure compliance with FLSA.  District directors oversee investigators, who play a key role in carrying out  FLSA enforcement. Investigators are trained to investigate a wide variety  of workplace conditions and complaints and enforce a variety of labor  laws in addition to FLSA. Regional and district offices conduct outreach  to employers and workers through brochures, workplace posters,  presentations or training sessions for individuals or groups, and Web- based information.
FLSA—which provides minimum wage and overtime pay protections— requires that employers pay those employees covered by the act at least  the minimum wage and pay overtime wages when they work more than   40 hours a week. FLSA requires that an employer-employee relationship  exist for a worker to be covered by the act’s provisions.
section_title: Number and Characteristics of Independent Contractors
paragraphs: In 2005, an estimated 7.4 percent of the total employed workforce were  independent contractors. By comparison, 6.7 percent of the workforce  were independent contractors in 1995. During this time period, the number  of independent contractors grew from an estimated 8.3 million to 10.3  million workers in 2005. (In 2005, there were about 42.6 million contingent  workers in the workforce—representing an estimated 31 percent of the  workforce.)
Independent contractors, in 2005, were on average 46 years old. The  majority were men (65 percent), had attended or graduated from college,  and 8 out of 10 were white, non-Hispanic. Independent contractors were  employed in a wide range of industries, but in 2005, 23 percent were  employed in professional services and 22 percent were employed in  construction. Regarding occupations, the percentage of independent  contractors in sales and related occupations (17 percent) and management  (16 percent) were greater than in other occupations. In 2005, 9 percent of  independent contractors indicated that they would prefer to work for  someone else. About 11 percent of independent contractors reported  family income below $20,000.
section_title: Misclassification of Employees Can Have Negative Outcomes for Workers and Government Programs
paragraphs: The tests used to determine whether a worker is an independent  contractor or an employee are complex, subjective, and differ from law to  law. Nevertheless, when employees are misclassified as independent  contractors, they may be excluded from coverage under key laws designed  to protect workers and may not have access to certain employer-provided  benefits, such as health insurance coverage and pension plans. Moreover,  misclassification of employees can affect the administration of many  federal and state programs. For example, misclassification could affect  payment of taxes and payments into state workers’ compensation and  unemployment insurance programs.
subsections: section_title: There Is Neither a Single or Simple Test Used to Determine whether a Worker Is an Independent Contractor or an Employee
paragraphs: No definitive test exists to distinguish whether a worker is an employee or  an independent contractor. The tests used to determine whether a worker  is an independent contractor or an employee are complex, subjective, and  differ from law to law. For example, the National Labor Relations Act, the  Civil Rights Act, the Fair Labor Standards Act, and the Employee  Retirement Income Security Act each use a different definition of an  employee and various tests, or criteria, to distinguish independent  contractors from employees.
In determining whether an employment relationship exists under federal  statutes, courts have developed several criteria. These criteria have been  classified as the economic realities test, the common law test, and a  combination of the two sometimes referred to as a hybrid test. The  economic realities test looks to whether the worker is economically  dependent upon the principal or is in business for him or herself. The test  is not precise, leaving determinations to be made on a case-by-case basis.  The test consists of a number of factors, such as the degree of control  exercised by the employing party over the worker, the worker’s  opportunity for profit or loss, the worker’s capital investment in the  business, the degree of skill required for the job, and whether the worker  is an integral part of the business. The traditional common law test  examines the employing party’s right to control how the work is  performed. To determine whether the employing party has this right,  courts may consider the degree of skill required to perform the work, who  supplies the tools and equipment needed to perform the work, and the  length of time the worker has been working for the employing party. When  the tests are combined in some type of hybrid, a court typically weighs the  common law factors and some additional factors related to the worker’s  economic situation, such as how the work relationship may be terminated,  whether the worker receives leave and retirement benefits, and whether  the hiring party pays Social Security taxes.
Aside from the complexities of distinguishing employees from  independent contractors, employers have economic incentives to  misclassify employees as independent contractors. Namely, employers are  not obligated to make certain financial expenditures for independent  contractors that they make for employees, such as paying certain taxes  (Social Security, Medicare, and unemployment taxes), providing workers’  compensation insurance, paying minimum wage and overtime wages, or  including independent contractors in employee benefit plans.
section_title: Misclassified Employees May Be Excluded from Coverage under Key Worker Protection Laws
paragraphs: Contingent workers who are employees are generally protected under key  laws designed to protect workers, but certain categories of contingent  workers—such as independent contractors—may be excluded from  coverage under these laws. While most of the key worker protection laws  do not distinguish between types of employees (i.e., contingent and  standard full-time employees), some laws contain requirements that  exclude certain categories of contingent workers or contain certain time- in-service requirements that make it difficult for them to be covered. In  addition, because these laws are based on the traditional employer- employee relationship, they generally cover only workers who are  employees; independent contractors, therefore, are not covered.
