This is the accessible text file for GAO report number GAO-09-717 
entitled 'Employee Misclassification: Improved Coordination, Outreach, 
and Targeting Could Better Ensure Detection and Prevention' which was 
released on September 9, 2009. 

This text file was formatted by the U.S. Government Accountability 
Office (GAO) to be accessible to users with visual impairments, as part 
of a longer term project to improve GAO products' accessibility. Every 
attempt has been made to maintain the structural and data integrity of 
the original printed product. Accessibility features, such as text 
descriptions of tables, consecutively numbered footnotes placed at the 
end of the file, and the text of agency comment letters, are provided 
but may not exactly duplicate the presentation or format of the printed 
version. The portable document format (PDF) file is an exact electronic 
replica of the printed version. We welcome your feedback. Please E-mail 
your comments regarding the contents or accessibility features of this 
document to Webmaster@gao.gov. 

This is a work of the U.S. government and is not subject to copyright 
protection in the United States. It may be reproduced and distributed 
in its entirety without further permission from GAO. Because this work 
may contain copyrighted images or other material, permission from the 
copyright holder may be necessary if you wish to reproduce this 
material separately. 

Report to Congressional Requesters: 

United States Government Accountability Office: 
GAO: 

August 2009: 

Employee Misclassification: 

Improved Coordination, Outreach, and Targeting Could Better Ensure 
Detection and Prevention: 

GAO-09-717: 

GAO Highlights: 

Highlights of GAO-09-717, a report to congressional requesters. 

Why GAO Did This Study: 

When employers improperly classify workers as independent contractors 
instead of employees, those workers do not receive protections and 
benefits to which they are entitled, and the employers may fail to pay 
some taxes they would otherwise be required to pay. The Department of 
Labor (DOL) and Internal Revenue Service (IRS) are to ensure that 
employers comply with several labor and tax laws related to worker 
classification. GAO was asked to examine the extent of 
misclassification; actions DOL and IRS have taken to address 
misclassification, including the extent to which they collaborate with 
each other, states, and other agencies; and options that could help 
address misclassification. To meet its objectives, GAO reviewed DOL, 
IRS, and other studies on misclassification and DOL and IRS policies 
and activities related to classification; interviewed officials from 
these agencies as well as other stakeholders; analyzed data from DOL 
investigations involving misclassification; and surveyed states. 

What GAO Found: 

The national extent of employee misclassification is unknown; however, 
earlier and more recent, though not as comprehensive, studies suggest 
that it could be a significant problem with adverse consequences. For 
example, for tax year 1984, IRS estimated that U.S. employers 
misclassified a total of 3.4 million employees, resulting in an 
estimated revenue loss of $1.6 billion (in 1984 dollars). DOL 
commissioned a study in 2000 that found that 10 percent to 30 percent 
of firms audited in 9 states misclassified at least some employees. 

Although employee misclassification itself is not a violation of law, 
it is often associated with labor and tax law violations. DOL’s 
detection of misclassification generally results from its 
investigations of alleged violations of federal labor law, particularly 
complaints involving nonpayment of overtime or minimum wages. Although 
outreach to workers could help reduce the incidence of 
misclassification, DOL’s work in this area is limited, and the agency 
rarely uses penalties in cases of misclassification. 

IRS enforces worker classification compliance primarily through 
examinations of employers but also offers settlements through which 
eligible employers under examination can reduce taxes they might owe if 
they maintain proper classification of their workers in the future. IRS 
provides general information on classification through its publications 
and fact sheets available on its Web site and targets outreach efforts 
to tax and payroll professionals, but generally not to workers. IRS 
faces challenges with these compliance efforts because of resource 
constraints and limits that the tax law places on IRS’s classification 
enforcement and education activities. 

DOL and IRS typically do not exchange the information they collect on 
misclassification, in part because of certain restrictions in the tax 
code on IRS’s ability to share tax information with federal agencies. 
Also, DOL agencies do not share information internally on 
misclassification. Few states collaborate with DOL to address 
misclassification, however, IRS and 34 states share information on 
misclassification-related audits, as permitted under the tax code. 
Generally, IRS and states have found collaboration to be helpful, 
although some states believe information sharing practices could be 
improved. Some states have reported successful collaboration among 
their own agencies, including through task forces or joint interagency 
initiatives to detect misclassification. Although these initiatives are 
relatively recent, state officials told us that they have been 
effective in uncovering misclassification. 

GAO identified various options that could help address the 
misclassification of employees as independent contractors. Stakeholders 
GAO surveyed, including labor and employer groups, did not unanimously 
support or oppose any of these options. However, some options received 
more support, including enhancing coordination between federal and 
state agencies, expanding outreach to workers on classification, and 
allowing employers to voluntarily enter IRS’s settlement program. 

What GAO Recommends: 

This report includes various recommendations to DOL and IRS to enhance 
enforcement of proper worker classification, improve outreach to 
workers about classification, and improve interagency coordination in 
addressing misclassification. In commenting on a draft of this report, 
DOL and IRS generally agreed with our recommendations. 

View [hyperlink, http://www.gao.gov/products/GAO-09-717] or key 
components. For more information, contact Andrew Sherrill at (202) 512-
7215 or sherrilla@gao.gov. 

[End of section] 

Contents: 

Letter: 

Background: 

The Current Extent of Misclassification Is Unknown, but 
Misclassification Can Be a Significant Problem with Adverse 
Consequences: 

DOL Has Taken Limited Steps to Detect and Address Misclassification: 

IRS Has Several Enforcement and Education Efforts That Focus on 
Misclassification but Faces Challenges in Undertaking These Efforts: 

Collaboration among Federal Agencies Is Limited, but States Report 
Successful Collaboration to Address Misclassification among Their 
Agencies and with IRS: 

Various Options Could Help Address Misclassification Challenges: 

Conclusions: 

Recommendations for Executive Action: 

Agency Comments and Our Evaluation: 

Appendix I: Scope and Methodology: 

Appendix II: Stakeholder Views on Options to Address Misclassification 
Challenges: 

Appendix III: Comments from the Department of Labor: 

Appendix IV: Comments from the Internal Revenue Service: 

Appendix V: GAO Contacts and Staff Acknowledgments: 

Tables: 

Table 1: Differences between General Tax Responsibilities of Employees 
and Independent Contractors: 

Table 2: Key Federal and State Agencies Affected by Employee 
Misclassification: 

Table 3: SB/SE Misclassification Examination Results by Examination 
Source, Fiscal Year 2008: 

Table 4: Options for Addressing Employee Misclassification: 

Table 5: Options for Addressing Employee Misclassification with the 
Greatest Level of Stakeholder Support: 

Table 6: Options to Address Misclassification by Expressed Support, 
Opposition, or Neutrality by a Majority of Stakeholder Group: 

Table 7: Types of Benefits and Drawbacks Stakeholders Identified across 
the 19 Options: 

Figure: 

Figure 1: Number of Misclassified Employees Identified by State Audits 
of Employers, 2000 to 2007: 

Abbreviations: 

CSP: Classification Settlement Program: 

DOL: Department of Labor: 

ETA: Employment and Training Administration: 

ETEP: Employment Tax Examination Program: 

FLSA: Fair Labor Standards Act: 

IRS: Internal Revenue Service: 

OSHA: Occupational Safety and Health Administration: 

QETP: Questionable Employment Tax Practices: 

SB/SE: Small Business/Self Employed Division: 

TIN: taxpayer identification number: 

WHD: Wage and Hour Division: 

[End of section] 

United States Government Accountability Office: 
Washington, DC 20548: 

August 10, 2009: 

The Honorable Edward M. Kennedy:
Chairman:
Committee on Health, Education, Labor, and Pensions:
United States Senate: 

The Honorable Richard J. Durbin:
Chairman:
Subcommittee on Financial Services and General Government:
Committee on Appropriations:
United States Senate: 

The Honorable Rob Andrews:
Chairman:
Subcommittee on Health, Employment, Labor, and Pensions:
Committee on Education and Labor:
House of Representatives: 

The Honorable Lynn Woolsey:
Chairwoman:
Subcommittee on Workforce Protections:
Committee on Education and Labor:
House of Representatives: 

In fiscal year 2007, states uncovered at least 150,000 workers who may 
not have received protections and benefits to which they were entitled 
because their employers misclassified them as independent contractors 
when they should have been classified as employees. According to the 
Bureau of Labor Statistics, approximately 10.3 million workers, or 7.4 
percent of the employed workforce, were classified as independent 
contractors in the United States in 2005, although it is not clear how 
many of these workers were misclassified. Misclassification can 
precipitate violations of labor and tax laws. Independent contractors 
are not covered by many of the labor laws that protect employees and 
are not eligible for many benefits to which employees are entitled. 
Misclassified employees may not know that they are improperly 
classified and may not be aware that they are being denied the 
protections and benefits to which they are entitled under federal and 
state laws. In addition, when employers misclassify workers as 
independent contractors, they may fail to pay and withhold payroll 
taxes they would otherwise be required to pay and withhold, and the 
workers may not be aware of their tax obligations. 

No single agency is directly responsible for ensuring proper worker 
classification. Several federal agencies have responsibility, however, 
for ensuring that workers receive the benefits and protections to which 
they are entitled as employees. The Department of Labor (DOL) is 
responsible for ensuring employer compliance with several labor laws, 
including the Fair Labor Standards Act of 1938 (FLSA). Other federal 
agencies responsible for enforcing laws that provide employees--but not 
independent contractors--with benefits and protections include the 
Equal Employment Opportunity Commission and the National Labor 
Relations Board. The Internal Revenue Service (IRS) is not responsible 
for ensuring that employee protections are provided, but is responsible 
for ensuring that employers and employees pay proper payroll tax 
amounts and that employers properly withhold taxes from workers' pay. 
IRS also seeks to provide general information to employers about worker 
classification. 

In response to your request, this report provides information on the 
misclassification of employees as independent contractors, including 
(1) what is known about the extent of the misclassification of 
employees as independent contractors and its associated tax and labor 
implications; (2) what actions DOL has taken to address 
misclassification, if any; (3) what actions IRS has taken to address 
misclassification, if any; (4) the extent to which DOL and IRS 
collaborate with each other, states, and other relevant agencies to 
prevent and address cases of employee misclassification; and (5) 
options that could help address challenges in preventing and responding 
to misclassification. 

To determine what is known about the extent of misclassification, we 
reviewed IRS's past estimates and its plans to update its estimates of 
the revenue losses associated with misclassification; analyzed the 
information from audits that states report to DOL on the number of 
employers they determined to have misclassified employees; and reviewed 
misclassification studies conducted by states, universities, and 
research institutes. To describe actions DOL has taken to address 
employee misclassification, we examined laws, regulations, and agency 
policies and documentation; examined summary data from DOL's Wage and 
Hour Division (WHD) on cases involving misclassification concluded 
during fiscal year 2008; reviewed select WHD misclassification case 
files; interviewed agency officials and investigators as well as 
employer and labor advocates; and surveyed states to obtain their 
perspectives on DOL's education and outreach efforts. To describe 
actions IRS has taken to address employee misclassification, we 
reviewed IRS's strategy for enforcing rules and regulations related to 
employee misclassification, analyzed data from IRS's enforcement 
programs related to employee misclassification, reviewed IRS's 
education and outreach activities, and interviewed independent 
contractor and labor advocates. To understand how DOL and IRS cooperate 
with each other and with states and other relevant agencies, we 
examined agency policies and procedures for referring cases involving 
misclassification, interviewed agency and state officials, conducted a 
Web-based survey of states to determine how they coordinate with DOL 
and IRS, and reviewed information from IRS's Questionable Employment 
Tax Practices (QETP) initiative, a collaboration between IRS and states 
aimed at increasing tax compliance by employers. To describe options to 
help address misclassification, we reviewed GAO and other federal 
agency reports and recommendations and other organizations' studies on 
misclassification of employees. We also surveyed relevant stakeholders 
to help identify such options and summarize any related trade-offs. 

We conducted this performance audit from August 2008 through August 
2009 in accordance with generally accepted government auditing 
standards. Those standards require that we plan and perform the audit 
to obtain sufficient, appropriate evidence to provide a reasonable 
basis for our findings and conclusions based on our audit objectives. 
We believe that the evidence obtained provides a reasonable basis for 
our findings and conclusions based on our audit objectives. For more 
information on our scope and methodology, see appendix I. 

Background: 

In general, employee misclassification occurs when an employer 
improperly classifies a worker as an independent contractor instead of 
an employee.[Footnote 1] As we reported in 2006, the tests used to 
determine whether a worker is an independent contractor or an employee 
are complex and differ from law to law.[Footnote 2] While laws vary in 
their definitions of the conditions that make a worker an employee, in 
general, a person is considered an employee if he or she is subject to 
another's right to control the manner and means of performing the work. 
In contrast, independent contractors are individuals who obtain 
customers on their own to provide services (and who may have other 
employees working for them) and who are not subject to control over the 
manner by which they perform their services. 

Many independent contractors are classified properly, and the 
independent contractor relationship can offer advantages to both 
businesses and workers. Businesses may choose to hire independent 
contractors for reasons such as being able to easily expand or contract 
their workforces to accommodate workload fluctuations or fill temporary 
absences. Workers may choose to become independent contractors to have 
greater control over their work schedules or when they pay taxes, 
rather than have employers withhold taxes from their paychecks. 

However, employers have financial incentives to misclassify employees 
as independent contractors. While employers are generally responsible 
for matching the Social Security and Medicare tax payments their 
employees make and paying all federal unemployment taxes and a portion 
of or all state unemployment taxes, independent contractors are 
generally responsible for paying their own Social Security and Medicare 
tax liabilities and do not pay unemployment taxes because they are not 
eligible to receive unemployment insurance benefits.[Footnote 3] In 
addition, businesses generally are not required to withhold the income, 
Social Security, or Medicare taxes from payments made to independent 
contractors that they are required to withhold for their employees. 
Independent contractors may also be responsible for making their own 
workers' compensation payments, depending on their state program. The 
differences, in general terms, between the tax responsibilities of 
employees and independent contractors are summarized in table 1. 

Table 1: Differences between General Tax Responsibilities of Employees 
and Independent Contractors: 

Type of tax: Federal income tax[A]; 
Individuals classified as employees: Businesses' general 
responsibilities: Withhold tax from employees' pay; 
Individuals classified as employees: Workers' general responsibilities: 
Pay full amounts owed, generally through withholding; 
Individuals classified as independent contractors: Businesses' general 
responsibilities: Generally, none[B]; 
Individuals classified as independent contractors: Workers' general 
responsibilities: Pay full amounts owed, generally through estimated 
tax payments[C]. 

Type of tax: Social Security and Medicare taxes[D]; 
Individuals classified as employees: Businesses' general 
responsibilities: Withhold one half of taxes from employees' pay and 
pay other half; 
Individuals classified as employees: Workers' general responsibilities: 
Pay half of total amounts owed, generally through withholding; 
Individuals classified as independent contractors: Businesses' general 
responsibilities: None; 
Individuals classified as independent contractors: Workers' general 
responsibilities: Pay full amounts owed, generally through estimated 
tax payments[C]. 

Type of tax: Federal unemployment tax[E]; 
Individuals classified as employees: Businesses' general 
responsibilities: Pay full amount; 
Individuals classified as employees: Workers' general responsibilities: 
None; 
Individuals classified as independent contractors: Businesses' general 
responsibilities: None; 
Individuals classified as independent contractors: Workers' general 
responsibilities: None. 

Type of tax: State unemployment tax; 
Individuals classified as employees: Businesses' general 
responsibilities: Pay full amount, except in certain states[F]; 
Individuals classified as employees: Workers' general responsibilities: 
None, except partial amount in certain states[F]; 
Individuals classified as independent contractors: Businesses' general 
responsibilities: None; 
Individuals classified as independent contractors: Workers' general 
responsibilities: None. 

Source: GAO analysis. 

Note: There are various exceptions to the general responsibilities 
included in this table. 

[A] Most states also require payment of state income taxes. 

[B] Employers are generally required to withhold taxes at a rate of 28 
percent from independent contractors who do not provide, or provide 
incorrect, taxpayer identification numbers (this practice is known as 
backup withholding). 

[C] For estimated tax purposes, the year is divided into four payment 
periods. 

[D] The overall tax rates for Social Security and Medicare for 2009 are 
12.4 percent and 2.9 percent of income, respectively. Social Security 
taxes are to be paid for earnings up to the established wage base limit 
($106,800 for 2009). 

[E] Employers generally are required to pay federal unemployment 
insurance on the first $7,000 of employee pay at a rate of 6.2 percent, 
which can be offset by a credit of up to 5.4 percent for timely payment 
of state unemployment insurance taxes, resulting in an effective rate 
as low as 0.8 percent. The rate is set to decrease to 6.0 percent in 
2010. 26 U.S.C. §§ 3301, 3302. 

[F] According to DOL, these states are Alaska, New Jersey, and 
Pennsylvania. 

[End of table] 

While businesses may be confused about how to properly classify 
workers, some employers may misclassify employees to circumvent laws 
that restrict employers' hiring, retention, and other labor practices, 
and to avoid providing numerous rights and privileges provided to 
employees by federal workforce protection laws. These laws include: 

* FLSA, which establishes minimum wage, overtime, and child labor 
standards for employees; 

* the Americans with Disabilities Act of 1990 and the Age 
Discrimination in Employment Act of 1967, which protect employees from 
discrimination based on disability or age; 

* the Family and Medical Leave Act of 1993, which provides various 
protections for employees who need time off from their jobs because of 
medical problems or the birth or adoption of a child; and: 

* the National Labor Relations Act, which guarantees the right of 
employees to organize and bargain collectively. 

Employers may also choose to misclassify their employees in order to 
avoid having to obtain proof that workers are U.S. citizens or obtain 
work visas for them. In addition, independent contractors generally do 
not qualify to participate in health and pension plans that employers 
may offer to employees. Finally, when employers misclassify employees, 
they may be able to undercut competitors because their costs are 
reduced. 

While some workers may agree to be misclassified as independent 
contractors in order to be paid in cash, avoid withholding of taxes, or 
prevent having to provide proof of their immigration status, other 
workers may not realize that they have been misclassified. In addition, 
they may not realize that as independent contractors, they are not 
protected under many laws designed to protect employees, and that they 
have obligations for which employees are not responsible, such as 
payment of their own taxes over the course of the year. 

Responsibility for enforcing laws that afford employee protections and 
administering programs that can be affected by employee 
misclassification issues is dispersed among a number of federal and 
state agencies, as shown in table 2. 

Table 2: Key Federal and State Agencies Affected by Employee 
Misclassification: 

Agency: DOL; 
Areas potentially affected by employee misclassification: 
* Minimum wage, overtime, and child labor provisions; 
* Job-protection and unpaid leave; 
* Safety and health protections. 

Agency: IRS; 
Areas potentially affected by employee misclassification: 
* Federal income and employment (payroll) taxes. 

Agency: Department of Health and Human Services; 
Areas potentially affected by employee misclassification: 
* Medicare benefit payments. 

Agency: DOL, IRS, and the Pension Benefit Guaranty Corporation; 
Areas potentially affected by employee misclassification: 
* Pension, health, and other employee benefit plans. 

Agency: Equal Employment Opportunity Commission; 
Areas potentially affected by employee misclassification: 
* Prohibitions of employment discrimination based on factors such as 
race, gender, disability, or age. 

Agency: National Labor Relations Board; 
Areas potentially affected by employee misclassification: 
* The right to organize and bargain collectively. 

Agency: Social Security Administration; 
Areas potentially affected by employee misclassification: 
* Retirement and disability coverage and payments. 

Agency: State agencies; 
Areas potentially affected by employee misclassification: 
* Unemployment insurance benefit payments; 
* State income and employment taxes; 
* Workers' compensation benefit payments. 

Source: GAO analysis. 

[End of table] 

Misclassification itself is not a violation of any federal labor law, 
but it can result in violations of federal and state laws. For example, 
DOL's Wage and Hour Division (WHD) may cite employers that have 
misclassified their employees as independent contractors for violations 
of FLSA relating to recordkeeping (not keeping required records for 
these employees), nonpayment of the federal minimum wage, and 
nonpayment of overtime. It also assesses back wages owed to workers in 
cases where misclassification leads to nonpayment of overtime or 
minimum wage. IRS can also assess taxes and penalties on employers that 
it finds have misclassified employees. 

However, some workers who would otherwise be considered employees are 
deemed not to be employees for tax purposes. With increased IRS 
enforcement of the employment tax laws beginning in the late 1960s, 
controversies developed over whether employers had correctly classified 
certain workers as independent contractors rather than as employees. In 
some instances when IRS prevailed in reclassifying workers as 
employees, the employers became liable for portions of employees' 
Social Security and income tax liabilities (that the employers had 
failed to withhold and remit), although the employees might have fully 
paid their liabilities for self-employment and income taxes. 

In response to this problem, Congress enacted section 530 of the 
Revenue Act of 1978.[Footnote 4] That provision generally allows 
employers to treat workers as not being employees for employment tax 
purposes regardless of the workers' actual status if the employers meet 
three tests.[Footnote 5] The employers must have filed all federal tax 
returns in a manner consistent with not treating the workers as 
employees, consistently treated similarly situated workers as 
independent contractors, and had a reasonable basis for treating the 
workers as independent contractors. Under section 530, a reasonable 
basis exists if the employer reasonably relied on (1) past IRS 
examination practice with respect to the employer,[Footnote 6] (2) 
published rulings or judicial precedent, (3) long-standing recognized 
practices in the industry of which the employer is a member, or (4) any 
other reasonable basis for treating a worker as an independent 
contractor. Section 530 also prohibits IRS from issuing regulations or 
Revenue Rulings with respect to the classification of any individual 
for the purposes of employment taxes. Congress intended that this 
moratorium to be temporary until more workable rules were established, 
but the moratorium continues to this day. The provision was extended 
indefinitely by the Tax Equity and Fiscal Responsibility Act of 1982. 
[Footnote 7] 

Federal agencies use different tests to determine whether a worker is 
an independent contractor or an employee. IRS uses the concepts of 
behavioral control and financial control and the relationship between 
the employer and the worker to determine whether a worker is an 
employee,[Footnote 8] while WHD uses six factors identified by the 
United States Supreme Court to determine employee status during 
investigations of FLSA violations. The complexity and variety of worker 
classification tests may also complicate agencies' enforcement efforts. 
In addition, states use varying definitions of employee. For example, 
according to a report commissioned by DOL, at least 4 states follow 
IRS's test, and at least 10 states use their own definitions. The 
remaining states use various definitions that rely at least in part on 
whether the employer has the right to control the worker. 

Decisions regarding employee status are sometimes determined through 
the courts. For example, in a recent decision, the United States Court 
of Appeals for the District of Columbia Circuit ruled that drivers for 
FedEx's small package delivery unit are independent contractors, and 
not employees, and therefore do not have the right to bargain 
collectively. FedEx had sought review of the determination by the 
National Labor Relations Board that the FedEx drivers were employees 
and that FedEx had committed an unfair labor practice by refusing to 
bargain with the union certified as the collective bargaining 
representative of its Wilmington, Massachusetts drivers. In ruling that 
the drivers are independent contractors, the court noted that because 
FedEx Ground drivers can operate multiple routes, hire extra drivers, 
and sell their routes without company permission, they were not like 
employees of traditional trucking companies.[Footnote 9] 

Legislation aimed at preventing employee misclassification has been 
introduced in previous sessions of Congress. At least four bills 
relating to employee misclassification were introduced in the 110th 
Congress. Two of the bills, both titled the Employee Misclassification 
Prevention Act (H.R. 6111 and S. 3648), were introduced in the House of 
Representatives and the Senate, respectively, to amend FLSA to require 
employers to keep records of independent contractors and to provide a 
special penalty for misclassification. Two other bills were aimed, in 
part, at amending the Internal Revenue Code to aid in proper 
classification. The Independent Contractor Proper Classification Act of 
2007 (S. 2044) was introduced in the Senate to provide procedures for 
the proper classification of employees and independent contractors, 
including amending the tax code and requiring DOL and IRS to exchange 
information regarding cases involving employee misclassification. In 
the House of Representatives, the Taxpayer Responsibility, 
Accountability, and Consistency Act of 2008 (H.R. 5804) sought to amend 
the Internal Revenue Code to modify the rules relating to the treatment 
of individuals as independent contractors or employees, including 
requiring IRS to inform DOL of cases involving employee 
misclassification. However, these bills were not enacted into law. 

The Current Extent of Misclassification Is Unknown, but 
Misclassification Can Be a Significant Problem with Adverse 
Consequences: 

Although the national extent of employee misclassification is unknown, 
earlier national studies and more recent, though not comprehensive, 
studies suggest that employee misclassification could be a significant 
problem with adverse consequences. 

In its last comprehensive estimate of misclassification, for tax year 
1984, IRS estimated that nationally about 15 percent of employers 
misclassified a total of 3.4 million employees as independent 
contractors, resulting in an estimated revenue loss of $1.6 billion (in 
1984 dollars).[Footnote 10] Nearly 60 percent of the revenue loss was 
attributable to the misclassified individuals failing to report and pay 
income taxes on compensation they received as misclassified independent 
contractors. The remaining revenue loss stemmed from the failure of (1) 
employers and misclassified independent contractors to pay taxes for 
Social Security and Medicare and (2) employers to pay federal 
unemployment taxes. 

For 84 percent of the workers misclassified as independent contractors 
in tax year 1984, employers reported the workers' compensation to IRS 
and the workers, as required, on the IRS Form 1099-MISC information 
return.[Footnote 11] These workers subsequently reported most of their 
compensation (77 percent) on their tax returns. In contrast, workers 
misclassified as independent contractors for whom employers did not 
report compensation on Form 1099-MISC reported only 29 percent of their 
compensation on their tax returns.[Footnote 12] 

Although IRS has not updated the information from its 1984 report, it 
plans to review the national extent of employee misclassification as 
part of a broader study of employment tax compliance.[Footnote 13] 
However, IRS officials anticipate that the results of this study will 
not be available until 2013, at the earliest. As part of its National 
Research Program, IRS plans to examine a randomly selected sample of 
employers' tax returns for tax years 2008 to 2010. IRS employment tax 
officials told us they may need to extend the study if they have not 
collected sufficient data to provide reliable estimates. For the 
misclassification part of the employment tax compliance study, they 
said they hope to estimate the number of employers that misclassify 
employees, the number of employees who are misclassified, and the 
resulting loss of tax revenue. The officials also said they are 
uncertain whether IRS will be able to collect sufficient data to 
estimate the extent of misclassification within particular industries 
or geographic regions. 

A study commissioned by DOL in 2000 found that from 10 percent to 30 
percent of firms audited in nine selected states had misclassified 
employees as independent contractors.[Footnote 14] The study also 
estimated that if only 1 percent of all employees were misclassified 
nationally, the loss in overall unemployment insurance revenue because 
of employers' underreporting of unemployment taxes across all states 
would be nearly $200 million annually. In addition, the Bureau of Labor 
Statistics periodically conducts a survey of contingent workers 
(defined as workers holding jobs that are expected to last only a 
limited period of time), including independent contractors.[Footnote 
15] The most recent survey, conducted in 2005, revealed that 10.3 
million U.S. workers were classified as independent contractors-- 
approximately 7.4 percent of all workers. However, the survey did not 
indicate how many of these workers were misclassified. 

State officials we interviewed told us that in their opinion, 
misclassification has generally increased over recent years. State 
activity in this area may support this view. For example, officials 
from New Hampshire's Department of Labor said the agency recently hired 
four new investigators to focus exclusively on investigations of 
employee misclassification. Summary data states reported to DOL's 
Employment and Training Administration, which oversees state 
administration of the unemployment insurance program, showed that from 
2000 to 2007 the number of misclassified workers uncovered by state 
audits had increased from approximately 106,000 workers to over 150,000 
workers, as shown in figure 1.[Footnote 16] While these counts reveal 
an upward trend, they likely undercount the overall number of 
misclassified employees, since states generally audit less than 2 
percent of employers each year. 

Figure 1: Number of Misclassified Employees Identified by State Audits 
of Employers, 2000 to 2007: 

[Refer to PDF for image: vertical bar graph] 

Year: 2000; 
Number of Misclassified Employees: 106,239. 

Year: 2001; 
Number of Misclassified Employees: 107,210. 

Year: 2002; 
Number of Misclassified Employees: 125,262. 

Year: 2003; 
Number of Misclassified Employees: 123,044. 

Year: 2004; 
Number of Misclassified Employees: 139,554. 

Year: 2005; 
Number of Misclassified Employees: 132,965. 

Year: 2006; 
Number of Misclassified Employees: 158,267. 

Year: 2007; 
Number of Misclassified Employees: 151,039. 

Source: GAO analysis of DOL data. 

[End of figure] 

State officials, however, told us that summary data they reported to 
DOL's Employment and Training Administration (ETA) did not include all 
misclassification identified by their investigations. For example, 
officials from one state said they did not report cases to DOL that did 
not meet ETA's prescriptive audit criteria that mandate, among other 
things, extensive testing of an employer's payroll records. 
Furthermore, the official pointed out that the data ETA collects do not 
include cases involving workers in the underground economy, where 
workers are paid in cash and income is not reported to states or IRS. 

Studies conducted by states, universities, and research institutes have 
been generally limited in scope--for example, confined to one state or 
a specific industry within a state. However, some of these studies have 
noted that misclassification is especially prevalent in certain 
industries, such as construction. For example, a study conducted by 
Harvard University on the extent of misclassification in the 
construction industry in Maine estimated that approximately 14 percent 
of construction firms misclassified at least some of their employees 
each year from 1999 to 2002.[Footnote 17] Maine state officials told us 
that following the study, they began targeting construction firms for 
their unemployment insurance audits and found higher levels of 
misclassification--up to 45 percent of the firms audited misclassified 
at least some of their employees. 

Misclassification may undermine workers' access to protections, such as 
unemployment insurance and workers' compensation. For example, one 
group that advocates for workers cited an instance of a construction 
worker who fell three stories, was severely injured, and incurred 
hospital expenses of over $10,000 related to the injury. Because the 
worker was misclassified as an independent contractor, his employer did 
not provide workers' compensation coverage for the employee. Several 
union officials told us that misclassification of workers is especially 
prevalent in the construction industry where workers are often paid 
entirely in cash and, as a result, are not noted on the employers' 
records at all, either as employees or independent contractors. These 
officials told us they believe that some employers have been emboldened 
to begin operating on a cash basis by the ease with which they are able 
to misclassify their workers. 

The WHD investigation case files we reviewed provided detail on several 
instances where misclassified employees did not receive minimum wages 
or overtime pay. For example, one case involved a medical transcription 
service that hired workers--whom WHD determined had been misclassified 
as independent contractors under FLSA--to work out of their homes 
transcribing medical files they downloaded from the company's computer 
system. When the system was not accessible, workers were not paid-- 
although they were required to remain available until the system became 
operational--and, as a result, they were not paid the minimum wage 
required by FLSA. 

DOL Has Taken Limited Steps to Detect and Address Misclassification: 

DOL's detection of employee misclassification is generally the indirect 
result of its investigations of alleged FLSA violations, particularly 
complaints involving nonpayment of overtime or minimum wages. WHD 
officials have stated to Congress that the misclassification of an 
employee as an independent contractor is not itself a violation of FLSA 
or other laws WHD enforces. Misclassification, however, is often 
associated with FLSA violations--in particular, recordkeeping 
violations and the failure to pay overtime or minimum wages. When WHD 
finds FLSA violations resulting from misclassification, it assesses 
back wages owed to workers as appropriate. In addition, although there 
is no penalty for recordkeeping violations, WHD requires businesses to 
place any workers the employer reclassifies as employees on the company 
payroll records, as per FLSA rules. 

Our review of the case files also showed that WHD investigators, in the 
course of their investigations, did not consistently review documents 
that could indicate that employees had been misclassified. 
Specifically, investigators may ask employers about independent 
contractors or uncover misclassification through worker interviews, 
according to the information contained in the case files. However, they 
did not, as a matter of course, review employer records such as IRS 
Forms 1099-MISC that show payments made to independent contractors. 
Reviewing these records could aid WHD investigators in identifying 
workers who have been misclassified. Although one district director 
told us it is standard practice for investigators in his office to ask 
for this type of information during an investigation, it is not WHD 
policy to do so. 

Many of the experts we interviewed said that targeted investigations of 
employers or industries could increase the detection of 
misclassification. Approximately 80 percent of the investigations WHD 
concluded in 2008 involving misclassification were initiated because of 
complaints from workers about possible labor violations. However, 
several experts we spoke with pointed out that some workers, such as 
immigrants or those in low-wage industries, are often less likely to 
file complaints with WHD.[Footnote 18] Thus, a lack of targeted 
investigations coupled with the reluctance of misclassified workers to 
complain may result in less effective enforcement of proper 
classification. WHD officials told us that their ability to conduct 
targeted investigations in recent years has been limited by reductions 
in agency resources combined with consistently high levels of worker 
complaints about possible labor law violations.[Footnote 19] According 
to WHD policy, the first priority of the agency's enforcement is to 
respond to these complaints.[Footnote 20] 

WHD conducts few investigations targeted at misclassification, though 
it has begun to place a greater focus on misclassification within 
existing agency initiatives. WHD concluded over 24,500 FLSA cases in 
fiscal year 2008, and misclassification was the primary reason for the 
violation identified in 131 investigations. Most of these 
investigations (80 percent) were initiated by complaints from workers 
rather than being targeted by WHD. In the 26 investigations that were 
targeted by WHD,[Footnote 21] the agency identified 341 misclassified 
employees who were owed back wages of over $88,000. In the 1990s, WHD 
implemented initiatives to conduct targeted investigations within low- 
wage industries with a history of FLSA violations, such as restaurants, 
hotels, and nursing homes. These initiatives enabled WHD to detect 
employee misclassification to the extent it was prevalent in those 
industries. WHD officials told us that in fiscal year 2007, in part 
because of heightened congressional interest in misclassification, they 
instructed their district directors to place a special emphasis on 
those low-wage industries within their districts with a history of 
misclassifying employees. During fiscal year 2009, for example, the New 
Orleans district office planned to conduct targeted investigations of 
the staffing and janitorial industries in its region, although it 
limited this effort to three investigations. 

