Misclassifying the “Underground Workforce” as a Form of Independent Contractor Misclassification

The lead story in today’s front page of the Texas Tribune reports on a hearing before the Texas Workforce Commission where the testimony focused on the intersection of undocumented aliens and independent contractor misclassification. The hearing was held in advance of the Workforce Commission’s preparation for its upcoming legislative agenda. Texas is no different than many states that are cracking down on misclassification of employees as independent contractors (ICs). But unlike most articles on the subject of IC misclassification, this article discussed the testimony of those who complain about the underground hiring of workers who are not paid on a W-2 or Form 1099 basis but rather under the table, either to undocumented aliens or to those willing to be paid in cash.

Some of those that support legislative bills designed to curtail IC misclassification frequently advance the argument that proposed new laws are needed to eradicate this “underground workforce.” While some regulators and employee rights organizations refer to cash payments as a form of IC misclassification, it is not really misclassification at all but rather a form of illicit conduct. IC misclassification, on the other hand, results when companies classify workers as ICs and report compensation on a Form 1099 for one or more workers that may be “employees” under state or federal law. These businesses do not withhold taxes from such workers’ pay, or make any contributions for Social Security and Medicare, or cover the workers for Unemployment and Workers Compensation, or pay any required overtime – none of which is required unless the company has failed to properly classify such workers as employees.

What should companies do that are using underground labor and not reporting that compensation? And what should businesses do that are reporting compensation on a 1099 basis for workers they have classified as ICs?

For companies that are involved in the “underground workforce,” it’s rather simple. They would be wise to cease using undocumented aliens and terminate all cash payments including to workers who are authorized to work in the U.S.  If they continue to employ workers with proper work authorization, they should classify them as “employees” and pay them on a W-2 basis. Alternatively, they can outsource them to a staffing company that will employ them, withhold state and federal income taxes, and accord them the protections of state and federal labor and employment laws. Those companies should also consider taking any necessary corrective steps with state and federal tax and workforce authorities.

In contrast, companies that use 1099ers but wish to avoid being swept up in the IC misclassification crackdown can often retain their 1099ers, provided their IC relationships are properly structured, documented, and implemented. Many states have laws that require a showing that individuals classified as ICs must be “free from control or direction in the performance of the service, both under contract and in fact.” Even in the absence of such state laws, many state workforce agencies and tax commissions are actively seeking to detect companies that are paying workers on a 1099 basis but improperly exercising direction and control over the manner or means by which the workers perform their services. Government regulators are even targeting companies that have properly structured their IC relationships but have simply failed to document those relationships in their IC agreements in a manner consistent with IC laws.

For those companies paying workers on a 1099 basis who are concerned that they may be misclassifying employees as ICs, their level of IC compliance can be considerably enhanced by (a) determining where they fall on the IC Compliance Scale™ in light of applicable state and federal IC laws, and (b) where necessary, restructuring, re-documenting, and/or re-implementing their IC relationships consistent with those laws. Some companies that wish to minimize their IC misclassification liability have done so using tools such as IC Diagnostics™, as described in a White Paper also published on this site.

Regulators such as those in the Texas Workforce Commission and agencies in other states are increasingly equating businesses involved in the “underground workforce” with those that may be doing nothing more than failing to dot their i’s and cross their t’s in their IC agreements with workers providing services though legitimate IC relationships. Businesses using 1099ers that wish to stay ahead of the IC misclassification curve should examine their exposure to this form of liability and take steps promptly to enhance their IC compliance in those states that permit IC relationships.

Your comments are invited.

Richard Reibstein
Lisa Petkun
Andrew Rudolph

This entry was posted in IC Compliance and tagged , , , . Bookmark the permalink.