Some of the key laws designed to protect workers but that only apply to  “employees” include the following:    Fair Labor Standards Act—establishes minimum wage, overtime,  and child labor standards;    Family and Medical Leave Act—requires employers to allow  employees to take up to 12 weeks of unpaid, job-protected leave for  medical reasons related to a family member’s or the employee’s  own health;    Occupational Safety and Health Act—requires employers to  maintain a safe and healthy workplace for their employees and  requires employers and employees to comply with all federal  occupational health and safety standards;    National Labor Relations Act—guarantees the right of employees to  organize and bargain collectively;    Unemployment Insurance—pays benefits to workers in covered  jobs who become unemployed and meet state-established eligibility  rules; and    Workers’ Compensation—provides benefits to injured workers  while limiting employers’ liability strictly to workers’ compensation  payments.
When employers have misclassified workers as independent contractors,  workers may need to go to court to establish their employee status and  their eligibility for protection under the laws. In addition, DOL may bring a  lawsuit on behalf of the worker or group of workers to require that the  employer provide the benefit or protection under the law.
section_title: Misclassified Employees May Not Have Access to Some Employer-Provided Benefits
paragraphs: Employees who are misclassified as independent contractors, because by  definition they would not be considered employees, may not have access  to certain employer-provided benefits, such as health insurance coverage  and pension plans. Some states and professional associations have  developed health insurance programs that help contingent workers access  health care. While these public and private initiatives are relatively new  and long-term outcomes have yet to be determined, the programs have  succeeded in expanding health insurance options for some contingent  workers.
section_title: Employee Misclassification Can Affect Administration of Government Programs
paragraphs: Misclassification of employees can affect the administration of many  federal and state programs, such as payment of taxes and pension  benefits. For example, if employers misclassify workers as independent  contractors, then they may not be paying the payroll taxes required to be  paid for employees. At the federal level, misclassification can reduce tax  payments, Medicare payments, and Social Security payments. At the state  level, misclassification can affect payments into state tax, workers’  compensation, and unemployment insurance programs.
section_title: DOL Detects and Addresses Employee Misclassification Through Investigations, but Offices We Studied Vary in How Often They Forward Misclassification Cases to Other Federal and State Agencies
paragraphs: DOL detects and addresses employee misclassification when enforcing the  FLSA minimum wage and overtime pay provisions. As part of its FLSA  investigation process, DOL examines the employment relationship— whether a worker is an employee or an independent contractor—to  determine which workers are covered. Investigators use various methods  to test the employment relationship of workers, including interviewing  employers and workers, reviewing payroll and related documents, and  touring work sites. While misclassification alone is not an FLSA violation,  it may contribute to FLSA violations or violations of other laws, such as  tax violations. DOL’s outreach efforts provide some information to  employers and workers on employee misclassification issues. DOL  procedures require officials to share information with other federal and  state agencies whenever investigators find possible violations of other  laws. However, the district offices that we contacted vary in how often  they forward misclassification cases as a possible violation of other  agencies’ laws.
subsections: section_title: Investigators Determine Workers’ Employment Relationship
paragraphs: DOL relies on complaints as a primary way to identify potential violations  for investigation. All FLSA investigations of minimum wage and overtime  pay complaints begin with an examination of workers’ employment  relationship because FLSA applies only to employees, not to independent  contractors. If investigators determine that a worker is an employee and  not an independent contractor, they continue with their FLSA  investigation to determine whether the employer has provided the  minimum wage and overtime pay required by the act.
section_title: Employee Misclassification, though Not an FLSA Violation, May Contribute to FLSA or Other Violations
paragraphs: Employee misclassification alone is not a violation of FLSA, but may  contribute to FSLA minimum wage and overtime pay violations or  violations of tax, workers’ compensation, or unemployment insurance  laws. DOL investigations have identified FLSA violations associated with  employee misclassification. For example, one misclassification case  involved a valet parking company located in Arizona that provided  services to local restaurants, sports venues, hotels, and theaters. In 2004,  this company paid $66,947 in minimum wage and overtime pay back wages  to 262 employees who had been misclassified as independent contractors.  When reviewing the employment relationship, the DOL investigator found  that the services provided by these workers were integral to the business,  and that the employer had imposed strict policies and procedures to  follow, and told them when they would work, where they would work,  what their pay rate would be, and what uniforms they would wear. The  investigator determined that the workers were not required to use  initiative, judgment, or foresight to be successful as independent  contractors, did not have any investment in facilities or equipment, and  were not operating to make a profit.