Examples of state efforts support the potential effect of targeted 
investigations aimed at detecting misclassification. New York's 
Department of Labor has created a task force that conducts 
investigations and audits aimed specifically at detecting 
misclassification. Among other activities, the task force conducts 
sweeps, or targeted investigations of businesses located within a 
certain area or within industries where misclassification is prevalent. 
In conducting investigations during 2007 and 2008 that targeted 
approximately 300 businesses in the retail and commercial industries, 
the task force found that 67 percent of the businesses were in 
violation of unemployment laws, labor standards, or workers' 
compensation laws. In addition, at the request of investigators, the 
task force scheduled follow-up audits of about half of these employers. 
As of December 2008, it had completed 54 of these audits and found in 
approximately 70 percent of them that employers had continued to 
misclassify at least some employees as independent contractors. 

In addition, the task force conducted targeted investigations of over 
600 businesses, primarily in the construction industry. It found labor 
violations in nearly half of these businesses and ordered follow-up 
investigations. Just over half of these investigations have been 
completed, resulting in nearly 7,800 employees being identified as 
misclassified. The state determined that the misclassification led to 
$2.2 million in unpaid wages, over $3.5 million in unpaid unemployment 
taxes and associated penalties, and over $1 million in penalties 
related to workers' compensation. As a result of all investigations 
conducted during a 16-month period ending December 31, 2008, the task 
force detected 12,300 instances of misclassification, with 
approximately $12 million in associated unpaid wages. In contrast, in 
fiscal year 2008, WHD identified 1,619 instances of misclassification 
nationwide during its investigations and assessed about $1 million in 
unpaid wages. 

DOL has begun to track cases of misclassification in its WHD 
investigations database. However, although DOL's Occupational Safety 
and Health Administration (OSHA) may identify misclassification during 
its safety and health inspections, it does not record this information 
in its inspections database. In addition, in their responses to our 
survey, a majority of state workforce agencies noted that their states 
collect data on the occurrences of misclassification, but most of those 
states do not send this information to DOL. For example, an official in 
one state agency told us that in 2008 his state conducted 
investigations that led to the detection of approximately 46,000 
instances of misclassification, but that DOL collected no information 
associated with those cases. Since this information would likely 
include the names of employers that misclassified their employees, and 
the industries involved, collecting it could enable DOL to focus its 
investigations more effectively on certain employers or industries with 
a known history of misclassification. 

DOL Makes Only Limited Use of Education or Penalties to Deter 
Misclassification: 

Although education and outreach to workers could help reduce the 
incidence of misclassification, DOL's work in this area is limited. The 
DOL Web site contains publications on the employment relationship under 
FLSA, some of which mention the use of independent contractors. 
[Footnote 22] However, the Web site does not provide material that 
focuses specifically on the subject of employee misclassification. In 
addition to publications, the DOL Web site provides printable workplace 
posters, some of which employers are required to display in their 
workplaces. However, none of WHD's posters contain information on 
employment relationships or misclassification. 

DOL employees sometimes hand out to workers pamphlets that contain 
general information on workers' rights. Also, DOL staff provides 
information materials at seminars and training sessions for employers. 
While these materials address what constitutes an employment 
relationship, they do not specifically mention misclassification. 
Similarly, WHD district directors we interviewed told us that their 
staffs do not conduct employer and worker outreach activities 
specifically on misclassification. However, some said their staffs may 
provide information about misclassification when answering questions 
from employers or workers. Finally, an OSHA official told us that the 
agency does not conduct any outreach or education directly related to 
misclassification, although officials in one region told us that 
workers were misclassified as independent contractors at over 80 
percent of the construction sites they inspected. 

According to our survey, few states regard DOL's efforts to educate 
workers and employers on employee misclassification to be effective. In 
fact, 16 states had no awareness of DOL education or outreach on the 
subject. Of the states that were aware of DOL's outreach activities, 
only 5 reported that they thought outreach for workers was effective, 
and only 6 stated that it was effective for employers. Further, some 
experts we interviewed also expressed the view that DOL's education and 
outreach efforts on misclassification are inadequate and that 
improvement is needed, especially for vulnerable populations. For 
example, some noted that immigrants are less likely to know their 
rights and are more likely to be misclassified than other types of 
workers. 

WHD district directors we interviewed noted that there are challenges 
associated with reaching vulnerable populations, such as immigrant 
workers. Some noted that many noncitizens, whether documented or not, 
are wary of government and therefore reluctant to approach DOL 
officials or attend DOL-sponsored events. Despite this challenge, the 
directors told us that their offices coordinate with immigrant 
population communities in order to educate workers on labor issues. For 
instance, staff from the Boston and New Orleans district offices told 
us they participate in presentations, information sessions, and forums 
with the Hispanic communities in their districts in coordination with 
the Mexican consulates. These activities are generally broad in scope 
but may include specific information on misclassification. 

When WHD identifies misclassification, the division does not use all 
available remedies--such as assessing financial penalties, pursuing 
back wages owed to workers who have been misclassified, and conducting 
follow-up investigations of employers that have misclassified workers--
to penalize employers who have violated FLSA and help ensure future 
compliance. WHD levied penalties in less than 2 percent of the cases 
involving misclassification it completed in fiscal year 2008--2 of 131 
investigations. In contrast, the division levied penalties in 6 percent 
of the cases involving FLSA violations from 2000 to 2007. WHD can only 
levy penalties for violations of the minimum wage or overtime pay 
provisions of FLSA when the violations are willful or repeated, though 
a WHD district director noted that it can be difficult to prove that 
employers are willfully misclassifying employees. In addition, although 
WHD determined that there were back wages to be paid in most of these 
cases, we found that investigators did not always follow up to ensure 
that employees were paid the back wages assessed. For example, in one 
case we reviewed, the employer did not provide documented proof that 
she paid back wages of over $5,000 owed to her employees, but WHD 
closed the case and recorded the back wages as paid. Further, WHD 
officials told us that if the division uncovers violations caused by 
misclassification, it does not generally conduct follow-up 
investigations to ensure that the employees are properly classified. 

IRS Has Several Enforcement and Education Efforts That Focus on 
Misclassification but Faces Challenges in Undertaking These Efforts: 

IRS's misclassification enforcement strategy relies on identifying and 
examining employers that have potentially misclassified employees. IRS 
primarily identifies employers to examine for potential 
misclassification through four sources: 

* The Determination of Worker Status (Form SS-8) Program, in which 
workers or employers request that IRS determine whether a specific 
worker is an employee or an independent contractor for purposes of 
federal employment tax and income tax withholding through the 
submission of Form SS-8.[Footnote 23] IRS examines some of the 
employers it determines to have misclassified workers through the SS-8 
program. 

* The Employment Tax Examination Program (ETEP), in which IRS uses 
specific criteria to identify for examination employers that have a 
high likelihood of having misclassified employees. 

* General employment tax examinations, meaning examinations of tax 
returns that are started because of separate employment tax issue that 
lead to examinations of classification issues. 

* The Questionable Employment Tax Practices (QETP) program, through 
which IRS and states share information on worker classification-related 
examinations and other questionable employment tax issues. IRS examines 
some employers that states have determined to have misclassified 
employees. 

IRS's Small Business/Self Employed Division (SB/SE) conducts the 
majority of IRS's misclassification-related examinations. It made 
applicable assessments (taxes and penalties) in 71 percent of such 
examinations that it closed during fiscal year 2008, resulting in a 
total of almost $64 million in assessments, as shown in table 3. A 
description of the four programs though which IRS primarily generates 
misclassification-related examinations follows table 3. Also following 
table 3 is a description of IRS's Classification Settlement Program 
(CSP), which enables qualifying employers under examination for 
misclassification-related issues to lower their misclassification- 
related tax liabilities if they agree to properly classify their 
workers in the future. 

Table 3: SB/SE Misclassification Examination Results by Examination 
Source, Fiscal Year 2008: 

Number of closed examinations[A]: 
Examination source: SS-8: 38; 
Examination source: ETEP: 221; 
Examination source: General examinations: 690; 
Examination source: QETP: 232; 
Examination source: All programs: 1,181. 

Percentage of all closed examinations by referral source: 
Examination source: SS-8: 3; 
Examination source: ETEP: 19; 
Examination source: General examinations: 58; 
Examination source: QETP: 20; 
Examination source: All programs: 100. 

Number of closed examinations with assessments: 
Examination source: SS-8: 30; 
Examination source: ETEP: 127; 
Examination source: General examinations: 522; 
Examination source: QETP: 165; 
Examination source: All programs: 844. 

Percentage of closed examinations with assessments[B]: 
Examination source: SS-8: 79; 
Examination source: ETEP: 57; 
Examination source: General examinations: 76; 
Examination source: QETP: 71; 
Examination source: All programs: 71. 

Total assessments (dollars in millions)[C]: 
Examination source: SS-8: $1.1; 
Examination source: ETEP: $11.8; 
Examination source: General examinations: $40.9; 
Examination source: QETP: $9.8; 
Examination source: All programs: $63.5. 

Average assessment per examination: 
Examination source: SS-8: $28,191; 
Examination source: ETEP: $53,378; 
Examination source: General examinations: $59,225; 
Examination source: QETP: $42,314; 
Examination source: All programs: $53,810. 

Source: GAO analysis of IRS data. 

Notes: We could not isolate the assessments made for taxpayers with CSP 
agreements because before fiscal year 2009, IRS did not separately 
track the outcomes of such examinations. For a qualifying taxpayer who 
enters into a CSP agreement, IRS records the dollar amount of the 
settlement as the assessment amount, not the dollar amount that would 
otherwise have been assessed for the taxpayer. IRS conducts 
examinations of taxpayers who do not comply with the terms of their CSP 
agreements, and assessments from such cases are included in table 3. 

[A] In fiscal year 2008, SB/SE conducted all of IRS's examinations 
based on ETEP and QETP, all but one of IRS's examinations based on SS- 
8 referrals, and the majority of IRS's misclassification-related 
examinations based on general examinations. Examinations completed in 
fiscal year 2008 cover tax returns from previous tax years. 

[B] A portion of the examinations that resulted in no assessments were 
closed because the taxpayers in question qualified for protection under 
section 530 of the Revenue Act of 1978, but IRS does not track the 
number of cases that are closed for this reason. 

[C] Total assessments for each examination source do not sum to the 
total assessments for all programs because of rounding. Assessment 
amounts may include tax liabilities related to other employment tax 
issues that were assessed to the same taxpayer concurrently, as well as 
any penalties. Total assessments reflect the amounts that examiners 
recommended rather than the amounts collected by IRS. Taxpayers may 
challenge IRS's recommended assessments. 

[End of table] 

Through its SS-8 program, IRS provides workers or employers that file 
Forms SS-8 with its determination on the correct classification of the 
workers in question. IRS also uses the program to identify employers 
that may have misclassified employees and therefore would be fruitful 
to examine. In fiscal year 2008, 72 percent of all Form SS-8 requests 
filed resulted in IRS determinations that the workers in question were 
employees, 25 percent were closed without any advice given, and 3 
percent resulted in determinations that the workers in question were 
independent contractors or had other results.[Footnote 24] IRS's SS-8 
unit makes these determinations, in part, using information workers or 
employers provide on Forms SS-8.[Footnote 25] After making 
classification determinations, IRS sends letters to employers to 
provide them with guidance on how to voluntarily amend their tax 
returns to comply with the determinations. IRS's SS-8 unit then uses 
specific criteria to determine which cases it should refer for 
examination, including the amount of compensation the worker in 
question earned, the number of similar workers hired by the employer, 
and whether the case likely involves fraud. The majority of employers 
the SS-8 unit determined to have misclassified employees are very small 
businesses, which generally are not referred because examining such 
businesses is generally not cost effective. As a result, IRS officials 
estimated that for recent tax years, only an average of 2 percent to 3 
percent of employers it identified to have misclassified employees 
through SS-8 determinations were referred for examination, and an even 
smaller percentage resulted in examinations.[Footnote 26] 

For ETEP, IRS uses a computer matching program to identify annually 
employers that potentially misclassified employees. The match criteria 
include employers that reported paying compensation to workers (on Form 
1099-MISC), the amount of compensation the workers reported on their 
tax returns, and the portion of the workers' total income that was paid 
by the employers.[Footnote 27] IRS uses these criteria to identify 
employers to examine with the greatest potential for tax assessments. 
IRS officials told us that generally IRS examines about 1 percent to 3 
percent of the employers it identifies annually through ETEP to have 
potentially misclassified employees. IRS does not examine some 
employers that it determines based on the ETEP match to have 
potentially misclassified employees, such as those that no longer 
appear to be in business; appear to have legitimate reasons for meeting 
the ETEP selection criteria, such as employers who compensate real 
estate agents, who are statutorily defined as independent contractors; 
or are protected by section 530. For tax year 2006, IRS identified over 
33,000 employers through ETEP.[Footnote 28] In fiscal year 2008, IRS 
examined 221 employers it identified through ETEP, as reflected in 
table 3. 

Over half (58 percent) of the misclassification-related examinations of 
employers that SB/SE conducted in fiscal year 2008 arose through the 
course of IRS examining employers for other types of employment tax 
noncompliance. IRS examiners in all divisions are trained about 
misclassification issues, but the depth of training depends upon the 
division and group in which the examiners work. 

According to IRS employment tax officials, QETP, initiated in December 
2007, has proven to be a useful source of timely leads on potential 
misclassification cases. QETP is a collaborative initiative between IRS 
and, currently, 34 participating states through which IRS and state 
workforce agencies share information on misclassification examinations. 
IRS employment tax officials told us that the examination information 
that states provide through QETP is especially useful to the agency 
because it is timely, making it easier for IRS to contact and collect 
money from noncompliant employers.[Footnote 29] 

In addition to its programs that generate misclassification 
examinations, IRS uses CSP to offer settlements to employers that it is 
examining for misclassification. Through CSP, which IRS initiated in 
1996, employers under examination that meet certain criteria can lower 
their misclassification-related assessments if they agree to correctly 
classify their workers in the future and pay proper employment taxes. 
[Footnote 30] As of November 2008, IRS had entered into about 2,800 
settlement agreements, of which about 2,500 involved SB/SE. Employment 
tax officials in this IRS division estimated that their CSP agreements 
signed through the end of 2006 have resulted in at least approximately 
$76 million in taxes voluntarily reported by participating employers 
without further IRS intervention.[Footnote 31] Of employers that 
entered into agreements through the end of 2006, IRS determined that 64 
percent appear to be in compliance with their agreements. IRS has not 
been able to determine, through a review of filing histories, whether 
the remaining 36 percent of employers have complied with their CSP 
agreements. IRS would need to examine these employers to determine if 
they are in compliance with their agreements. 

IRS Uses Various Methods to Educate Taxpayers about Proper 
Classification: 

IRS provides extensive general information on its Web site on worker 
classification issues for employers and workers, including flyers, IRS 
forms, fact sheets, a Web cast, and a training manual providing in- 
depth information on how IRS examiners determine a worker's correct 
classification. IRS also held a national phone forum on worker 
classification determinations in May 2009 targeted at tax professionals 
and small business employers and organizations. IRS officials noted 
that a key IRS worker classification Web page was recently linked to 
IRS's main page and was viewed nearly 800,000 times in fiscal year 
2008. 

IRS's outreach strategies include the use of handouts, e-mail lists, 
and industry newsletters. In 2008, IRS began conducting worker 
classification workshops. IRS employment tax officials said that IRS 
targets these workshops toward persons working as payroll 
professionals, who are most likely to handle workers' pay paperwork, 
and paid tax return preparers. IRS does not generally conduct outreach 
on classification issues for workers. 

IRS Faces Challenges in Enforcing Compliance with and Educating 
Taxpayers about Classification Regulations: 

IRS's programs aimed at enforcing proper worker classification and 
educating taxpayers about this issue face three main challenges. First, 
because misclassification is a complex issue, addressing proper 
classification can be labor intensive for the IRS officials involved. 
For example, in determining whether workers are employees or 
independent contractors, IRS examiners must look to the common law, 
which can be a complex process.[Footnote 32] The examiners must collect 
and weigh evidence on the related common law factors to determine what 
is relevant for classifying each relationship between the respective 
businesses and the workers in question. 

