Rep. McDermott Introduces Bill to Stop Employee Misclassification

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On July 30, Rep. Jim McDermott (D-WA), along with six cosponsors, introduced the Taxpayer Responsibility, Accountability, and Consistency Act (H.R. 3408) which is aimed at stopping the misclassification of employees as independent contractors.

For each worker that a company "employs," it must withhold income and payroll taxes, pay benefits and unemployment insurance, and comply with labor laws. But companies do not have these expenses when they use "independent contractors" rather than "employees." Independent contractors are themselves responsible for paying the employer half of payroll taxes, as well as the employee half, and they generally don't receive other benefits like health insurance from companies that hire them.

As a result, some employers intentionally misclassify workers as "independent contractors" to avoid these costs.

It's unclear exactly how much misclassifying employees costs the U.S. Treasury. In theory, it would not matter to the Treasury whether payroll taxes are entirely paid by workers (as is the case for independent contractors) or half paid by employers (as is the case for employees) but the reality is that workers misclassified as independent contractors may be unable to shoulder the payroll taxes and are often unaware of this responsibility until the taxes are due. Or the income to independent contractors is simply not reported at all. 

A Government Accountability Office (GAO) report issued earlier this year found that only 8 percent of small businesses with assets under $10 million submitted 1099-MISC forms that are due whenever independent contractors are used. It seems pretty unlikely that only 8 percent of those companies are really hiring independent contractors. When income is not reported to the IRS by a third party, the income is correctly reported only 46 percent of the time.

Many employers use a loophole created by Sec. 530 of the Revenue Act of 1978 which is commonly referred to as "Sec. 530 relief." It allows employers to classify workers as independent contractors if they have historically done so, or if it is the industry practice. H.R. 3408 would repeal Sec. 530 and replace it with a new test which would be more difficult to meet. The old "Sec. 530 relief" would continue to be available for one year after the new bill is enacted.

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