section_title: DOL’s Outreach Efforts Provide Some Information on Employee Misclassification Issues
paragraphs: As part of general FLSA outreach efforts to employers and workers, DOL  provides some information on establishing the employment relationship.  While these outreach efforts primarily focus on how to comply with  provisions of FLSA—minimum wage, overtime pay, and child labor—they  also include some information on the employment relationship.  Specifically, information on employment relationship issues is available to  employers and workers through brochures, pamphlets, fact sheets, and  Web-based information. According to DOL officials, outreach efforts  conducted specifically for industries likely to use independent contractors  may also address the topic of employee misclassification.
Another form of outreach that DOL provides is its workplace poster. FLSA  regulations require that every employer that has employees subject to the  act’s provisions post a notice explaining the act in a prominent and  accessible place at the work site. While DOL relies heavily on complaints  from workers to enforce FLSA, the FLSA workplace poster does not  provide a telephone number for workers or others to call to register  complaints.
section_title: DOL Offices We Studied Vary in How Often They Forward Misclassification Cases to Other Federal and State Agencies
paragraphs: Employers’ misclassification of workers as independent contractors may  in some circumstances violate tax, unemployment insurance, and workers’  compensation laws. According to the Field Operations Handbook, DOL  regional or district officials are required to share information with other  appropriate federal and state agencies whenever investigators conducting  FLSA investigations find instances of possible violations of other laws. At  the same time, however, the handbook cautions investigators not to  interpret laws outside their authority. We discussed whether DOL  forwards misclassification cases identified during an FLSA investigation.  The DOL officials we spoke to in nine district offices could not provide the  number of misclassification cases they referred to other agencies because  they do not track this information. However, their responses indicated that  district offices vary in how often they implement the procedures to refer  cases to other agencies. Some of the DOL district offices told us that they  notified IRS and state agencies when they found misclassification, while  others told us that they had little or no contact with other agencies  regarding misclassification issues. These district offices also reported that  it was rare for them to receive misclassification referrals from other  federal or state agencies.
section_title: Conclusions and Recommendations for Executive Action
paragraphs: DOL investigators identify instances of employee misclassification when  responding to minimum wage and overtime pay complaints. However,  because the FLSA workplace poster does not provide an easy method for  workers to report complaints, DOL may be missing opportunities to  address other instances of potential misclassification. Improving the  workplace poster would reinforce DOL’s complaint-based strategy and  would help further protect the wages of employees who may be  misclassified.
While DOL investigators conducting FLSA investigations are required to  share information with other federal and state agencies whenever they  find instances of possible violations of other laws, DOL district offices we  studied varied in how often they forwarded misclassification cases to  other agencies. DOL does not know the extent to which district offices  refer misclassification cases to other agencies. DOL cautions investigators  not to interpret laws outside their authority, but referring misclassification  cases identified through FLSA investigations would not require DOL to  interpret other agencies’ laws. In addition, referring this information may  assist other federal and state agencies in addressing misclassification.  Furthermore, when DOL does not refer cases of misclassification, other  agencies lose opportunities to fulfill their fiduciary duties in conserving  government funds.
To facilitate the reporting of FLSA complaints, we recommended that the  Secretary of Labor instruct the Wage and Hour Division to revise the FLSA  workplace poster to include national, regional, and district office  telephone numbers and a Web site address that complainants may use to  report alleged employee misclassification issues. Following the  publication of our report, DOL notified the Congress that it was  redesigning the poster and expected the work to be completed in spring  2007.
To facilitate addressing employee misclassification across federal and  state programs, we recommended that the Secretary of Labor instruct the  Wage and Hour Division to evaluate the extent to which misclassification  cases identified through FLSA investigations are referred to the  appropriate federal or state agency potentially affected by employee  misclassification, and take action to make improvements as necessary. In  addressing its referral mechanism, the Wage and Hour Division officials  should consider building upon efforts by district offices currently engaging  in referrals. Following the publication of our report, DOL notified the  Congress that it was researching the nature and effectiveness of the  referral of potential employee misclassification by different district offices  to various federal and state agencies. DOL also noted that it will consider  appropriate revisions to its procedures, and expected the work to be done  by the end of September 2007.
Mr. Chairmen, this concludes my prepared statement. I will be happy to  answer any questions that you or other members of the subcommittees  may have.
section_title: GAO Contacts and Staff Acknowledgments
paragraphs: For future information regarding this testimony, I can be contacted at  (202) 512-7215. Key contributors to this testimony were Brett Fallavollita  and Linda Siegel.
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