Misclassification in Building Industry Impairs Worker Supply, Hurts Compliant Contractors

The constraints that growing worker misclassification puts on the construction sector’s efforts to get and keep skilled workers is a national concern that industry and labor representatives, federal agencies, and even Congress must address, stakeholders told Bloomberg BNA in recent interviews.

Misclassified workers—those who are treated as independent contractors instead of regular employees, as they should be—are paid 53 cents for every dollar regular construction employees get, researchers at the Economic Roundtable recently reported (60 CLR 722, 9/4/14). Their employers can use the savings from the reduced pay, benefits and payroll taxes to outbid other companies on construction projects, the group said.

Both of these factors have contributed to a labor shortage in the construction industry, some industry representatives say.

Employers that misclassify cheat workers out of wages and benefits and are responsible for skilled workers leaving the industry for more reliable employment elsewhere, Matthew Capece, a representative for the Carpenters and Joiners of America, told Bloomberg BNA Sept. 11.

Other industry groups agree there is a worker shortage in the industry but disagree that misclassification is the cause. Brian Turmail, spokesman for Associated General Contractors, told Bloomberg BNA Oct. 17 that retiring baby boomers and a school system focused on college prep classes are major contributors to the worker shortage.

But Capece cites the fact that misclassified workers are often paid low wages under illegal conditions. “That’s not a mix that will attract skilled people to the industry. That not really an attractive job description,” Capece said.

To address the problem, industry and union representatives say Congress should take action on pending legislation to close loopholes in federal tax law that may protect contractors that participate in misclassification. And the law should impose severer penalties on employers that continue to misclassify workers, they say.

Some representatives are also calling for construction project owners, including developers and companies that provide financing for projects, to be held accountable for failing to ensure that contractors they hire are complying with the law.

Efforts to Stop Misclassification Increase.

In 2000, the Labor Department released a study showing that 10 percent to 30 percent of audited employers misclassify their workers as independent contractors and that the practice has cost the federal government billions of dollars in revenue.

According to an August 2014 survey fact sheet from the National Employment Law Center, Labor Department audits of employers showed that the average number of misclassified workers more than doubled between 2002 and 2011.

NELP also found that several state studies have shown that misclassification in construction is usually several percentage points higher than in other industries.

In response to what has resulted in a significant spike in payroll fraud, the DOL this year said it’s ramping up initiatives to increase detection of contractors that misclassify their workers. The agency also announced it would be helping several states in their efforts to catch employers that commit payroll fraud (59 CLR 1476, 1/30/14). The department recently awarded more than $10 million in grants to 19 state programs to help them address misclassification activities (60 CLR 769, 9/18/14).

Misclassification Goes Up in Down Economy.

Dana Thompson, political affairs director at the Sheet Metal and Air Conditioning Contractors’ National Association (SMACNA), told Bloomberg BNA Aug. 28 that misclassification practices tend to increase during periods of economic recession, when construction employers are seeking to cut their operating costs.

Employers that commit this form of payroll fraud can pocket as much as 30 percent in labor costs by avoiding the legal obligation to withhold employees’ taxes from their paychecks, and failing to pay overtime, workers compensation, and unemployment insurance, Thompson said. These employers also avoid paying into Social Security and Medicare.

Employers in the “underground economy” that were misclassifying workers or engaging in other forms of payroll fraud, ended up gaining a competitive advantage when the recession hit in 2007, Bruce Wick, director of risk management for CALPASC- California Professional Association of Specialty Contractors, told Bloomberg BNA Aug. 22.

Construction workers feeling the pressure to keep their jobs or find work may lower their standards and accept a job with an employer that isn’t abiding by the law when the economy and job market are down, Thompson said.

Mark Fowler, executive vice president of the Western Wall & Ceiling Contractors Association, echoing Thompson’s comments, told Bloomberg BNA Aug. 29: “When a recession hits, people get out of the union. People resort to whatever they have to do to survive.”

Practice ‘Destroying the Social Fabric’ of Industry.

As the number of workers who are misclassified grows, Michael Cunningham, executive director of the Texas State Building and Construction Trades Council, told Bloomberg BNA Sept. 10, the practice is “destroying the social fabric of our industry.”

The issue is so rampant in construction that the practice has almost become ingrained in the industry, Wick said. “We need to change our cultural view. Employees need to be taken care of. Employees need to be protected,” he said.

According to Thompson, employers that misclassify workers continue to adopt new ways of evading the legal employee-employer relationship. It’s gone so far, she said, that some employers have pushed their workers into purchasing a franchise, forming limited liability companies, or joining an incorporated group of individuals to avoid having to report them as regular employees.

For example, the Labor Department recently won a lawsuit against Utah-based staffing services company Universal Contracting LLC, which made about 1,000 construction workers enter agreements that made them Class B members of an LLC instead of employees (60 CLR 486, 6/26/14). After filing the lawsuit, DOL Wage and Hour Division Southwest Regional Administrator Cynthia Watson said in an April 11,2013, statement that Universal Contracting was “intentionally skirting the law” by claiming their workers weren’t employees because they were members of an LLC.

A federal judge ruled that the workers should have been classified as employees under the Fair Labor Standards Act.

The actions of Universal Contracting and companies that participate in the same payroll fraud practices are “degrading the construction workforce,” Thompson said.

“One of the things we always worry about is our ability to recruit and train new workers,” Thompson said. “When you don’t have enough skilled workers, you don’t have the skilled base of employees that you need for future projects.”

Worker Shortage Related?

Several national employer associations over the past year have voiced their concerns about a skilled worker shortage, Capece said. In July , the National Association of Home Builders released the results of a survey revealing that worker and subcontractor shortages have become more widespread in the residential sector since 2013. The results showed 41 percent of homebuilders reporting a labor shortage, up from 20 percent in 2012 and 28 percent in 2013.

A 2013 survey from the Associated General Contractors found that 74 percent of contractors responding reported trouble finding skilled workers. At the time, AGC Chief Executive Officer Stephen Sandherr said the association needed to take steps to ensure there would be enough workers to meet demand.

Capece says that if better policies were in place to protect construction workers from payroll fraud, contractors wouldn’t be facing a worker shortage. “The industry would have an easier time attracting and keeping skilled labor if it decided to reverse the trend of paying workers low wages off the books,” Capece said.

However, AGC spokesman Brian Turmail told Bloomberg BNA Oct. 17 that job classification errors committed by contractors aren’t the cause of the decline in labor. “We’ve done a lot of surveying of our members on this issue, and haven’t heard that as a cause for worker shortages. The real problem is we have a public educational system that is almost entirely focused on preparing students for college tracks,” Turmail said.

Turmail added that the worker shortage issue is exacerbated by retiring baby boomers and construction workers who were let go during the recession and have picked up jobs in other sectors of the economy.

Compliant Companies Miss Out on Work.

Not only are workers discouraged from remaining in the construction sector, Fowler said, but misclassification has also deterred contractors from committing to the industry. Fowler is a former residential construction contractor.

He said that because contractors that misclassify are illegally slashing their labor costs, they can outbid other contractors for work on major construction projects. “It makes it even tougher on a contractor because of reporting everything properly. It puts you at a disadvantage,” Fowler said.

Thompson said that remaining competitive has become one of the biggest issues for employers that do comply with the law.

According to National Federation of Independent Business Senior Executive Counsel Elizabeth Milito, in some cases, employers aren’t trying to misclassify a worker to save money or win bids. They simply aren’t aware of the process for classifying workers correctly, she said Sept. 16.

“Even companies that believe they are following the rules have been surprised to learn they didn’t completely comply,” Milito said. “The rules are different in every state. The distinction between an employee and a contractor is not as clear as it should be.”

Milito said some employers have trouble keeping up with the “crackdown” and major changes to state policies with regard to what classifies someone as an independent contractor.

Enforcement: Unions, Congress and Agencies.

What strategies should be used to monitor and penalize contractors that keep misclassifying workers is a topic still up for debate. Industry representatives agree that reducing misclassification should be a priority for the industry, but there are different proposals for the best course of action.

Wick said federal and state agencies should revamp the ways they reprimand contractors that break the law, by enforcing a more severe punishment—taking away the employer’s ability to continue running its company.

“The underground employer says, ‘If you fine me once every five years, that’s the cost of doing business.’ We need enforcement agencies to understand the seriousness of the battle. When they find a bad actor, they need to pursue this person to either come into compliance or go out of business. There is no place to allow them to continue to take advantage of employees,” Wick said.

Accountability for Prime Contractors.

Wick, Fowler and Capece agreed that agencies should enforce policies that hold prime contractors as well as project owners accountable for the misclassification violations of their subcontractors. “How many project owners and prime contractors say they’re going to take the low bid and look the other way?” Wick said. “We just kind of have this evasive belief that the underground economy is not a bad thing.”

However, Milito told Bloomberg BNA that a policy whereby owners and general contractors are responsible for payroll fraud committed by other actors is “not workable.” “The general contractor just can’t be made responsible for all the players below them. It can be difficult for a general contractor to monitor and control misclassification in all the layers below,” Milito said.

Fowler added that the federal and state governments alone don’t have the staffing to go out and investigate all of the job sites. He argued that deteriorating union membership in the construction industry, especially in the residential sector, has a role to play in the rise of misclassification incidents.

“The unions were able to police things in the ‘70s, because the union had this real connection to the manpower,” Fowler said. Fowler added that more “union-run” work in all sectors of construction would provide an additional reporting and enforcement mechanism.

Federal Bills Proposed.

On the legislative side, Thompson said that Congress has been somewhat hesitant to take on the issue of misclassification. There are currently two bills in the House and Senate that have support from SMACNA and other proponents of stronger misclassification legislation that would amend federal law to make it more difficult to commit payroll fraud without being detected.

Senate Bill 1687, sponsored by Sen. Robert Casey (D. Pa.) and House Bill 4611, sponsored by Rep. Joe Courtney (D-Conn.) would amend the Fair Labor Standards Act to require employers to classify their employees correctly and notify their employees of their classification or face more severe penalties for violations.

Senate Bill 1706, sponsored by Sen. Sherrod Brown (D-Ohio) and House Bill 4503, sponsored by Rep. Jim McDermott (D-Wash.) would amend Section 530 of the Internal Revenue Code by prohibiting reduced penalties for employers in the construction industry that, without a legitimate reason, don’t withhold income taxes from their employees’ paycheck; eliminating a moratorium on new IRS guidance addressing worker classification; allowing the IRS to reclassify independent contractors as employees; and repealing the “safe harbor” created by Section 530 that allows employers to continue treating workers that the IRS finds were misclassified as independent contractors if they have a reasonable basis for doing so.

AGC has criticized S.1706, saying it would “harm the industry it seeks to help.” In a June 25 letter to Brown, AGC Government Affairs Director Jeffrey Shoaf wrote that there are legitimate independent contractor relationships in the construction industry. “[P]roper use of independent contractors should not be jeopardized in exchange for punishing a small minority of employers that may abuse the system,” Shoaf wrote.

Turmail said AGC members have no tolerance for contractors that abuse the practice of using independent contractors “in a shameless attempt to undermine their competitors on the backs of workers.” However, AGC members are concerned about legislative proposals that penalize legitimate contractors along with the unscrupulous ones.

Without any legislative action and better enforcement, Thompson said, the “pool of ethical and responsible employers gets smaller and smaller.” And according to Cunningham, the pool of interested recruits and skilled workers will also continue to shrink without changes.

“We need stronger federal misclassification laws. Many states have taken on the responsibility, but we have been at this for a long time,” Cunningham said. “You get cheated once. You get cheated twice. Why would you want to stay in an industry where you’re going to be cheated ? We need people to step up to the plate and not be part of the problem.”

To contact the reporter on this story: Jewel Edwards in Washington at jedwards@bna.com

To contact the editor responsible for this story: Karen Ertel at kertel@bna.com