NC Trend: Taxing matters

 In April 2016, NC Trend

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When tax documents began arriving in mailboxes in January and February, Bradley Hicks’ phone began ringing from workers expecting W-2 forms but instead opening 1099s. The war over “employee misclassification” has prompted class-action lawsuits nationally and, in North Carolina, Gov. Pat McCrory formed a new unit to crack down on employers who misidentify employees as independent contractors. The Employee Classification Section in the state Industrial Commission, headed by Hicks, emerged through an executive order in December.

One of the first to thank McCrory was Doug Burton, owner of Whitman Masonry in Raleigh, who has been focused on the issue since 2010, when his company was underbid by 25% on a job involving a small bank branch. It was a simple job, with each bidder likely paying the same amount for supplies. “To get beat that bad, it had to be on the labor side,” Burton says. “The same people were beating me all the time. I knew they were subbing their labor out, going down the misclassified path.”

Burton’s experience illustrates the difficulty facing law-abiding companies that are repeatedly underbid by competitors who cut expenses by classifying workers as independent contractors. Such a designation saves business owners from paying unemployment taxes or withholding income taxes for those workers. In turn, employees miss out on workers’ compensation insurance and unemployment benefits.

On the other side of the debate are ride-hailing rivals Uber and Lyft and other companies involved in the rapidly expanding “sharing economy.” They depend on contract workers to provide rides, run errands, deliver meals, manage technology projects and handle hundreds of other tasks. Independent contracting benefits some workers by giving them more flexibility to set their own work schedules, while companies promote the strategy as a way to cut costs. The number of W-2s issued declined between 2010 and 2014, while the number of 1099s increased by 16 million, Bloomberg reported in December.

Advocates of tighter regulations say misclassification is costing state and federal governments millions of dollars. After Burton notified government agencies about the problem in his industry, he was featured in a series by Raleigh’s News & Observer in 2012 and a follow-up report two years later. Violations in North Carolina’s construction industry alone cost state and federal governments $467 million a year in taxes, according to the report, which based its estimate on payroll records for the state’s construction industry.

McCrory’s Executive Order No. 83 is not the state’s first attempt to fight misclassification, and some view it as a stopgap until new laws are passed. Legislation stalled in the General Assembly, and a task force formed by Gov. Beverly Perdue in 2012 had no significant impact. “It’s going to take a little bit of time to evaluate how effective it is,” Burton says. “It’s not going to be cleaned up overnight, but it’s a good first step.”

The order’s main thrust is to promote cooperation between state agencies, knocking down information silos that have hindered investigations and enforcement of existing regulations. The N.C. Departments of Commerce and Revenue and the N.C. Industrial Commission are required to work with the new section, while state labor and insurance departments were invited to cooperate with other agencies. Labor Commissioner Cherie Berry, whose inaction on misclassification has drawn criticism, declined to be interviewed. In a statement, she said, “We welcomed the opportunity to be a partner in the governor’s executive order,” and said her staff has met with Hicks. While the labor department regulates minimum wage and overtime issues, it isn’t involved in tax disputes and other misclassification issues.

“We hope it will have a big impact,” says Bill Rowe, director of advocacy at the North Carolina Justice Center, a Raleigh nonprofit that advocates for workers’ rights. “It will depend on the level of enforcement and cooperation between agencies.”

Hicks, who took his post in January, is confident the new section will help catch offenders, protect workers and bring in tax revenue. It is the primary contact for citizens to report suspected cases of misclassification, which will prompt investigations into regulations that may have been violated. The misclassification effort also benefits from software that analyzes data from different agencies, flagging potential offenders for follow-ups or audits. In the silos that operated before McCrory’s order, it was hard to see a full picture.

The increased vigilance on employee misclassification may prompt more employers to seek legal advice to ensure they aren’t caught in crossfire. “I help them identify risks and understand what various government agencies or courts would say about this worker, and whether they have a reasonable basis to argue that this worker is an independent contractor,” says  Susie Gibbons, a partner at Poyner Spruill in Raleigh.

Employees also need to check their relationships with workers hired through staffing agencies, says Travis Hockaday, a partner with Smith Anderson in Raleigh. He calls the governor’s executive order an important step in addressing misclassification. Understanding employment laws can be difficult for workers, particularly those who can’t afford legal advice. The Justice Center can only accept a limited number of cases, says Carol Brooke, a staff attorney.

Workers often don’t even realize they have been misclassified, or they fear repercussions if they file complaints, Hicks says. The 23 workers who called the state’s Division of Employment Security in 2014-15 to file an unemployment claim were told there was no reporting of their history. That led to an audit finding 548 misclassified workers, with cumulative wages of $5 million. Employers paid taxes, penalities and interest of about $61,000 — a tiny fraction of lost funds due to misclassification in the state.

To encourage reporting, Hicks’ group created an online form to handle anonymous tips. And there may be more of those as tax deadlines approach. Until workers opened those 1099s instead of W-2s, some of them didn’t know their companies considered them to be independent contractors, not employees.

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