The Electrical Worker online
May 2013

Exposing the Underground Economy
Labor, Lawmakers Take on Payroll Fraud
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It's still before dawn in Austin, Texas. The sun won't be seen for hours, but parking lots and street corners throughout the city are alive with chatter as laborers, carpenters and even some electricians arrive early to queue up for jobs. Construction is booming in the metro area, and subcontractors are on the lookout for employees willing to work on the cheap. Spanish is the first language here. Most are immigrants from Mexico and Central America. Many are undocumented.

Dependent on the goodwill of the foreman for work, their average hourly wage often amounts to less than $10. They don't have an office or business cards, and often the only work items they own are a pair of steel-toed boots. The last thing they would call themselves are small businessmen. But according to tax forms filed by their employer (at least for those who don't just pay under the table), that is exactly what they are. And that means they are ineligible for unemployment benefits, minimum wage, overtime pay or Social Security. And they are not covered by the National Labor Relations Act and other workplace protections.

The practice is called "1099ing," after the IRS Form 1099 issued to contractors, and it's one of the biggest problems facing workers across the country. It's against the law, but in Texas, payroll fraud is becoming more and more the norm in the construction industry.

"I can't emphasize how big a problem it is," says Austin Local 520 Business Manager Chris Wagner. "And it ends up hurting those businesses that follow the law."

Deliberate misclassification can save dishonest contractors upwards of 30 percent in payroll and other taxes, but for workers, taxpayers and honest employers, the practice amounts to millions in lost wages and revenue.

A recent analysis of the state construction industry by the Workers Defense Project — an Austin-based workers' rights group — found that more than 40 percent of Lone Star construction workers were misclassified as independent contractors.

The group says that rampant misclassification amounts to a hidden tax on employers who follow the law. As its report states: "Payroll fraud in the construction industry results in at least $54.5 million in lost unemployment insurance taxes each year … As the tax rate goes up, and law-abiding employers pay more for each of their employees, the contractors who avoid taxes get an even greater advantage."

The federal government also loses out to the tune of $4.7 million in lost tax revenues, according to the U.S. Government Accountability Office.

The end result is continued pressure on employers to drive working standards, along with wages and benefits, downward. As one subcontractor told WDP researchers: "Payroll fraud pushes the market lower, lower and lower. If it doesn't change, we'll have to do things like eliminate medical benefits, maybe cut wages, maybe stop their 401(k). If it doesn't stop in two or three years, we may have to join them."

And with no workplace protections or overtime rules in effect, misclassified workers are ripe for abuse. "There are people getting paid $8 to $12 an hour for 12 to 14 hours a day, seven days a week, straight-time, no overtime, no benefits," says Wagner.

The practice also lets employers off the hook about having to inquire about their workers' legal status, making it an easy way to exploit undocumented workers.

Telling the difference between an independent contractor and a regular employee is relatively easy, says Kim Bobo, executive director of Interfaith Workers Justice. She is the author of "Wage Theft in America," a 2008 book documenting widespread payroll fraud.

"I call it the mirror test," she told a March meeting of policy makers and workers' rights activists on Capitol Hill. "If you get up in the morning and look in the mirror and say 'I'm going to work for myself today,' then you're an independent contractor. But if you look in the mirror and say 'I'm going to work for someone else,' then you're not a contractor."

While payroll fraud can be found in nearly every part of the economy — from agriculture to the service sector — it is particularly prevalent in the construction industry. The residential sector is especially hard hit due to its relatively low costs and quick project turnover time, not to mention low union density.

But as the Austin residential market moves away from low-rise housing developments to more high-profile high-rises and condominium projects in the city center, misclassification is posing more of a threat to honest employers and the building trades.

"Here in Texas, it's very common," says Seventh District International Representative David Gonzales. "Contractors can lower composite crew rates substantially. You can't compete."

One of the worst offenders, says Wagner, is Power Design, Inc., a Florida-based contractor responsible for many ongoing downtown projects. The company stays out of the hiring process, handing over responsibility to newly formed subcontractors whose sole purpose is to supply Power Design with cheap labor.

"They are like ghost companies," he says. "They just come out of nowhere to provide the big contractors with misclassified workers."

Contracting out hiring is a common practice among those dishonest employers who put multiple layers between themselves and their employees to avoid responsibility for breaking the law, says Catherine Ruckelshaus, legal co-director with the National Employment Law Project. Ruckelshaus has written numerous papers on payroll fraud.

"A lot of major corporations have stayed out of lawsuits by pushing responsibility for payroll fraud onto their subcontractors," she says, listing some of the biggest names on the NASDAQ ticker — Comcast Corp, Walmart, FedEx Corp., Target, among others.

Not Just Construction

The cable industry is home to some of the biggest violators, including Comcast and Time Warner Cable. Both companies have been sued by installers who alleged they were cheated out of overtime pay and health benefits due to payroll fraud.

It is also a problem in the telecommunications industry.

Over the last decade, hundreds of cell towers, used by major telecommunications carriers to broadcast cell phone signals, went up across the country. As the PBS news program Frontline and investigative Web site ProPublica revealed last summer, installing and maintaining these structures, which can exceed hundreds, even thousands, of feet is among the most dangerous jobs in America, with a death rate 10 times that of the construction industry.

Many of those injured workers and their families did not qualify for workers' compensation, because they were officially classified as independent contractors. AT&T sought to have a lawsuit filed against the company by the families of two cell tower workers who died — due in large part to unsafe working conditions — dismissed because the carrier claimed both men were contractors, not full-time employees.

AT&T would later enter into a confidential settlement with the family of one of the workers. A judge dismissed the case against the carrier regarding the other worker.

Cracking Down

One of the most effective forces against payroll fraud is the building trades unions, says Ruckelshaus. "They are in a good position to fight this problem because they often have access to those who are the victims."

Wagner says Local 520 is active in targeting payroll fraud in the Texas construction industry, running their own investigations into companies that misclassify workers. They report violators to the Department of Labor and the Texas Workforce Commission. But the problem, says Wagner, is that investigations often take so long that the projects are complete by the time authorities are ready to take action. In addition, the punishment is usually not strong enough to deter wrongdoers from doing it again. "You might get a fine, but a lot of contractors just consider it the cost of doing business," he says.

Elected officials and government regulators are starting to get more aggressive about cracking down on misclassification — inspired in part by the recession, which has forced cash-strapped state governments to go after needed back taxes.

Since 2003, more than 30 states have passed anti-payroll fraud legislation. In some locations, new laws, along with beefed-up enforcement of existing laws, have helped expose some of the worst offenders and recovered millions in dollars in back wages and taxes.

In Massachusetts, a special joint task force on employee misclassification set up by Gov. Deval Patrick in 2008 has netted the state more than $3 million in back wages and fines, while bringing 24,000 workers under workers' compensation insurance.

In New York State, regulatory officials identified more than 18,000 instances of payroll fraud, assessing $2 million in unpaid wages and $10.5 million in back taxes.

In some states, legislation has been passed that targets misclassification in the construction industry.

Baltimore Building and Construction Trades Council President Rod Easter, who is also a Local 24 member, says the verdict is still out on how effective the 2009 legislation is, but said he is hopeful it will act as a tougher deterrent for irresponsible contractors.

"The economic downturn made it difficult to measure the law's impact, but with work picking up, I think it will prevent misclassification from spreading," he says.

In January, Texas state Rep. Joe Deshotel introduced legislation that would subject employers who deliberately misclassify their workers to fines of up to $5,000 per employee not properly classified.

"Some people are interested in this because it's socially wrong," Deshotel told the Texas Tribune. "Other people are supportive because it gives unfair [advantages] to their business competitors."

Deshotel is a leading Democrat and a union ally, but his bill has received wide bipartisan support. Both Republicans and leading business leaders, including Stan Marek, head of one of Texas' largest nonunion construction contractors associations, supports it. So does the Texas Association of Business.

"I'm sympathetic to conservative arguments against increased regulation of almost any business," writes journalist Scott Braddock in the Dallas Morning News. "But this is a rule-of-law issue, and legitimate businesses can't compete with those who cheat … that's why more and more conservative Republicans in state leadership are saying Texas must crack down on this growing problem."

On the federal level, the Department of Labor under former Secretary Hilda Solis ramped up its enforcement efforts, making fighting payroll fraud a priority.

The department entered into memorandums of understanding with 14 states to go after law-breaking employers. Since 2011, the Wage and Hour Division has collected $9.5 million in back wages resulting from payroll fraud, which the department reports is a 50 percent increase in the number of workers receiving back pay since the agreements were signed.

Sens. Sherrod Brown (D-Ohio) and Tom Harkin (D-Iowa) have introduced legislation that would amend the Fair Labor Standards Act to require employers to provide employees their formal work status in writing, in addition to establishing a presumption of regular employment for most workers.

The states that do the best job fighting payroll fraud are, not surprisingly, those with the toughest laws on the books, says Ruckelshaus. "If all employers get is a slap on the wrist, then it will keep happening."

Local 520's Wagner agrees, saying that penalties in Texas are much too lenient. "Too often, by the time the state comes down on guilty employers, they've already finished that project and left town."

One of the more important things union members can do to fight misclassification is to raise public awareness of payroll fraud. According to the National Consumers League, two in three Americans have not heard of misclassification. "We have to let politicians and the community know that it's a problem, and something has to be done," says Wagner.



Chris Wagner, Austin Local 520 Business Manager

Who Loses With Misclassification?

Worker misclassification — payroll fraud — happens when an employer falsely labels his employees as independent contractors. Found in every part of the economy — construction, broadcasting, telecommunications, the service sector and entertainment — it lets employers get out of paying state and federal payroll taxes.

Federal, state and coffers: The federal government loses out on billions of dollars in Social Security, Medicare and unemployment insurance payments. Misclassification also costs the states millions of dollars in unemployment insurance taxes.

Workers: Independent contractors do not pay into Social Security and Medicare or receive unemployment, overtime pay or workers' compensation. They also don't qualify for the minimum wage and are not protected by labor law and many safety regulations.

Honest Employers: Dishonest contractors can undercut those that follow the law during the bidding process, making it hard for law abiding employers to compete.

What You Can Do to
Fight Payroll Fraud

Union members can be the most effective advocates against payroll fraud. The following resources can help you take action.

The Department of Labor's worker misclassification Web site has numerous resources and information on payroll fraud:

The National Employment Law Project is one of the country's leading advocates for workers' rights, including those improperly classified:

Workplace Fairness provides comprehensive information on workers' rights, including wage and hour laws on its Web site:

Want to find out if you are a contractor or a regular employee? The IRS has 20 Questions that every employer and employee needs to ask: