On January 10, the DOL’s Wage and Hour Division issued Final Rules clarifying whether workers can be classified as independent contractors under the Fair Labor Standards Act (FLSA). Effective March 11, 2024, the Final Rules will strengthen the criteria used for classifying workers as independent contractors and will deter unscrupulous contractors from using independent contractor status to avoid paying overtime, unemployment taxes, workers comp, and health benefits to provide a competitive advantage when bidding on construction projects.
The Final Rules clarify the six-point test used for determining independent contractor status. The Final Rules emphasize that the determination should be made by weighing all of the relevant factors under a “totality of the circumstances” –rather than relying on a single factor.
The Final Rules provide consistency in applying the six-point economic reality test, which assesses whether:
- There is an opportunity for profit or loss;
- The work relationship is permanent or temporary;
- There is a degree of control by the worker and the nature of control;
- The work performed is integral to the potential employer’s business;
- There is skill and initiative required by the worker, and
- The level of investment in evidence by the worker and potential employer.
SMACNA strongly supported the Proposed (and now Final) Rule because the rule provides for greater protections against deliberate misclassification of workers as independent contractors. Specifically, SMACNA’s comments to the DOL focused on the need for a presumption of employee status unless all of the six points of the independent contractor definitional criteria are met. SMACNA further commented that DOL should create a notice of worker status for legitimate independent contractors and that contractors should sign and verify their status rather than allowing employers to designate them as independent contractors. SMACNA noted that the DOL should develop regulations specific to the construction industry, requiring independent contractors to affirm their contractor status for every job.
Misclassification of workers has been a longstanding and well-known fraudulent practice in the construction industry. Unscrupulous contractors have misclassified employees as independent contractors to cheat on tax withholding and cheat their workers out of overtime, minimum wages, health care benefits, unemployment insurance, and avoid workers’ Compensation. In addition, these contractors have used misclassification to avoid I-9 verification to confirm legal work status and have undercut competitive bidders, including SMACNA contractors, that pay their employees prevailing wages and benefits. SMACNA contractors will benefit from a more stringent standard used to determine legitimate Independent Worker classification by scrutinizing contractors that have fraudulently misclassified workers, enforcing penalties against those found abusing the law, and avoiding tax and benefit assessments.
For at least four decades, SMACNA has sounded the alarm on the costs and unfairness to legitimate contractors of worker status fraud. “Worker status fraud” is the deliberate misclassification of workers as independent contractors by unscrupulous construction contractors to rob taxpayers, shortchange workers, and steal business from legitimate contractors that pay family-sustaining wages and benefits. In 1999, SMACNA called worker status fraud “an epidemic in the construction industry.” Even then, it was becoming increasingly impossible for legitimate contractors to compete against unscrupulous contractors that classified more than half of their workers as independent contractors. Unfortunately, the industry’s prognosis and, bad practices, and illegal contracting have only worsened.
The construction business and contract bidding are highly competitive. Projects are frequently awarded to the lowest bidder, and, as a result, there is an inherent pressure to lower costs and win more projects. Because material costs are typically similar, unscrupulous contractors look to worker status fraud as an easy way to reduce their employee numbers and overall labor costs. For example, worker status fraud avoids “employee” related costs, such as: employment taxes, withholding of employee-side taxes, unemployment insurance, workers’ compensation premiums, health insurance, retirement benefits, paid sick leave, family medical leave, and overtime premium pay. Contractors who misclassify their workers as independent contractors also avoid I-9 (or worker status) verification requirements, OSHA safety standards, and any potential union organizing.
To be clear, worker status fraud in the construction industry is not about unsophisticated businesses making “difficult legal calls” or applying complicated legal factors to ambiguous facts. It is about cheating. It is about unscrupulous contractors making a conscious decision to avoid tax laws, wage and hour laws, workers’ compensation laws, unemployment insurance laws, and other basic responsibilities of being a legitimate construction contractor. This is done to gain a competitive advantage against law-abiding competitors, realize increased and illegally gained profits, and avoid the financial risks that honest entrepreneurs must accept. Construction contractors that engage in worker status fraud do not bear the risks of unanticipated overtime, bad planning, or poor execution. Instead, this racket transfers these risks onto workers and taxpayers.
Unfortunately, the statistics show that worker misclassification “crime pays” and worker status fraud gives unscrupulous contractors a significant competitive advantage against legitimate contractors that play by the rules. Study after study has shown that, by engaging in worker status fraud, unscrupulous contractors can reduce their labor costs by as much as 50%:
- A 2021 study by the Midwest Policy Institute found:
- Unscrupulous contractors in Wisconsin can reduce their labor costs by 31% by misclassifying workers as independent contractors.
- Unscrupulous contractors in Minnesota can reduce their labor costs by 36% by misclassifying workers as independent contractors.
- Unscrupulous contractors in Illinois can reduce their labor costs by 29% by misclassifying workers as independent contractors.
- In 2020, Harvard Law Professor Mark Elrich opined that “[t]he ability to eliminate as much as 30% (or more) of labor costs by simply reclassifying a company’s workforce as independent contractors was a clever and effective method to gain a competitive edge over other contractors who continued to bear the burden of required mandates.”
- A 2019 study in the District of Columbia found that contractors who misclassify workers reduce their labor costs by 16.7% to 48.1%.
- A 2011 study estimated that 19% of California construction workers were misclassified as independent contractors and these workers earned only 67 cents for every dollar earned by comparable workers with employee status.
- A 2010 study by the Ohio Attorney General’s office estimated that misclassifying a worker makes a 20% to 30% cost difference per worker.
- A 2007 study by the Minnesota Office of the Legislative Auditor found that a construction contractor could lower its labor costs by 26% by misclassifying employees as independent contractors.
Law abiding contractors that “play by the rules” are at a nearly unsurmountable competitive disadvantage. Not surprisingly, then, over the past 20 years, numerous studies have found misclassification rates in the construction industry have grown where states have done little or nothing to push back with enforceable laws and regulations. Today the misclassification rates are estimated to be as high as 33% and climbing. That is why SMACNA, and a coalition of contractors have pushed back for decades and again to advocate for these new final rules.
Thus, while SMACNA supports the DOL’s Final Rules regarding independent contractors, we believe there is much more work to be done to remedy the current epidemic of deliberate misclassification of workers by unscrupulous contractors in the construction industry. Specifically, SMACNA believes that federal regulators, including the DOL and the IRS, should develop rules specific to the construction industry to prevent unscrupulous contractors from deliberately misclassifying workers to gain an unfair advantage over law-abiding contractors that pay workers middle-class wages and benefits.
Questions regarding the new rule should be sent to either the SMACNA Legislative or Labor Relations Departments.