Second, given competing agency priorities, IRS has limited resources to 
allocate to these programs. With regard to enforcement, it has 
resources to examine only a small percentage of the potential 
misclassification cases it detects. As shown in table 3, SB/SE 
completed examinations of less than 1,200 employers in 2008, a very 
small number when compared to the millions of small business and self- 
employed taxpayers in the United States. IRS focuses its examinations 
on employers with potential for large assessments or cases that likely 
affect a number of workers. To encourage voluntary compliance, IRS 
sends SS-8 determination letters to employers, and has also sent "soft 
notices" to employers it determined had not reclassified their workers 
after receiving these letters. However, IRS officials told us that SS- 
8 determination letters and soft notices can be ineffective if the 
letter or the notice signals that IRS will not further pursue the 
noncompliant employers. For example, according to these officials, only 
about 20 percent of employers that are sent SS-8 determination letters 
but that are not selected for examination voluntarily comply with IRS's 
classification determination. With regard to education, IRS uses 
indirect methods to reach the millions of businesses across the United 
States, such as sending correspondence to a large list of contacts in 
various industries and posting information in industry newsletters. 
According to IRS employment tax officials, information on 
misclassification is generally passed down two or three levels in order 
to reach employers. 

Third, according to IRS officials we interviewed, section 530 is both a 
major reason that it cannot examine many of the suspected cases of 
misclassification it identifies and an impediment to its ability to 
educate taxpayers on misclassification issues, as discussed below. 

* Before examining each potential misclassification case, IRS examiners 
must verify whether the employer in question qualifies for section 530 
protection.[Footnote 33] This verification process can be time and 
labor intensive, because examiners must determine whether the employers 
in question meet the three tests for section 530 protection.[Footnote 
34] 

* Section 530 also restricts IRS's ability to issue regulations and 
Revenue Rulings with respect to the classification of any individual 
for purposes of employment taxes. Because of this limitation, IRS 
restricts the educational information it issues to informal general 
guidance and SS-8 determinations and rulings, which provide 
recommendations on how to classify specific workers. However, as noted 
previously, applying the classification rules can be complex. IRS 
employment tax officials told us that businesses regularly request 
IRS's guidance on how to classify workers. In accordance with section 
530, IRS officials do not answer such inquiries but instead recommend 
that the businesses file Form SS-8 requests, which take time for the 
businesses to file and for IRS to process. Representatives of worker, 
business, and paid tax return preparer groups pointed to a great deal 
of confusion about proper worker classification. In an interview, 
representatives of IRS's Taxpayer Advocate Service told us that IRS 
should have the ability to issue guidance on the rules it enforces, in 
the interest of effective tax administration. 

Collaboration among Federal Agencies Is Limited, but States Report 
Successful Collaboration to Address Misclassification among Their 
Agencies and with IRS: 

DOL and IRS typically do not exchange the information they collect on 
misclassification, and DOL does not share information internally. 
However, when an employee is misclassified there is a potential for 
violations of both tax and labor laws, and sharing information could 
enable multiple agencies to address the consequences of 
misclassification. For example, WHD does not always send information on 
cases involving misclassification to other federal and state agencies, 
although WHD's policies and procedures direct it to share such 
information with other federal and state agencies. WHD officials said 
they may not provide referrals to states or other federal agencies 
because the definition of an employee varies by statute and the 
division does not want its investigators to interpret statutes outside 
its jurisdiction. WHD officials told us there were no legal limitations 
on sharing information from an investigation, although they said they 
were reluctant to share information on open cases because they did not 
want to compromise their investigations. 

Although WHD has a memorandum of understanding stating that it will 
share information with IRS, WHD officials said they are concerned about 
referring cases to IRS because they fear that employers would be 
reluctant to cooperate with the division if they knew that it refers 
cases to IRS. However, in these cases, WHD could obtain a subpoena to 
compel the employer to provide WHD with records. Similarly, WHD depends 
on complaints from workers to drive much of its workload and locate 
employers that are in violation of the laws under its purview. 
According to these officials, if workers who were not paying taxes 
properly knew that WHD shared information with IRS about its 
investigations, they might be less likely to file complaints or 
cooperate during investigations. 

In cases where WHD refers a case involving misclassification to states 
or other federal agencies, or to other divisions within DOL, it does 
not track these referrals centrally. Therefore, officials do not know 
how often or to whom cases are referred. In addition, officials are not 
able to ensure that cases are referred consistently across offices. 
Some district offices, however, keep track of the forms used to make 
such referrals. The referrals are usually made by the district offices, 
which maintain records of the referrals in their files and send the 
originals to the agencies to which WHD has referred the cases. 

OSHA may uncover misclassification during its inspections of potential 
health and safety violations but generally does not refer these cases 
to WHD or IRS. OSHA officials told us that although they have a number 
of memorandums of understanding with other agencies and divisions 
within DOL, these pertain to issues such as child labor and migrant 
workers and not to misclassification. However, we found that OSHA has a 
memorandum of understanding with WHD dating from 1990 that states that, 
in order to secure the highest level of compliance with labor laws, the 
agencies will exchange information and referrals where appropriate. 
This agreement also states that both agencies will report the results 
of any referrals to the other agency and will establish a system to 
monitor the progress of actions taken on referrals. However, while OSHA 
tracks referrals and results in its database, WHD has not established 
such a system. 

ETA, which oversees unemployment insurance, collects only summary data 
from states on the number of employees they have found to be 
misclassified during unemployment insurance audits. While DOL funds the 
administration of state unemployment insurance programs, states are 
responsible for all tax collection, benefit payment, and investigations 
and audits. Therefore, officials told us that detailed employer or 
employee-specific information is available only at the state level, and 
ETA is unable to refer potential misclassification cases to WHD. 
Moreover, since state agencies are administrators of their own 
programs, officials told us that ETA does not investigate instances of 
misclassification that occur in state unemployment insurance programs. 

Other federal agencies with jurisdiction over laws affected by 
misclassification told us that they do not work with DOL or track cases 
involving misclassification. Officials from the National Labor 
Relations Board, which enforces the right of employees to bargain 
collectively, told us that the agency does not work with DOL. Equal 
Employment Opportunity Commission officials said that they have not 
worked with DOL in any substantial way, although they do have a 
memorandum of understanding with DOL. 

According to officials, IRS does not share misclassification-related 
information with DOL and shares only limited information with other 
federal agencies. In general, IRS is prohibited from sharing taxpayer 
information with other agencies per section 6103 of the Internal 
Revenue Code.[Footnote 35] IRS and the Social Security Administration 
have memorandums of understanding in place to facilitate information 
sharing on employment tax cases and issues, but they do not regularly 
share information on misclassification, according to IRS employment tax 
officials. However, the officials told us that the two agencies are 
creating a joint employment tax task team, and noted that the Social 
Security Administration can use IRS employment tax information to 
ensure that misclassified workers are given Social Security credit for 
wages earned. Contracting officers from several federal agencies we 
interviewed said that they saw relatively high volumes of potential 
misclassification among workers on federal construction contracts, and 
that the payroll information they collect could be of value to IRS. 
However, many of these agencies did not have information sharing 
relationships with IRS. 

DOL Generally Does Not Work with States, but IRS Shares Information 
with Them: 

Less than 25 percent of states collaborate with DOL to identify 
employee misclassification. In responding to our survey, 12 states said 
that they have some type of collaborative arrangement with DOL in this 
area. These arrangements may include sending information to DOL, 
receiving information from DOL, and conducting joint investigations 
with DOL of cases involving potential misclassification. Approximately 
56 percent of states we surveyed said that they collect data on 
misclassification beyond the summary unemployment insurance audit data 
they are required to report to DOL's ETA on a quarterly basis. Although 
this information could be useful to DOL in pursuing potential FLSA 
violations stemming from misclassification, state officials we 
interviewed said that they are not required to report it to DOL. For 
example, officials told us that they do not report information on 
employees who were misclassified but paid in cash and whose wages were 
not reported to IRS or state revenue agencies. DOL could use 
information on these employees to target investigations of possible 
FLSA violations, such as improper payment of overtime. 

IRS and state workforce agencies share information on misclassification 
as part of QETP. IRS, DOL, and state workforce agencies collaborated to 
create QETP in September 2005. In its first year, 5 states participated 
and additional states have been added over time. Currently, IRS and 
workforce agencies from 34 states share information on audits involving 
misclassification as part of QETP.[Footnote 36] IRS employment tax 
officials remarked that QETP sends an important message to employers 
and workers that IRS and states are working together on compliance 
issues. According to the IRS officials, the state agencies audit 
employers to determine whether they have classified workers correctly 
and paid state unemployment taxes as appropriate. We surveyed 
participating state agencies, and most respondents reported that audit 
information IRS provided was helpful. 

In addition to sharing audit reports for employers that were found to 
have misclassified their employees, IRS also shares other types of 
misclassification-related data with some states. Nineteen of the state 
workforce agencies we surveyed reported that they receive Form 1099- 
MISC data from IRS.[Footnote 37] The state agencies may use these data 
to identify potential cases of misclassification. According to IRS 
employment tax officials, IRS also shares the worker classification 
determinations it makes through its SS-8 program with some state 
agencies; IRS issues these determinations following employers' or 
workers' requests for determinations of employment status. Fourteen of 
the state workforce agencies we surveyed reported receiving this 
information from IRS.[Footnote 38] 

Some state workforce agencies surveyed noted that IRS's QETP 
information sharing and communication practices could be improved. For 
example, two states commented that the information they receive from 
IRS is somewhat dated. Some states that participated in our survey 
reported frustration over not receiving requested information from IRS 
or difficulty contacting IRS officials. IRS officials with whom we 
spoke were aware that some states were not receiving QETP referrals, 
and stated that IRS was in the process of centralizing its QETP 
administration in order to rectify the problem. They also said that IRS 
is in the process of clearing out a backlog of referrals from states. 
According to IRS employment tax officials, IRS has completed the 
centralization of QETP administration and taken steps to clear the 
backlog of referrals from states. Finally, some states we surveyed also 
reported several key barriers to effectively using information provided 
by IRS. These included resource limitations within their own agencies, 
data system incompatibilities, and difficulties complying with IRS's 
legal requirements for safeguarding taxpayer data. 

Some States Are Identifying Misclassification through Collaborative 
Initiatives Involving Their Revenue, Labor, and Enforcement Agencies: 

Some states have made efforts to address misclassification and have 
reported successful collaboration among their own agencies. States are 
particularly concerned because of misclassification's impact on 
workers' compensation programs and unemployment tax revenue, among 
other programs. In addition, states may incur additional costs, such as 
the cost of providing health care to uninsured workers, as a result of 
misclassification. Some states have passed legislation related to 
misclassification. For example, Massachusetts passed legislation that 
standardizes the definition of an employee and penalizes employers for 
misclassification, regardless of whether it was intentional. The 
statute authorizes the state Attorney General to impose substantial 
civil and criminal penalties and, in certain circumstances, to ban 
violators from obtaining state public works contracts. 

Several states have recently created interagency initiatives or joint 
task forces aimed at detecting misclassification, often by executive 
order of the states' governors. These task forces share information 
across revenue, labor, and enforcement agencies. For example, the New 
York State Joint Enforcement Task Force on Employee Misclassification, 
which was formed in September 2007, is led by the New York Department 
of Labor and includes revenue agencies, other enforcement agencies, and 
the Attorney General's office. Since its inception, the task force has 
engaged in joint enforcement sweeps, coordinated assignments, and 
systematic referrals and data sharing between state agencies. New York 
state officials told us that they now consider it customary to use a 
multiagency approach and cross-agency coordination to deal with 
misclassification. 

However, some of these state task forces have encountered challenges, 
particularly in coordination among state agencies. The agencies must 
overcome or ease restrictions on sharing information outside their 
jurisdictions, which may require state legislative action. State 
officials we interviewed cited other challenges, such as the fact that 
the lead agency does not have oversight authority over task force 
members, which makes it difficult to direct their efforts; the limited 
resources of many state agencies; and dealing with the added layers of 
bureaucracy involved in tracking cases and enforcing compliance 
together. 

While these task forces are relatively recent innovations, state 
officials told us that they have already been effective in uncovering 
misclassification. New York state officials told us that the state 
uncovers many more misclassified employees through task force 
activities than solely through the unemployment insurance audits 
required by DOL. The state estimated that in just over a year's time, 
its misclassification task force uncovered 12,300 instances of employee 
misclassification and, as noted earlier, $157 million in unreported 
wages. The task force's enforcement activities also resulted in over 
$12 million in workers' back wages being assessed against employers. 

Various Options Could Help Address Misclassification Challenges: 

As far back as 1977, we have analyzed options for addressing tax 
noncompliance arising from employee misclassification. In 1977, we 
recommended a specific definition to clarify who should be considered 
an independent contractor, and in 1979, we concluded that some form of 
tax withholding could be warranted to reduce tax noncompliance among 
self-employed workers.[Footnote 39] In 1992, we offered options to 
improve independent contractor tax compliance, such as ensuring that 
their taxpayer identification numbers (TIN) are valid, informing them 
of their classification status and tax obligations, and closing gaps in 
the payments that are required to be reported on Form 1099-MISC. 
[Footnote 40] For this report, we explored current options to address 
the challenges raised by employee misclassification, some of which are 
similar to the options we analyzed in these prior reports. 

We identified 19 options to address the challenges raised by employee 
misclassification by reviewing literature and speaking with various 
groups, including those representing (1) labor and advocacy, (2) 
independent contractors and small businesses, and (3) tax 
professionals.[Footnote 41] These options would require either 
legislative or administrative actions. Table 4 lists the 19 options. 
The list is not ranked in any order, but rather is grouped in seven 
broad categories.[Footnote 42] 

Table 4: Options for Addressing Employee Misclassification: 

A. Clarify the employee/independent contractor definition and expand 
worker rights: 

1. Clarify the distinction between employees and independent 
contractors under federal law. 

2. Allow workers to challenge a classification determination in U.S. 
Tax Court. 

3. Ensure that workers have adequate legal protection against 
retaliation from filing a Form SS-8. 

4. Define misclassification as a violation under FLSA. 

B. Revise section 530 of the Revenue Act of 1978: 

5. Narrow the definition of "a long-standing recognized practice of a 
significant segment of the industry" so that fewer firms qualify for 
this reasonable basis for the section 530 safe harbor provision. 

6. Lift the ban on IRS/Treasury issuing regulations or revenue rulings 
clarifying the employment status of individuals for purposes of 
employment taxes. 

C. Provide additional education and outreach: 

7. Require service recipients[A] to provide standardized documents to 
workers that explain their classification rights and tax obligations. 

8. Expand IRS outreach to service recipient, worker, and tax advisor 
groups to educate them about classification rules and related tax 
obligations, targeting groups IRS deems to be "at risk". 

9. Create an online classification system, using factors similar to 
those used in the SS-8 determination process, to guide service 
recipients and workers on classification determinations. 

10. Increase the use of IRS notices to service recipients in industries 
with a potentially high incidence of misclassification to educate them 
about classification rules and ask them to review their classification 
practices. 

D. Withhold taxes for independent contractors: 

11. Require service recipients to withhold taxes for independent 
contractors whose TINs IRS cannot verify or who IRS has determined are 
not fully tax compliant. 

12. Require universal tax withholding for payments made to independent 
contractors, using tax rates that are relatively low (e.g., 1 percent 
to 5 percent of payment amounts). 

13. Require service recipients to withhold taxes from payments made to 
independent contractors who request withholding in writing. 

E. Collect data on misclassification and independent contractors: 

14. Measure the extent of misclassification and related impacts on tax 
revenues at the national level. 

15. Require each independent contractor to apply for a separate 
business TIN. 

F. Enhance IRS compliance programs: 

16. Expand IRS's CSP to include service recipients that voluntarily 
contact IRS about their misclassified workers. 

17. Require service recipients to submit Forms SS-8 for all newly 
retained independent contractors. 

G. Enhance coordination and information sharing: 

18. Enhance coordination between IRS, DOL, and other federal agencies 
to share data and address misclassification. 

19. Enhance coordination between IRS, states, and selected local 
governments to share data and address misclassification. 

Source: GAO analysis of literature reviews and interviews with affected 
stakeholders. 

[A] By "service recipients," we mean businesses and other entities that 
receive services from independent contractors or employees in the 
course of a trade or business, not including consumers or individuals 
who seek services for their homes or personal use. 

[End of table] 

We asked 11 external stakeholders to provide input on these 19 options, 
including (1) the extent to which they supported or opposed each option 
and (2) the benefits and drawbacks of each option (see appendix II for 
a summary of these benefits and drawbacks for each option).[Footnote 
43] These stakeholders included 4 groups that represent the views of 
small businesses, independent contractors, and those who hire them 
(i.e., independent contractor groups); 4 groups that represent the 
views of organized labor (i.e., labor groups); 2 groups that represent 
the tax preparation and advice community; and 1 federal agency that 
uses contractors. We received responses from 9 of these groups. 
[Footnote 44] 

No Option Had Unanimous Support or Opposition: 

Stakeholders did not unanimously support or oppose any of the 19 
options. Although views were mixed, stakeholders generally expressed 
support for the options more frequently than they expressed opposition. 
For example, at least seven of the nine responding stakeholders 
supported three options (see table 5). 

Table 5: Options for Addressing Employee Misclassification with the 
Greatest Level of Stakeholder Support: 

* Ensure that workers have adequate legal protection against 
retaliation from filing a Form SS-8 (option 3); 

* Require service recipients to provide standardized documents to 
workers that explain their classification rights and tax obligations 
(option 7); 

* Increase the use of IRS notices to service recipients in industries 
with a potentially high incidence of misclassification to educate them 
about classification rules and ask them to review their classification 
practices (option 10). 

Source: GAO analyses of stakeholder responses to questions about 19 
options. 

Note: Options included in this table were supported by seven or eight 
stakeholders out of the nine from which we received input on the 19 
options. 

[End of table] 

In contrast, five of nine stakeholders opposed one option--narrowing 
the definition of "a long-standing recognized practice of a significant 
segment of the industry" under section 530 of the Revenue Act (option 
5). While all three independent contractor groups opposed this idea on 
the grounds that the protection was important, two labor groups that 
opposed the option did so because it only narrowed rather than 
eliminated this protection. 

Labor Groups and Others Were Generally More Supportive of Options Than 
Independent Contractor Groups: 

In general, labor groups, a group representing tax preparers, and a 
federal agency that hires contractors tended to be more supportive of 
the 19 options than independent contractor groups. We analyzed whether 
the majority of stakeholders in each group--that is, over half of them--
stated that they supported, opposed, or were neutral on the 19 options. 
Table 6 shows that a majority of the labor group respondents (i.e., at 
least 3 of the 4) supported 9 options and opposed none. Similarly, the 
tax professional group and the federal agency both supported 10 options 
and opposed none. In contrast, a majority of the independent contractor 
respondents (i.e., at least 2 of the 3) supported 7 options and opposed 
8. A blank cell in the table indicates that the stakeholders for the 
group lacked a majority view on the option. 

Table 6: Options to Address Misclassification by Expressed Support, 
Opposition, or Neutrality by a Majority of Stakeholder Group: 

Option: 1. Clarify the distinction between employees and independent 
contractors within federal law; 
Labor groups: [Empty]; 
Independent contractor groups: Support; 
Other groups[A]: Support. 

Option: 2. Allow workers to challenge determinations in Tax Court; 
Labor groups: Support; 
Independent contractor groups: Oppose; 
Other groups[A]: Support. 

Option: 3. Ensure that workers have protection for filing a Form SS-8; 
Labor groups: Support; 
Independent contractor groups: Support; 
Other groups[A]: Support. 

Option: 4. Define misclassification as a violation under FLSA; 
Labor groups: Support; 
Independent contractor groups: Oppose; 
Other groups[A]: [Empty]. 

Option: 5. Narrow the definition of "a long-standing recognized 
practice of a significant segment of the industry"; 
Labor groups: [Empty]; 
Independent contractor groups: Oppose; 
Other groups[A]: Support. 

Option: 6. Lift the ban on IRS clarifying employment status; 
Labor groups: Support; 
Independent contractor groups: Oppose; 
Other groups[A]: [Empty]. 

Option: 7. Require service recipients to give workers documents that 
explain classification; 
Labor groups: Support; 
Independent contractor groups: Support; 
Other groups[A]: [Empty]. 

Option: 8. Expand IRS outreach; 
Labor groups: [Empty]; 
Independent contractor groups: Support; 
Other groups[A]: Support. 

Option: 9. Create an online classification system; 
Labor groups: [Empty]; 
Independent contractor groups: Oppose; 
Other groups[A]: Support. 

Option: 10. Increase the use of IRS notices; 
Labor groups: Support; 
Independent contractor groups: Support; 
Other groups[A]: Support. 

Option: 11. Require service recipients to withhold taxes for certain 
independent contractors; 
Labor groups: Neutral; 
Independent contractor groups: Oppose; 
Other groups[A]: Support. 

Option: 12. Require universal tax withholding for payments made to 
independent contractors; 
Labor groups: [Empty]; 
Independent contractor groups: Oppose; 
Other groups[A]: [Empty]. 

Option: 13. Require service recipients to withhold taxes at independent 
contractor request; 
Labor groups: [Empty]; 
Independent contractor groups: Neutral; 
Other groups[A]: Support. 

Option: 14. Measure the extent of misclassification at the national 
level; 
Labor groups: Support; 
Independent contractor groups: Neutral; 
Other groups[A]: [Empty]. 

Option: 15. Require each independent contractor to apply for a separate 
business TIN; Labor groups: [Empty]; Independent contractor groups: 
Support; Other groups[A]: [Empty]. 

Option: 16. Expand IRS's CSP; 
Labor groups: [Empty]; 
Independent contractor groups: Support; 
Other groups[A]: [Empty]. 

Option: 17. Require service recipients to submit Forms SS-8 for newly 
retained independent contractors; 
Labor groups: [Empty]; 
Independent contractor groups: Oppose; 
Other groups[A]: Support. 

Option: 18. Enhance coordination between IRS, DOL, and other federal 
agencies; 
Labor groups: Support; 
Independent contractor groups: Neutral; 
Other groups[A]: [Empty]. 

Option: 19. Enhance coordination between IRS, states, and selected 
local governments; 
Labor groups: Support; 
Independent contractor groups: Neutral; 
Other groups[A]: [Empty]. 

Source: GAO analyses of stakeholder responses to questions about 19 
options. 

Note: "Support" indicates that over half of the respondents in the 
group generally or strongly supported the option. "Oppose" indicates 
that over half of the respondents in the group generally or strongly 
opposed the option. "Neutral" indicates that over half the group was 
neutral on the option or had no opinion. A blank cell indicates that 
the option lacked a consensus opinion by a majority of stakeholders. 

[A] Other groups included a group representing tax professionals and a 
federal agency that hires contractors. 

[End of table] 

Stakeholders Identified Various Benefits and Drawbacks to the Options: 

We asked stakeholders what they perceived to be the benefits and 
drawbacks of each option. We did not follow up on these responses to 
clarify and understand the basis for the stakeholders' perceptions on 
benefits and drawbacks. As a result, absent other relevant data, these 
responses did not allow us to uniformly assess whether the benefits 
outweighed the drawbacks for each option, or vice versa. Table 7 lists 
examples of types of benefits and drawbacks identified across all the 
options. 

Table 7: Types of Benefits and Drawbacks Stakeholders Identified across 
the 19 Options: 

Examples of types of benefits identified: 
* Improved tax compliance; 
* Greater equity/justice for workers; 
* More consistency/uniformity in classifying; 
* More education/understanding; 
* More attention/visibility; 
* More worker protection; 
* Less misclassification; 
* Less manipulation of classification rules; 

Examples of types of drawbacks identified: 
* Higher financial costs/burdens for businesses;
* Inequities among those using independent contractors;
* Economic disruption/upheaval;
* More litigation;
* Political opposition;
* Less freedom of choice;
* Deter use of independent contractors;
* More manipulation of classification rules. 

Source: GAO analyses of stakeholder responses to questions about 19 
options. 

[End of table] 

We found that some of the stakeholders had different perceptions of 
whether an outcome for an option would be beneficial. For example, some 
respondents said that creating an online classification system could 
help reduce confusion over classification rules and unintentional 
misclassification. However, other respondents stated that such a system 
would produce inconsistent determinations and could be manipulated to 
achieve desired classification determinations. Similarly, some 
stakeholders said that requiring a separate TIN for independent 
contractors could increase voluntary tax compliance or help facilitate 
IRS compliance and enforcement efforts. However, others expressed the 
opinion that a separate TIN could be conducive to tax fraud or 
manipulation of the classification system. Finally, some perceived that 
expanding CSP to include employers that volunteer to disclose their 
misclassified employees would benefit such employers by reducing their 
financial exposure while others viewed this same outcome as allowing 
them to escape financial sanctions for misclassifying. (See appendix II 
for summaries of the types of benefits and drawbacks for each option.) 

We also asked IRS officials to share their insights on the benefits and 
drawbacks of the options from a tax administration perspective. Some of 
their insights included the following: 

* Expanding CSP to include employers that voluntarily ask to 
participate could help reduce employee misclassification, although 
allowing voluntary participation raises issues of equity and may create 
a safe harbor from examination. For example, this expansion could bring 
into compliance employers that voluntarily disclose that they have 
misclassified employees but would reduce the financial sanctions they 
face for having done so. IRS employment tax officials said that they 
recently created a team to explore these and other issues related to 
such an expansion and that they hope to start soliciting comments on a 
proposal from across IRS starting in summer 2009. 

* "Soft" (i.e., non enforcement) notices to educate employers that 
appear to be misclassifying employees and to encourage them to correct 
their classifications might not be effective unless IRS is able to 
follow up with employers that do not change their classification 
behavior. Notices also are more effective if they are sent 
strategically rather than using a "shotgun" approach. Furthermore, 
sending notices to employers in certain industries without sufficient 
justification for targeting them likely would create a backlash that 
IRS would have to manage. 

* Expanded information sharing with other federal agencies generally 
can help IRS to be more effective at enforcing proper worker 
classification. However, section 6103 protections against improper 
disclosure of tax data generally hamper such sharing and one-way 
information sharing can create resentment among other agencies. 

* Creating standardized documents on worker rights and tax obligations 
can impose burdens on businesses, although such burdens could be 
reduced by requiring employers to provide such documents only to newly 
hired or retained workers rather than to all workers. Also, IRS may not 
currently have the authority to require employers to provide such 
documents to workers. 

* Requiring a separate TIN for each independent contractor could help 
compliance but would impose some costs on businesses and IRS to 
reprogram its computers. 

* Requiring Forms SS-8 for all newly retained independent contractors 
would create tremendous costs for IRS, and it may not be able to review 
the forms quickly enough to affect some independent contractors who 
employers retain on a short-term basis. 

* An online classification system that uses factors like those that IRS 
uses to make Form SS-8 determinations could provide guidance to those 
unsure about classifying workers. However, the system should not be 
used to make classification determinations because those entering the 
data could manipulate their entries to receive a desired outcome. 

Some of the identified options relate to goals, objectives, and 
strategies in IRS's Strategic Plan for 2009-2013. For example, IRS's 
plan envisions placing more emphasis on providing more targeted and 
timely guidance and outreach on how to voluntarily comply and creating 
opportunities for taxpayers to proactively resolve tax disputes as soon 
as possible as part of its goal to improve service to make voluntary 
compliance easier. To enforce the law to ensure that everyone meets 
their tax obligations, IRS plans to strengthen its partnerships with 
other government agencies to leverage resources in a way that allows 
quick identification and pursuit of emerging tax schemes through 
education as well as enforcement. IRS also seeks to expand its 
enforcement approaches by allowing for alternative treatment of 
potential noncompliance. These approaches include expanding the use of 
soft notices to educate taxpayers and to encourage them to self-correct 
to avoid traditional enforcement contacts, such as examinations, as 
well as expanding incentives and opportunities for taxpayers to 
voluntarily self-correct noncompliant behavior. 

Conclusions: 

Misclassification can have a significant impact on federal and state 
programs, businesses, and misclassified employees. It can reduce 
revenue that supports such programs as Social Security, Medicare, 
unemployment insurance, and workers' compensation. Further, employers 
with responsible business practices may be undercut by competitors who 
misclassify employees to reduce their costs, for example, by not paying 
payroll taxes or providing benefits to workers. Employers may also 
exploit vulnerable workers, including low-wage workers and immigrants, 
who are unfamiliar with laws pertaining to employment relationships, 
including laws designed to protect workers. For example, misclassified 
workers may not be paid properly for overtime or may not know that 
their employers are not paying worker's compensation premiums. 

Although misclassification is a predictor of labor law violations, and 
although state examples show that targeting misclassification is an 
effective way to uncover violations, DOL is not taking advantage of 
this opportunity by looking for misclassification in its targeted 
investigations. As a result, employers may continue to misclassify 
employees without consequences and workers may remain unprotected by 
labor laws and not receive benefits to which they are entitled. 
Furthermore, because DOL conducts limited education and outreach on 
misclassification, many workers have insufficient information on 
employment relationships and may not understand their employment status 
and rights. In addition, vulnerable populations, including low-wage 
workers and immigrants, may not know they are misclassified and, as 
result, may not receive the protections and benefits to which they are 
entitled. By not regularly sharing information on cases involving 
misclassification, federal and state agencies are also losing 
opportunities to protect workers and to make the most effective use of 
their resources. Also, because DOL is not working with states active in 
this area to identify misclassification, it is not using its resources 
most effectively by establishing a collaborative effort between federal 
and state agencies to address misclassification. 

Many of the IRS-related options we analyzed to address 
misclassification were generally perceived to have merit as means to 
address misclassification, but all have some drawbacks, according to 
those stakeholders we surveyed. Although several options had support 
from many of those who provided input, we had no reliable measure of 
the extent of misclassification and did not have sufficient information 
to weigh the benefits compared to the drawbacks of the options given 
the scope of our work. Even so, qualitative information provided by the 
stakeholders can help policymakers and tax administrators judge whether 
any of the options merit pursuit. 

Likewise, some actions have potential to address misclassification in a 
cost-effective manner while also adhering to IRS's strategic vision for 
the next few years. For example, IRS and DOL can do more to educate 
employers and workers. Given that most complaints come from workers, 
further educating them about the consequences of misclassification may 
be especially useful. Developing a standard document on classification 
rights and related tax obligations that all new workers would either be 
given by employers or referred to on agencies' Web sites would be 
particularly well targeted. Similarly, IRS could build on its existing 
state contacts to resolve current concerns with the QETP initiative, 
which mutually benefits both federal and state parties. Regularly 
collaborating with participating states can help ensure that issues are 
addressed by both IRS and states in a timely manner. Finally, expanding 
CSP to allow for voluntary self-correction of classification decisions 
could prompt compliance among employers that IRS is unlikely to pursue 
through enforcement because of limited resources. Soft notices targeted 
to employers that appear to be misclassifying would give them a chance 
to self correct before IRS decides whether to examine them and should 
be tested to determine their effectiveness. 

Recommendations for Executive Action: 

We are making six recommendations to the Secretary of Labor and the 
Commissioner of Internal Revenue to assist in preventing and responding 
to employee misclassification. 

* To increase its detection of FLSA and other labor law violations, we 
recommend that the Secretary of Labor direct the WHD Administrator to 
increase the division's focus on misclassification of employees as 
independent contractors during targeted investigations. 

* To enhance efforts to protect workers and make the most effective use 
of their resources, we recommend that the Secretary of Labor direct the 
WHD Administrator and the Assistant Secretary for OSHA to ensure that 
information on cases involving the misclassification of employees as 
independent contractors is shared between the two entities and that 
cases outside their jurisdiction are referred to states and other 
relevant agencies, as required. 

* To identify promising practices in addressing misclassification and 
use agency resources most effectively, we recommend that the Secretary 
of Labor and the Commissioner of Internal Revenue establish a joint 
interagency effort with other federal and state agencies to address the 
misclassification of employees as independent contractors. Because tax 
data may provide useful leads on noncompliance, the task force should 
determine to what extent tax information would assist other agencies 
and, if it would be sufficiently helpful, seek a legislative change 
through the Department of the Treasury to allow for sharing of tax 
information with appropriate privacy protections. 

* To enhance understanding of classification issues by workers-- 
especially those in low-wage industries--we recommend that the 
Secretary of Labor collaborate with the Commissioner of Internal 
Revenue to offer education and outreach to workers on classification 
rules and implications and related tax obligations. Such collaboration 
should include developing a standardized document on classification 
that DOL would require employers to provide to new workers. 

* To maximize the effectiveness of the relatively new QETP initiative, 
we recommend that the Commissioner of Internal Revenue create a forum 
for regularly collaborating with participating states to identify and 
address data sharing issues, such as ensuring clear points of contact 
within IRS for states and expeditious sharing of data. 

* To increase proper worker classification, we recommend that the 
Commissioner of Internal Revenue extend the CSP to include employers 
that volunteer to prospectively reclassify their misclassified 
employees, and as part of this extension test whether sending notices 
describing the program to potentially noncompliant employers would be 
cost effective. Employers to which IRS would send notices could include 
those referred for examination but who may not be examined because of 
higher priorities, resource limitations, or other reasons. 

Agency Comments and Our Evaluation: 

In their comments on a draft of this report, both DOL and IRS generally 
agreed with our recommendations, and either agreed to implement or to 
take steps consistent with our recommendations, such as exploring their 
implementation. WHD, OSHA, and IRS provided written comments on the 
draft, which are reprinted in their entirety in appendixes III (DOL 
comments from WHD and OSHA) and IV (IRS comments). In addition, ETA 
provided technical comments, which we incorporated. 

DOL agreed with our recommendation to increase WHD's focus on 
misclassification of employees as independent contractors during 
targeted investigations. WHD commented that it would reexamine its 
training documents and field guidance to ensure that employee 
classification was addressed during all stages of an investigation. In 
addition, WHD agreed to focus on increasing compliance for workers in 
industries where misclassification is prevalent. 

DOL also agreed that there is value in sharing information on cases 
involving the misclassification of employees as independent contractors 
between WHD and OSHA and with state agencies. WHD and OSHA stated that 
they are both committed to working closely together to exchange 
information and improve protections afforded workers. In addition, WHD 
said that it would assess its current referral processes to ensure that 
they adequately provided for referrals to other agencies in cases 
related to employee misclassification. 

In their comments, the agencies expressed support for our 
recommendation to establish a joint interagency effort to address 
misclassification. DOL stated that a joint effort between DOL and IRS 
may prove useful in WHD's efforts to enforce wage and hour laws, and 
that WHD would participate in any such interdepartmental effort. 
Similarly, IRS stated that coordination between departments and 
agencies at the federal and state levels is an effective way to 
encourage voluntary compliance and agreed to work with the Secretary of 
Labor to explore developing a joint effort, subject to disclosure rules 
under section 6103 of the Internal Revenue Code and other privacy 
rules. 

In addition, DOL and IRS agreed to explore opportunities to collaborate 
to offer education and outreach to workers on the topic of worker 
classification, including developing a standardized document that DOL 
would require employers to provide to new workers. WHD agreed to reach 
out to IRS to explore opportunities for joint outreach to workers, and 
IRS agreed to collaborate with the Secretary of Labor, make education 
and outreach materials available to DOL, and work with the Secretary of 
Labor to explore developing a standardized document on classification 
for DOL to provide to new workers. 

Finally, IRS agreed to work with state workforce agencies participating 
in QETP to establish a forum to identify and address data sharing and 
IRS points of contact issues using its Enterprise Wide Employment Tax 
Program. IRS also said it would consider expanding the CSP to employers 
not under examination and commented that if it decides to expand the 
program, it will consider all options, including issuing notices and 
soft letters and soliciting volunteers through outreach and education. 
We appreciate that IRS will consider these actions and continue to 
believe that extending the CSP to include employers that volunteer to 
prospectively reclassify their misclassified employees would be an 
effective way to increase proper worker classification and that it 
would be useful to test whether sending notices would be a cost- 
effective feature of an expanded program. 

As we agreed with your offices, unless you publicly announce the 
contents of this report earlier, we plan no further distribution of it 
until 30 days from the date of this letter. At that time, we will send 
copies of this report to the Secretary of Labor, the Commissioner of 
Internal Revenue, and relevant congressional committees. The report is 
also available at no charge on GAO's Web site at http://www.gao.gov. 

Please contact Andrew Sherrill at (202) 512-7215 or sherrilla@gao.gov 
or Michael Brostek at (202) 512-9110 or brostekm@gao.gov if you or your 
staffs have any questions about this report. Contact points for our 
Offices of Congressional Relations and Public Affairs may be found on 
the last page of this report. Key contributors to this report are 
listed in appendix V. 

Signed by: 

Andrew Sherrill: 
Director, Education, Workforce and Income Security: 

Signed by: 

Michael Brostek:
Director, Tax Issues:
Strategic Issues Team: 

[End of section] 

Appendix I: Scope and Methodology: 

To determine what is known about the extent of the misclassification of 
employees as independent contractors and its associated tax and labor 
implications, we reviewed studies on misclassification conducted by the 
Internal Revenue Service (IRS), the Department of Labor (DOL), and 
others. We reviewed IRS's estimate on the extent of misclassification 
and the associated revenue loss for tax year 1984. We also interviewed 
IRS officials responsible for planning an update to that estimate. From 
DOL, we reviewed a study it commissioned in 2000 on the extent of 
misclassification. We also analyzed the information states report to it 
regarding their findings of misclassification during their audits of 
employers.[Footnote 45] We analyzed summary data that the states 
reported for the years 2000 to 2007. These data included the number of 
employers in each state, the number of audits completed, and the number 
of misclassified employees identified during these audits. We also 
reviewed misclassification studies conducted by states, universities, 
and research institutes. Finally, we interviewed officials from federal 
and state agencies to obtain their views on misclassification and its 
consequences for workers. 

To describe actions taken by DOL to address employee misclassification, 
we examined DOL policies and documentation, including DOL's Wage and 
Hour Division's (WHD) Field Operations Handbook and the Occupational 
Safety and Health Administration's Field Operations Manual. We 
interviewed agency officials at the national and district levels, as 
well as several investigators from WHD, and spoke with employer and 
labor advocates to obtain their perspectives on DOL's efforts. In some 
cases, we relied on interviews conducted for a previous closely related 
GAO testimony, issued in July 2008.[Footnote 46] We also obtained and 
analyzed WHD data on cases involving misclassification concluded during 
fiscal year 2008. We could not obtain data for other time periods 
because WHD did not flag cases to indicate whether they involved 
misclassification before fiscal year 2008. We assessed the reliability 
of the data and determined them to be sufficiently reliable for the 
purposes of this report. However, because DOL only flagged cases as 
involving misclassification when it was the primary reason for Fair 
Labor Standards Act (FLSA) violations, and because WHD officials told 
us that not all investigators understood how to properly flag these 
cases, this information may be incomplete. 

In total, we examined data for 131 cases involving 1,619 misclassified 
employees who were denied payment for overtime or were paid less than 
minimum wage. Using these data from the WHD database, we judgmentally 
selected 26 case files to review. We selected cases based on factors 
such as the number of employees misclassified, the total amount of back 
wages computed, whether a single employee was owed over $10,000 in back 
wages, whether civil money penalties were assessed, and whether the 
case resulted from a complaint or was directed by the agency. We 
conducted reviews of 13 case files in the WHD New Orleans and Boston 
offices and requested copies of the remaining selected case files from 
WHD. Because we judgmentally selected these files, our findings from 
the reviews of case files are not projectable to all WHD cases. 

To obtain information on state coordination with DOL and IRS, state 
perspectives on DOL's education and outreach efforts, and whether 
states collect data on cases involving misclassification, we conducted 
a Web-based survey of unemployment insurance directors in all states, 
the District of Columbia, and Puerto Rico. We administered two versions 
of this survey: one for states participating in the Questionable 
Employment Tax Practices (QETP) program and one for states that do not 
participate in the QETP program. After we drafted the questionnaire, we 
asked for comments from a knowledgeable official at the National 
Association of State Workforce Agencies as well as from an independent 
GAO survey professional. 

We conducted two pretests of the survey, one with a state participating 
in the QETP program and one with a state that does not participate in 
the QETP program, to check that (1) the questions were clear and 
unambiguous, (2) terminology was used correctly, (3) the questionnaire 
did not place an undue burden on agency officials, (4) the information 
could feasibly be obtained, and (5) the survey was comprehensive and 
unbiased. We received responses from all 32 states on the survey for 
QETP participants, for a response rate of 100 percent. We did not 
receive a response from 1 state on the survey for states that do not 
participate in QETP, for a response rate of 95 percent. We were unable 
to contact the official in Puerto Rico within the study's time period. 
Finally, we interviewed officials in 4 states to obtain more 
information about their efforts to address misclassification and, where 
applicable, reviewed documentation on these efforts. 

To describe actions IRS takes to address employee misclassification, we 
interviewed officials from the employment tax group within IRS's Small 
Business/Self Employed Division (SB/SE), which conducts the majority of 
IRS misclassification-related examinations. We also obtained data on 
SB/SE examinations of worker misclassification for tax year 2008 
generated from four sources: (1) the Determination of Worker Status 
(Form SS-8) program, (2) the Employment Tax Examination Program (ETEP), 
(3) QETP, and (4) general IRS employment tax examinations, including 
cases referred from other divisions within IRS. SB/SE conducted all IRS 
misclassification examinations generated by ETEP and QETP, over 97 
percent of the examinations generated by the SS-8 program, and the 
majority of general examinations IRS conducted during fiscal year 2008. 
We also obtained data from IRS's Classification Settlement Program. We 
assessed the reliability of these IRS data sources and found them to be 
sufficiently reliable for the purposes of this report. To obtain 
information on IRS's education and outreach activities that address 
misclassification, we interviewed officials from the employment tax 
group within SB/SE, interviewed independent contractor and labor 
advocates, and reviewed educational materials on classification IRS 
makes available on its Web site. 

To understand how DOL and IRS cooperate with each other and with states 
and other relevant agencies, we examined agency policies and procedures 
for sharing information on misclassification and referring cases 
involving misclassification, and interviewed agency and state 
officials. We also reviewed information IRS provided on its 
arrangements with states through the QETP program. 

To describe options that could help address challenges in preventing 
and responding to misclassification, we reviewed GAO and other federal 
agency reports and recommendations and other organizations' studies on 
misclassification of employees. We also interviewed 19 relevant 
stakeholders representing various groups, including (1) labor and 
advocacy groups, (2) groups that represent small businesses and 
independent contractors, (3) groups that represent tax professionals, 
(4) authors who have published on misclassification issues, and (5) 
federal agencies, to help identify options and summarize any associated 
trade-offs. Based on those discussions, we identified 19 options to 
include in this report. We originally identified over 100 options but 
reduced the list to 19 options that directly addressed 
misclassification challenges and issues, were not already being 
implemented, and were distinct from each other. In addition, we did not 
include other options that we have recently analyzed or recommended in 
prior reports on misclassification or that are indirectly related to 
worker misclassification, such as for information reporting on payments 
made to independent contractors. 

We surveyed 11 stakeholders for their views on the 19 options we 
identified, asking them to state their level of support or opposition 
to the options and what they perceived to be the strengths and 
drawbacks of each option. These stakeholders included 4 groups that 
represent the views of small businesses, independent contractors, and 
those who hire them (i.e., independent contractor groups); 4 groups 
that represent the views of organized labor (i.e., labor groups); 2 
groups that represented the tax preparation and advice community; and 1 
federal agency that uses contractors. We received responses from 9 of 
these groups.[Footnote 47] We analyzed the responses we received in 
order to present summary information in the report. 

We conducted this performance audit from August 2008 through July 2009 
in accordance with generally accepted government auditing standards. 
Those standards require that we plan and perform the audit to obtain 
sufficient, appropriate evidence to provide a reasonable basis for our 
findings and conclusions based on our audit objectives. We believe that 
the evidence obtained provides a reasonable basis for our findings and 
conclusions based on our audit objectives. 

[End of section] 

Appendix II: Stakeholder Views on Options to Address Misclassification 
Challenges: 

We identified 19 options to address challenges involved with preventing 
and responding to worker misclassification by reviewing related 
literature and interviewing knowledgeable persons about 
misclassification. As we identified these options, we asked these 
stakeholders for their views on the options, including what they 
considered to be the benefits and drawbacks of each. These stakeholders 
included IRS officials and representatives of organizations 
representing workers, independent contractors, tax professionals, and a 
federal agency that hires contractors. 

The following is a summary of the options and their perceived 
associated benefits and drawbacks. Neither the list of options nor the 
list of their perceived associated benefits and drawbacks is 
exhaustive. Some of the options are concepts rather than fully 
developed proposals with details of how they would be implemented. 
Additional detail could bring more benefits and drawbacks to light. The 
benefits and drawbacks are not weighted and are not listed in order of 
importance or by frequency of mention. Options should not be judged by 
the number of benefits and drawbacks. Some of the options overlap, 
covering more than one problem, while other options only deal with 
specific aspects of a problem. 

A. Clarify the employee/independent contractor definition and expand 
worker rights: 

1. Clarify the distinction between employees and independent 
contractors under federal law by unifying multiple definitions, 
limiting the number of factors used to make determinations, and making 
the factors more conclusive: 

Benefits: 

* Could reduce manipulation of classification rules: 

* Could improve equity and efficiency of classification rules: 

* Could improve worker protection if an expansive definition is 
adopted: 

* Could improve objectivity of rules/reduce confusion: 

Drawbacks: 

* Lobbying and political compromises could weaken the definition: 

* Lobbying and political compromises could lead to a more restrictive 
definition: 

* Could lead to increased litigation if a new definition has no history 
or precedent: 

* Could create transitional costs and upheavals in working 
relationships: 

* Could deter use of independent contractors: 

* A "one-size-fits-all" approach may cause imbalances and more problems 
than it solves in certain industries: 

* IRS and government agencies could incur costs to administer a new 
definition: 

* Could sidetrack key anti-abuse reforms: 

* No need to harmonize definitions since courts work well in doing so: 

* Could encourage more employers to engage in fraud: 

2. Allow workers to challenge classification determinations in U.S. Tax 
Court: 

Benefits: 

* Could increase equity and protections for workers: 

* Could reduce incentives for misclassification: 

Drawbacks: 

* Could result in more or unnecessary litigation: 

* Would be unfair to businesses: 

* Could deter use of independent contractors: 

* Too narrow to limit challenges to just Tax Court and just workers: 

3. Ensure that workers have adequate legal protection from retaliation 
for filing a Form SS-8: 

Benefits: 

* Could help reduce misclassification/improve misclassification 
compliance: 

* Could help improve worker protection and justice: 

Drawbacks: 

* Could result in more litigation: 

* Limits ability of employers to end contractual relationships as 
needed: 

* Could reduce use of independent contractors: 

* Not necessary because retaliation is rare and independent contractors 
can protect themselves through a contract: 

* Does not include worker protection for other actions to challenge 
misclassification: 

4. Define misclassification as a violation under FLSA: 

Benefits: 

* Could help increase voluntary compliance: 

* Would allow federal agencies, including DOL, to take greater 
enforcement actions: 

Drawbacks: 

* Could increase costly lawsuits for businesses: 

* Could deter use of independent contractors: 

* Unfair to penalize businesses and contractors for confusing and 
subjective regulations: 

B. Revise section 530 of the Revenue Act of 1978: 

5. Narrow the definition of "a long-standing recognized practice of a 
significant segment of the industry" so that fewer firms qualify under 
this reasonable basis for the section 530 safe harbor: 

Benefits: 

* Could reduce incentive to misclassify and increase voluntary 
compliance: 

* Could reduce confusion: 

* Could help reduce tax gap related to misclassification: 

Drawbacks: 

* Opens the door to eroding the protection of section 530: 

* Could create inequities among those who use independent contractors: 

* Could lead to economic disruption or upheaval in some industries: 

* Ignores unique issues that some industries possess: 

* Unnecessary because current definition can be hard to meet: 

* Only narrows rather than eliminates "industry practice": 

6. Lift the ban on IRS/Treasury regulations or revenue rulings 
clarifying the employment status of individuals for purposes of 
employment taxes: 

Benefits: 

* Could reduce requests for individual classification determinations 
and associated costs: 

* More consistent application of the rules: 

* Could increase voluntary compliance: 

* Could allow IRS to more effectively prevent misclassification and 
enforce classification: 

* Could improve understanding and reduce confusion over classification: 

Drawbacks: 

* No need because existing case law is sufficient: 

* IRS favors employee status: 

* Could erode section 530 protection: 

* Could increase litigation and lobbying costs: 

* IRS cannot fix the classification problem without congressional 
guidance: 

* A national standard would not affect state definitions: 

* Could disrupt working relationships: 

* Political influences could slant the new guidance: 

C. Provide additional education and outreach: 

7. Require service recipients to provide standardized documents to 
workers that explain their classification rights and tax obligations: 

Benefits: 

* Could increase voluntary compliance: 

* Could help reduce misclassification by reducing errors: 

* Could help educate workers about classification: 

Drawbacks: 

* Could discriminate against some independent contractors: 

* Relies on employers instead of IRS to inform workers: 

* Could be ineffective if workers cannot understand the documents: 

* Employers would incur costs and burdens: 

8. Expand IRS outreach to service recipient, worker, and tax advisor 
groups to educate them about classification rules and related tax 
obligations, targeting groups IRS deems to be "at risk": 

Benefits: 

* Could increase voluntary compliance: 

* Could improve uniformity of classifications: 

* Could reduce misclassification by reducing errors: 

Drawbacks: 

* Could deter use of independent contractors: 

* Could divert IRS resources from enforcement: 

* Does not target tax advisors who facilitate misclassification: 

* Could lead to unfair targeting of business groups: 

* Could lead to independent contractors suing their clients: 

9. Create an online classification system, using factors similar to 
those used in the SS-8 determination process, to guide service 
recipients and workers on classification determinations: 

Benefits: 

* Uses electronic instead of paper-based processes: 

* Could minimize the need for SS-8 determinations: 

* Could provide more information to workers and service recipients: 

* Could streamline decision making on classifications: 

* Could reduce confusion and unintentional misclassification: 

Drawbacks: 

* IRS would incur costs to develop system: 

* Still relies on subjective weighting of evidence and is likely to 
produce inconsistent determinations: 

* Not all workers have access to computers: 

* Could be manipulated by employers to attain desired classification: 

10. Increase the use of IRS notices to service recipients in industries 
with a potentially high incidence of misclassification to educate them 
about the classification rules and ask them to review their 
classification practices: 

Benefits: 

* Could increase voluntary compliance: 

* Could improve understanding of correct classification: 

Drawbacks: 

* IRS would incur costs to develop and mail notices: 

* Could be ineffective if not combined with IRS enforcement: 

* Could expose employers to more litigation: 

* Could create adversarial relationships between employers and workers: 

* Could be unfair to targeted industries: 

D. Withhold taxes for independent contractors: 

11. Require service recipients to withhold taxes, with rates at an 
adequate level to induce compliance, for independent contractors whose 
taxpayer identification numbers (TIN) cannot be verified or if notified 
by IRS during the TIN verification process that the contractors are not 
fully tax compliant: 

Benefits: 

* Could identify more misclassification: 

* Could help improve voluntary filing and tax compliance by having 
taxes paid up front: 

Drawbacks: 

* Would impose costs and burdens on employers: 

* Does not hold employers financially accountable for 
misclassification: 

* TIN verification is not effective: 

* Could face political opposition: 

* Discriminates against independent contractors: 

* Could result in withholding errors: 

12. Require universal tax withholding for payments made to independent 
contractors using tax rates that are relatively low (e.g., 1 percent to 
5 percent of payment amounts): 

Benefits: 

* Would make payments to workers more visible: 

* Could increase voluntary filing and tax compliance by having taxes 
paid up front: 

* Could help identify misclassification: 

* Such low rates would not be burdensome to independent contractors: 

Drawbacks: 

* Would impose costs and burdens on employers and workers: 

* Could expose employers to underwithholding penalties: 

* Does not hold employers financially accountable for 
misclassification: 

* Could deter use of independent contractors: 

* Does not recognize that profit margins vary widely across businesses: 

* Could be used to intimidate undocumented workers: 

* Withholding amounts could be too high or withholding rate could be 
too low: 

* Could lead to increased "off-the-books" payments for services: 

13. Require service recipients to withhold taxes from payments made to 
independent contractors who request withholding in writing: 

Benefits: 

* Could increase voluntary filing and tax compliance by having taxes 
paid up front: 

* Would be practical because withholding is voluntary: 

* Could help independent contractors meet their tax obligations: 

* Could make misclassification easier to identify and less likely to 
occur: 

Drawbacks: 

* Could increase employers' costs and exposure to penalties for 
withholding errors: 

* Could deter use of independent contractors: 

* Does not hold employers financially accountable for 
misclassification: 

* Would need additional remedies for workers if employer did not remit 
taxes to IRS: 

E. Collect data on misclassification and independent contractors: 

14. Measure the extent of misclassification and related impacts on tax 
revenues at the national level: 

Benefits: 

* Could raise awareness of misclassification: 

* Would provide data to support any reform efforts: 

* Could help IRS more effectively address misclassification: 

* Could improve understanding of correct classification: 

Drawbacks: 

* Timely estimates could be costly: 

* May not be successful: 

* Could take a while and delay needed reforms: 

15. Require each independent contractor to apply for a separate 
business TIN: 

Benefits: 

* Could increase voluntary compliance: 

* Reinforces business status and obligations of independent 
contractors: 

* Could facilitate IRS compliance and enforcement efforts: 

* Could prompt workers to think about their desired status: 

Drawbacks: 

* IRS would incur costs: 

* Would impose burdens on independent contractors to apply: 

* Could be harmful to some industries: 

* Employers could use it to force workers into independent contractor 
status or to justify their independent contractor classifications: 

F. Enhance IRS compliance programs: 

16. Expand IRS's Classification Settlement Program (CSP) to allow for 
CSP treatment for service recipients that voluntarily contact IRS about 
their misclassified workers before any contact from IRS about potential 
misclassification: 

Benefits: 

* Would reduce the financial exposure of participating employers: 

* Could increase voluntary compliance: 

* Would not unnecessarily burden employers: 

Drawbacks: 

* IRS would incur costs to expand program: 

* Unfairly rewards intentional misclassification: 

* Could create section 530 protection or allow other manipulation of 
classification rules for some employers: 

17. Require service recipients to submit Forms SS-8 for all newly 
retained independent contractors: 

Benefits: 

* Could increase voluntary compliance/reduce misclassification: 

* Shifts burden of proof to the independent contractor: 

* Provides IRS more information about independent contractors for 
compliance and enforcement: 

Drawbacks: 

* Current SS-8 process does not sufficiently protect workers or 
investigate employers: 

* Would impose burdens and costs on employers and independent 
contractors: 

* Could severely slow down the contracting process: 

* Could deter use of independent contractors: 

* Could allow for more manipulation of classification rules unless the 
rules are clarified and IRS more vigorously investigates employers: 

* Does not address IRS's bias for employee status: 

* IRS's costs would be significant: 

G. Enhance coordination and information sharing: 

18. Enhance coordination between IRS, DOL, and other federal agencies 
to share data and address misclassification: 

Benefits: 

* Could increase voluntary compliance: 

* Could deter intentional misclassification: 

* Could make federal enforcement more efficient: 

* Could improve consistency across federal agencies: 

Drawbacks: 

* IRS may not be able to use all the information that it receives: 

* Could deter some workers from reporting misclassification, especially 
if it leads to questions about their immigration status: 

* Could result in loss of privacy for individuals affected by the 
information sharing: 

* Could be hampered by differences in agency definitions of employee 
status: 

19. Enhance coordination between IRS, states, and selected local 
governments to share data and address misclassification: 

Benefits: 

* Could help increase voluntary compliance: 

* Could improve federal agency efficiency and effectiveness: 

Drawbacks: 

* IRS may not be able to use all the information it receives: 

* Could deter some workers from reporting misclassification: 

* Could result in loss of privacy for individuals affected by the 
information sharing: 

* Could be hampered by different definitions of employee status: 

* Having too many government agencies involved could hamper action and 
allow employers to manipulate rules: 

[End of section] 

Appendix III: Comments from the Department of Labor: 

U.S. Department of Labor: 
Assistant Secretary for Employment Standards: 
Washington, D.C. 20210: 

July 14, 2009: 

Mr. Andrew Sherrill: 
Director: 
Education, Workforce, and Income Security Issues: 
U.S. Government Accountability Office: 
Washington, D.C. 20548: 

Dear Mr. Sherrill: 

Thank you for the opportunity to comment on the Government 
Accountability Office's (GAO) draft report entitled "Employee 
Misclassification: Improved Coordination, Outreach, and Targeting Could 
Better Ensure Detection and Prevention" (GAO-09717). 

The draft report provides four recommendations to the Secretary of 
Labor, two of which directly cite the Employment Standards 
Administration's Wage and Hour Division (WED). Our comments follow the 
restated recommendations. 

Recommendation 1: 

To increase its detection of FLSA and other labor law violations, we 
recommend that the Secretary of Labor direct the Wage and Hour Division 
Administrator to increase the division's focus on misclassification of 
employees as independent contractors during targeted investigations. 

Response: 

WHD agrees with this recommendation. WHD investigators must establish 
an employment relationship to pursue remedies on behalf of workers 
under most of the statutes that the agency enforces, including the Fair 
Labor Standards Act and the Family and Medical Leave Act. To reinforce 
this position, the agency will reexamine its training materials and 
field guidance documents to ensure that all investigative staff is 
aware of the potential for employer misclassification of workers as 
independent contractors, that procedures are clearly articulated, and 
that investigators address employers' classification practices during 
all stages of an investigation. In addition, WHD's future performance 
planning priorities will focus on increasing compliance on behalf of 
workers employed in industries that are characterized by frequent 
incidences of independent contractor misclassification. 

Recommendation 2: 

To enhance efforts to protect workers and make the most effective use 
of their resources, we recommend that the Secretary of Labor direct the 
Wage and Hour Division Administrator and the Assistant Secretary for 
OSHA to ensure that information on cases involving misclassification of 
employees as independent contractors is shared between the two 
divisions and that cases outside their jurisdiction are referred to 
states and other relevant agencies, as required. 

Response: 

WHD agrees that there is value in sharing information about 
misclassification with the Occupational Safety and Health 
Administration (OSHA) and with state agencies, as appropriate. To this 
end, WI-ID and OSHA are committed to working together to improve 
coordination between the two agencies and to institutionalize the 
exchange of information on this issue. WHD will also assess its current 
referral processes to ensure that they adequately provide for referrals 
of potential violations of other laws outside WHD's jurisdiction that 
may be related to the misclassification of workers as independent 
contractors. 

Recommendation 3: 

To identify promising practices in addressing misclassification and use 
agency resources most effectively, we recommend that the Secretary of 
Labor and the Commissioner of Internal Revenue establish a joint 
interagency effort with other federal and state agencies to address the 
misclassification of employees as independent contractors. Because tax 
data may provide useful leads on noncompliance, the task force should 
determine to what extent tax information would assist other agencies, 
and if it would be sufficiently helpful, seek a legislative change 
through the Department of Treasury to allow for sharing of tax 
information with appropriate privacy protections. 

Response: 

WHD agrees that a joint effort between the Department of Labor and the 
Internal Revenue Service may prove useful in its efforts to enforce 
wage and hour laws. WHD will actively participate in any such 
interdepartmental effort. 

Recommendation 4: 

To enhance understanding of classification issues by workers-especially 
those in low-wages industries-we recommend that the Secretary of Labor 
collaborate with the Commissioner of Internal Revenue to offer 
education and outreach to workers on classification rules and 
implications and related tax obligations. Such collaboration should 
include developing a standardized document on classifications that DOL 
would require employers to provide to new workers. 

Response: 

WHD will reach out to the Internal Revenue Service to explore 
opportunities for joint outreach to workers. 

WHD appreciates the seriousness of the adverse consequences to workers 
who are misclassified as independent contractors. Again, thank you for 
the opportunity to comment on the draft report. 

Sincerely, 

Signed by: 

J.R. Correll, for: 
Shelby Hallmark: 
Acting Assistant Secretary: 

[End of letter] 

U.S. Department of Labor: 
Assistant Secretary for Occupational Safety and Health: 
Washington, DC 20210: 

July 11, 2009: 

Mr. Andrew Sherrill, Director: 
Education, Workforce and Income Security: 

Mr. Michael Brostek, Director: 
Tax Issues: 
Strategic Issues Team: 

United States Government Accountability Office: 
441 G Street, N.W. 
Washington, D.C. 20548: 

Dear Messrs. Sherrill and Brostek: 

The Occupational Safety and Health Administration (OSHA) appreciates 
the opportunity to review and comment on your draft report entitled 
Employee Misclassification: Improved Coordination, Outreach and 
Targeting Could Better Ensure Detection and Prevention. 

The OSH Act requires all employers to maintain a safe and healthful 
workplace. It is the employer's responsibility to ensure the health and 
safety of the workers as the employer has direct control of the 
workplace and the actions of the employees who work there. 
Consequently, misclassification of employees as contingent workers 
generally will not result in an employer responsible for OSHA 
violations escaping citation. 

Nonetheless, OSHA understands the serious ramifications workers face in 
lost protections and benefits due to misclassification. OSHA is 
committed to working closely with the Administrator of the Wage and I-
lour Division to enhance the exchange of information on this issue and 
improve protections afforded workers. 

Again, thank you for the opportunity to respond to GAO's draft report. 

Sincerely, 

Signed by: 

Jordan Barab: 
Acting Assistant Secretary 

[End of section] 

Appendix IV: Comments from the Internal Revenue Service: 

Department Of The Treasury: 
Deputy Commissioner: 
Internal Revenue Service: 
Washington, D.C. 20224: 

July 10, 2009: 

Mr. Michael Brostek: 
Director, Strategic Issues: 
United States Government Accountability Office: 
Washington, DC 20548: 

Dear Mr. Brostek: 

Thank you for the opportunity to review the Government Accountability 
Office's (GAO) draft report entitled, "Employee Misclassification: 
Improved Coordination, Outreach, and Targeting Could Better Ensure 
Detection and Prevention (Job Code GAO-09-717)." 

We recognize that when employers improperly classify workers as 
independent contractors instead of employees, those workers do not 
receive protections and benefits to which they are entitled, and the 
employers may fail to pay taxes they would otherwise be required to 
pay. We agree that coordination between the departments and agencies at 
the federal and state levels is an effective way to encourage voluntary 
compliance and help address employee misclassification. 

The IRS enforces worker classification compliance primarily through 
administration of our SS-8 program and through employment tax 
examinations. IRS offers a classification settlement program where 
employers may be eligible to reduce audit assessments if they agree to 
prospectively treat their workers as employees in the future. IRS also 
provides general information on worker classification through 
publications and fact sheets available on our Web site and through 
outreach targeted to tax and payroll professionals and employers. 
However, IRS faces challenges with these compliance efforts because of 
resource constraints and legal limits placed on IRS in providing 
guidance under Section 530 of the Revenue Act of 1978. 

Your report identifies various options that could help address the 
misclassification of employees as independent contractors. We 
appreciate the suggestions and will carefully consider them as we work 
with the Secretary of Labor and others to explore those options. 

The enclosed response addresses each recommendation separately. 

If you have questions or concerns, please contact Christopher Wagner, 
Commissioner, Small Business/Self-Employed Division at (202) 622-0600. 

Sincerely, 

Signed by: 

Linda E. Stiff: 

Enclosure: 

[End of letter] 

Enclosure: 

Recommendation: 

To identify promising practices in addressing misclassification and use 
agency resources most effectively, we recommend that the Secretary of 
Labor and the Commissioner of Internal Revenue establish a joint 
interagency effort with other federal and state agencies to address the 
misclassification of employees as independent contractors. Because tax 
data may provide useful leads on noncompliance, the task force should 
determine to what extent tax information would assist other agencies, 
and if it would be sufficiently helpful, seek a legislative change 
through the Department of the Treasury to allow for sharing of tax 
information with appropriate privacy protections. 

Comment: 

We agree that coordination between departments and agencies at the 
federal and state levels is an effective way to encourage voluntary 
compliance. We agree to work with the Secretary of Labor to explore 
developing a joint effort subject to disclosure rules under IRC Section 
6103, as well as privacy rules under 5 U.S.C. 552a. 

Recommendation: 

To enhance understanding of classification issues by workers - 
especially those in low-wage industries - we recommend that the 
Secretary of Labor collaborate with the Commissioner of Internal 
Revenue to offer education and outreach to workers on classification 
rules and implications and related tax obligations. Such collaboration 
should include developing a standardized document on classification 
that DOL would require employers to provide to new workers. 

Comment: 

We agree to collaborate with the Secretary of Labor, and we will make 
education and outreach materials available to the DOL. We agree to work 
with the Secretary of Labor to explore developing a standardized 
document on classification for the DOL to provide to new workers. 

Recommendation: 

To maximize the effectiveness of the relatively new QETP initiative, we 
recommend the Commissioner of Internal Revenue create a forum for 
regularly collaborating with participating states to identify and 
address data sharing issues, such as ensuring clear points of contact 
within IRS for states and expeditious sharing of data. 

Comment: 

We agree to work with participating State Workforce Agencies (SWAs) in 
the Questionable Employment Tax Program (QETP) to establish a forum to 
identify and address data sharing and IRS points of contact issues. We 
will utilize the Enterprise Wide Employment Tax Program (EWETP) to 
achieve this. 

Recommendation: 

To increase proper worker classification, we recommend that the 
Commissioner of Internal Revenue extend the Classification Settlement 
Program to include employers who volunteer to prospectively reclassify 
their misclassified employees, and as part of this extension test 
whether sending notices describing the program to potentially 
noncompliant employers would be cost effective. Employers to whom IRS 
would send notices could include those referred for examination but who 
may not be examined due to higher priorities, resource limitations, or 
other reasons. 

Comment: 

We will review the existing Classification Settlement Program and 
consider the possibility of expanding to employers not under audit. If 
expansion of this program is appropriate, we will consider all options, 
including issuing notices and soft letters and soliciting volunteers 
through outreach and education. 

[End of section] 

Appendix V: GAO Contacts and Staff Acknowledgments: 

GAO Contacts: 

Andrew Sherrill, (202) 512-7215 or sherrilla@gao.gov: 

Michael Brostek, (202) 512-9110 or brostekm@gao.gov: 

Acknowledgments: 

In addition to the contacts named above, Revae Moran, Acting Director; 
Tom Short, Assistant Director; Amy Sweet, Analyst-in-Charge; Jeff 
Arkin, Analyst-in-Charge; Susan Bernstein; Jessica Bryant-Bertail; 
Scott Charlton; Doreen Feldman; Jennifer Gravelle; Maura Hardy; David 
Perkins; Ellen Phelps Ranen; Albert Sim; Andrew J. Stephens; and 
Gregory Wilmoth made key contributions to this report. 

[End of section] 

Footnotes: 

[1] In this report, we define the term employer as an entity that 
compensates employees, independent contractors, or both for services 
received in the course of a trade or business. Thus, the term does not 
include consumers or individuals who contract for services. While 
independent contractors may also be classified improperly as employees, 
this report focuses on the misclassification of employees as 
independent contractors. 

[2] GAO, Employment Arrangements: Improved Outreach Could Help Ensure 
Proper Worker Classification, [hyperlink, 
http://www.gao.gov/products/GAO-06-656] (Washington, D.C.: July 11, 
2006). 

[3] The Federal Unemployment Tax Act (26 U.S.C. §§ 3301-3311), in 
combination with 53 state-administered programs, provides for payments 
of unemployment compensation to workers who have lost their jobs. State-
administered programs are subject to broad federal guidelines and 
oversight. States determine key elements of their programs, including 
who is eligible to receive state unemployment benefits and how much 
they receive. State unemployment tax revenues are held in trust by the 
U.S. Treasury and are used by the states to pay for regular, weekly 
unemployment benefits. Federal unemployment tax is used to administer 
the state and federal unemployment insurance programs, to administer 
the loan fund for state advances, to fund extended benefits when 
authorized by Congress, and to provide labor exchange services under 
the Wagner-Peyser Act. 

[4] Pub. L. No. 95-600, 92 Stat. 2763 (Nov. 6, 1978). 

[5] Section 530 does not apply in the case of certain technical workers 
(engineers, designers, drafters, computer programmers, systems 
analysts, or other similar skilled workers engaged in a similar line of 
work) who provide services for third parties pursuant to arrangements 
between the business for whom the technical worker works and the third 
party. Tax Reform Act of 1986, Pub. L. No. 99-514, § 706 (Oct. 22, 
1986). 

[6] In 1989, we stated that Congress may want to consider repealing the 
limitation on IRS prospectively reclassifying employees who may have 
been misclassified. See GAO, Tax Administration: Information Returns 
Can Be Used to Identify Employers Who Misclassify Workers, GAO/GGD-89-
107 (Washington, D.C.: Sept. 25, 1989). Based in part on this report, 
Congress modified section 530 through the Small Business Job Protection 
Act of 1996 (Pub. L. No. 104-188, August 20, 1996) to limit the past 
examination practice reasonable basis to examinations for employment 
tax purposes of whether a worker should be treated as an employee. 

[7] Pub. L. No. 97-248, 96 § 269(c)(1)(C)(2), 96 Stat. 324 (Sept. 3, 
1982). 

[8] See IRS Publication 1779, Independent Contractor or Employee, and 
Publication 15-A, Employer's Supplemental Tax Guide. 

[9] FedEx Home Delivery v. National Labor Relations Board, 563 F.3d 492 
(D.C. Cir. 2009). 

[10] The study did not include an estimate of the percentage of all 
independent contractors who were misclassified by their employers (that 
is, of all independent contractors, the percentage that should have 
been classified as employees). 

[11] Employers are generally required to report payments of $600 or 
more in any given year made to independent contractors on Form 1099- 
MISC, unless the independent contractors are incorporated. 

[12] In past reports, we identified various options to improve tax 
compliance among independent contractors and sole proprietors, who are 
included in a category of self-employed taxpayers along with 
independent contractors. In 1996, we identified two approaches to 
increase tax compliance of independent contractors: (1) require 
businesses to withhold taxes from payments to independent contractors 
and (2) improve information reporting on payments made to independent 
contractors. See GAO, Tax Administration: Issues in Classifying Workers 
as Employees or Independent Contractors, [hyperlink, 
http://www.gao.gov/products/GAO/T-GGD-96-130] (Washington, D.C.: June 
20, 1996). In 2007, we analyzed various options to address tax 
noncompliance among sole proprietors. See GAO, Tax Gap: A Strategy for 
Reducing the Gap Should Include Options for Addressing Sole Proprietor 
Noncompliance, [hyperlink, http://www.gao.gov/products/GAO-07-1014] 
(Washington, D.C.: July 13, 2007). In 2009, we made various 
recommendations to improve compliance with filing Forms 1099-MISC. See 
GAO, Tax Gap: IRS Could Do More to Promote Compliance by Third Parties 
with Miscellaneous Income Reporting Requirements, [hyperlink, 
http://www.gao.gov/products/GAO-09-238] (Washington, D.C.: Jan. 28, 
2009). 

[13] We previously attempted to estimate the extent of 
misclassification and the extent of income tax losses using compliance 
data that existed in 1994, but these data were not sufficient to 
produce reliable estimates. See GAO, Tax Administration: Estimates of 
the Tax Gap for Service Providers, [hyperlink, 
http://www.gao.gov/products/GAO/GGD-95-59] (Washington, D.C.: Dec. 28, 
1994). 

[14] Planmatics, Inc., Independent Contractors: Prevalence and 
Implications for Unemployment Insurance Program (Rockville, Md: U.S. 
Department of Labor, February 2000). 

[15] This survey, a supplement to the Current Population Survey, is a 
household survey in which workers are asked to self-report information 
about their jobs. It was conducted in February 1995, 1997, 1999, 2001, 
and 2005. 

[16] States may uncover misclassification during their audits of 
employers' unemployment insurance tax payments. DOL requires states to 
report summary information related to misclassification from these 
audits on a quarterly basis, including the overall number of 
misclassified employees identified. We did not evaluate whether states 
changed their audit criteria over this period of time, which may 
explain the increase in some or all of the numbers of misclassified 
workers identified by the states. In addition, we note that during this 
period, the total number of employers audited by states increased from 
approximately 114,000 to about 117,000. 

[17] Construction Policy Research Center, Harvard University, The 
Social and Economic Costs of Employee Misclassification in the Maine 
Construction Industry (Cambridge, Mass.: Apr. 25, 2005). This study was 
based on unemployment insurance audits conducted by the state of Maine. 
We did not assess the study to determine whether the methodology used 
was reliable. 

[18] Experts we spoke with explained that this reluctance sometimes 
stems from the fear of losing one's job, employer coercion, or, in the 
case of immigrant workers, apprehension about interacting with the 
federal government. 

[19] On March 25, 2009, the Secretary of Labor announced plans to hire 
150 new investigators. WHD officials said they did not know whether 
this would enable them to target more employers for investigation. 

[20] GAO has recently conducted evaluations of WHD's enforcement 
efforts and made recommendations for improvement. See GAO, Fair Labor 
Standards Act: Better Use of Available Resources and Consistent 
Reporting Could Improve Compliance, [hyperlink, 
http://www.gao.gov/products/GAO-08-962T] (Washington, D.C.: July 15, 
2008); Department of Labor: Wage and Hour Division's Complaint Intake 
and Investigative Processes Leave Low Wage Workers Vulnerable to Wage 
Theft, [hyperlink, http://www.gao.gov/products/GAO-09-458T] 
(Washington, D.C.: Mar. 25, 2009); and Department of Labor: Wage and 
Hour Division Needs Improved Investigative Processes and Ability to 
Suspend Statute of Limitations to Better Protect Workers Against Wage 
Theft, [hyperlink, http://www.gao.gov/products/GAO-09-629] (Washington, 
D.C.: July 23, 2009). 

[21] Although WHD categorized nine of these cases as targeted 
investigations, they actually stemmed from investigations based on 
complaints from workers. In addition, targeted investigations that do 
not result in violations are not flagged as involving employee 
misclassification in WHD's database. Therefore, we were unable to 
determine the effectiveness of the agency's targeting strategy. 

[22] Department of Labor, Wage and Hour Division, Employment 
Relationship Under the Fair Labor Standards Act, WH Publication 1297 
(Washington, D.C., August 1985); "Fact Sheet #13: Employment 
Relationship Under the Fair Labor Standards Act," [hyperlink, 
http://www.dol.gov/esa/whd/fact-sheets-index.htm] (accessed June 1, 
2009); and "Fact Sheet #35: Joint Employment and Independent 
Contractors Under the Migrant and Seasonal Agricultural Worker 
Protection Act," [hyperlink, http://www.dol.gov/esa/whd/fact-sheets-
index.htm] (accessed June 1, 2009). 

[23] IRS Form SS-8, Determination of Worker Status for Purposes of 
Federal Employment Taxes and Income Tax Withholding. 

[24] According to IRS employment tax officials, the SS-8 unit closes 
about 20 percent of cases it receives each year without a determination 
for various reasons. For example, IRS may need to contact employers in 
order to make a determination for Form SS-8 requests filed by workers, 
and some workers withdraw their SS-8 requests because of fear of 
retaliation from their employers. To avoid duplication, the SS-8 unit 
does not make a determination in cases where IRS is examining the 
employer. In addition, a case is closed if the associated Form SS-8 is 
incomplete and IRS is unable to contact the applicant. 

[25] About 90 percent of Form SS-8 requests are filed by workers. 

[26] IRS examines an even smaller percentage of all Forms SS-8 filed. 
For example, IRS closed 39 examinations of employers that it identified 
through SS-8 determinations in fiscal year 2008 out of the almost 
12,000 such requests filed. This amount was an increase from the 
average of 6,000 Form SS-8 requests that were filed annually for fiscal 
years 2005 through 2007. This increase was prompted, in part, by a new 
IRS form (Form 8919) that informs workers who think they may have been 
misclassified that they can file a Form SS-8 to obtain a determination 
from IRS. 

[27] In a 1989 report, we recommended that IRS match independent 
contractors' information returns with their tax returns to more 
systematically identify employers that are misclassifying employees as 
independent contractors. One scenario we discussed in the report 
involved identifying independent contractors with incomes of more than 
$10,000 to identify contractors who received all of their income from 
one employer. See GAO/GGD-89-107. IRS's use of this matching process 
during the review led it to assess $9.9 million in additional taxes and 
penalties against 67 employers found to have misclassified workers. 

[28] ETEP match data for tax year 2006 were the most recent data 
available at the time that we did our work. 

[29] IRS officials reported that some QETP audit referrals it receives 
contain extraneous information or are provided in a format that is 
difficult to use. However, IRS officials have worked with at least one 
state workforce agency to help the state tailor the information it 
forwards to IRS. 

[30] For example, employers must have filed all required information 
returns for their workers to be eligible to participate in CSP. 

[31] IRS calculated this figure by first noting the dollar amount of 
each CSP agreement, multiplying the dollar amount for each agreement by 
the number of tax years since the taxpayer signed the agreement, and 
summing the values of all CSP agreements that had been signed since CSP 
was initiated. 

[32] For employment tax purposes, the Internal Revenue Code 
incorporates the common law definition of an employee. 26 U.S.C. § 
3121(d)(2). The Department of the Treasury's regulations state that an 
employee-employer relationship generally exists when the business has a 
right to control and direct the worker not only as to the result to be 
accomplished but also as to the details and means by which that result 
is accomplished. 26 C.F.R. §§ 31.3121(d)-1(c); 31.3306(i)-1; 31.3401(c)-
1. IRS's Revenue Ruling 87-41 contains a list of 20 factors or elements 
that IRS examiners can use to determine whether a worker is an employee 
under the common law. IRS examination training materials characterize 
these 20 factors as being based on three concepts: behavioral control, 
financial control, and the relationship between the employer and the 
worker. 

[33] IRS has interpreted the Small Business Job Protection Act of 1996, 
which added subsection (e) to section 530, as requiring the first step 
in examining any case involving employment tax obligations of an 
employer with respect to workers to be determining whether the business 
meets the requirements of section 530. Pub. L. No. 104-188, § 1122, 110 
Stat. 1755, 1766 (Aug. 20, 1996), codified at 26 U.S.C. § 3401 note. 

[34] As previously mentioned, in order to receive section 530 
protection, employers must have filed all federal tax returns in a 
manner consistent with not treating the workers in question as 
employees, consistently treated similarly situated workers as 
independent contractors, and had a reasonable basis for treating the 
workers as independent contractors. 

[35] 26 U.S.C. § 6103. The protection of taxpayer information is 
commonly thought to be critical to voluntary compliance with the tax 
code and necessary to protect taxpayer privacy. There are statutory 
exceptions to the general prohibition, such as those permitting the 
sharing of certain information with state tax officials and the Social 
Security Administration. 26 U.S.C. § 6102(d),(l)(1). 

[36] Seven additional state agencies reported that they were working 
with IRS to become QETP members. 

[37] According to IRS officials, as of April 2009, 22 state workforce 
agencies were enrolled in the process to receive Form 1099-MISC data 
extracts. 

[38] According to IRS officials, as of May 2009, 31 states were 
enrolled in a process to receive information from classification 
determinations. 

[39] GAO, Tax Treatment of Employees and Self-Employed Persons by the 
Internal Revenue Service: Problems and Solutions, [hyperlink, 
http://www.gao.gov/products/GAO/GGD-77-88] (Washington, D.C.: Nov. 21, 
1977) and Compliance Problems of Independent Contractors, Testimony 
109909 (Washington, D.C.: July 17, 1979). 

[40] GAO, Tax Administration: Approaches for Improving Independent 
Contractor Compliance, [hyperlink, 
http://www.gao.gov/products/GAO/GGD-92-108] (Washington, D.C.: July 23, 
1992). Other options dealt with improving information reporting on 
payments made for services to independent contractors, including 
incentives to file Form 1099-MISC, and requiring more information to be 
reported on tax returns about the payments made for services. 

[41] For a more detailed discussion of our methodology in selecting 
options to include in this report, see appendix I. 

[42] The list also does not include options that we have recently 
analyzed or recommended in prior reports that are indirectly related to 
worker misclassification, such as information reporting on payments 
made to independent contractors. For example, in [hyperlink, 
http://www.gao.gov/products/GAO-09-238] we made various recommendations 
to improve compliance with filing Forms 1099-MISC, and in [hyperlink, 
http://www.gao.gov/products/GAO-07-1014] we analyzed various options to 
address tax noncompliance among sole proprietors, a group of taxpayers 
that includes independent contractors. 

[43] We identified these 11 stakeholder groups from the original 19 
that we interviewed early in our study. We selected the 11 based on 
those that provided specific ideas and comments on the options in our 
first round of interviews and that expressed willingness to respond to 
our written data collection instrument. 

[44] We did not receive responses from one of the paid tax return 
preparer groups and one of the independent contractor groups. 

[45] All states, the District of Columbia, and Puerto Rico are required 
to report information regarding their unemployment insurance audits to 
DOL on a quarterly basis. 

[46] [hyperlink, http://www.gao.gov/products/GAO-08-962T]. 

[47] We did not receive survey responses from one of the groups 
representing the tax preparation and advice community and one of the 
independent contractor groups. 

[End of section] 

GAO's Mission: 

The Government Accountability Office, the audit, evaluation and 
investigative arm of Congress, exists to support Congress in meeting 
its constitutional responsibilities and to help improve the performance 
and accountability of the federal government for the American people. 
GAO examines the use of public funds; evaluates federal programs and 
policies; and provides analyses, recommendations, and other assistance 
to help Congress make informed oversight, policy, and funding 
decisions. GAO's commitment to good government is reflected in its core 
values of accountability, integrity, and reliability. 

Obtaining Copies of GAO Reports and Testimony: 

The fastest and easiest way to obtain copies of GAO documents at no 
cost is through GAO's Web site [hyperlink, http://www.gao.gov]. Each 
weekday, GAO posts newly released reports, testimony, and 
correspondence on its Web site. To have GAO e-mail you a list of newly 
posted products every afternoon, go to [hyperlink, http://www.gao.gov] 
and select "E-mail Updates." 

Order by Phone: 

The price of each GAO publication reflects GAO’s actual cost of
production and distribution and depends on the number of pages in the
publication and whether the publication is printed in color or black and
white. Pricing and ordering information is posted on GAO’s Web site, 
[hyperlink, http://www.gao.gov/ordering.htm]. 

Place orders by calling (202) 512-6000, toll free (866) 801-7077, or
TDD (202) 512-2537. 

Orders may be paid for using American Express, Discover Card,
MasterCard, Visa, check, or money order. Call for additional 
information. 

To Report Fraud, Waste, and Abuse in Federal Programs: 

Contact: 

Web site: [hyperlink, http://www.gao.gov/fraudnet/fraudnet.htm]: 
E-mail: fraudnet@gao.gov: 
Automated answering system: (800) 424-5454 or (202) 512-7470: 

Congressional Relations: 

Ralph Dawn, Managing Director, dawnr@gao.gov: 
(202) 512-4400: 
U.S. Government Accountability Office: 
441 G Street NW, Room 7125: 
Washington, D.C. 20548: 

Public Affairs: 

Chuck Young, Managing Director, youngc1@gao.gov: 
(202) 512-4800: 
U.S. Government Accountability Office: 
441 G Street NW, Room 7149: 
Washington, D.C. 20548: