In an age of rising benefit costs and other constraints on the operations of professional service firms, some firms are turning to a range of tactics to reclassify workers to take them off the formal payroll and, therefore, lower their costs and administrative burdens. However, doing so may subject the employer to state and federal employment law fines and penalties.
All this is happening against the backdrop of a broader shifting of risk from employers to workers, who are shouldering an increasing share of responsibility for everything from health insurance premiums to retirement income to job security. While the future might present a model where everyone is truly an independent contractor and neither those actually providing services nor those using the services have any continuing or controlling interest in each other, such a situation does not currently exist and any firm that thinks it can avoid employment responsibilities, tax obligations, or employment practices liability needs to carefully consider alternatives to hiring workers.
Regulators and courts have increased their scrutiny of the relationship between business entities and independent contractors. Alleged misclassification of workers has been one of the primary battlegrounds of this shift, leading to high-profile lawsuits.
For decades, some professional service firms have shifted work from employees to independent contractors to cut their overhead and labor costs and, at times, to qualify for special government procurement assistance. Often, this has been accomplished by relabeling workers and slightly altering the conditions of their work. And some professional service firms have simply ignored regulatory and tax guidance and “informally” used the services of professionals and clerical workers as “consultants” or “leased personnel” or “temps.”
Now, however, businesses—including design firms and construction contractors—are turning to other kinds of employment relationships, such as setting up workers as owners of limited liability companies (LLCs) in an attempt to shield the businesses from tax and labor statutes. In response, some state and federal agencies are aggressively clamping down on such arrangements, passing local legislation, filing briefs in workers’ own lawsuits, and closely tracking the spread of what they see as questionable employment models.
For instance, construction companies in Arizona and Utah have been charged with using phony LLCs. In that investigation, the Federal Labor Department and its state counterparts found that more than 1,000 construction workers were building houses as employees one day and then a day later had begun performing the same work on the same job sites as so-called owners of LLCs, but without any wage or safety protection. In April, the construction firms that had put the plan in place—and had avoided paying hundreds of thousands of dollars in payroll taxes—were ordered to pay $700,000 in back wages, damages, and penalties.
Companies that abuse the system deny workers access to overtime and minimum wage pay requirements as well as health and safety protections, and they lower the standards at rival firms, which often cannot compete unless they follow the lead of unscrupulous firms. During an economic downturn, many who need some sort of employment might go along with the pretense of being an independent contractor. But as the economy improves and demand for qualified and committed workers increases, firms in design and construction that try to avoid regulatory and taxation responsibilities by creating sham business relationships could find that they face not only legal action, but client abandonment.