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Open Letter to IRS: End Employee Misclassification Now

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With the federal government continuing to face record deficits, it's time for the IRS to get serious about the practice of employee misclassification, which will continue to add billions in tax losses if left unchecked, thus causing widespread damage to our nation's economy.

Misclassifying actual employees as independent contractors will cost the U.S. Treasury Department an estimated $7 billion in lost payroll tax revenue over the next ten years. The overall negative impact on our economy and the competitive landscape will be even worse.

Misclassification hurts companies that bid on jobs honestly, while decreasing the payroll costs by as much as 30 percent for companies that don't play by the rules. These dishonest companies also save millions on their unemployment insurance taxes, workers compensation premiums, social security contributions and administrative payroll costs. At the same time, law abiding companies are not only at a huge disadvantage in having to compete with cheaters who cut corners, but they are forced to pay higher workers compensation premiums as costs escalate to make up the overall shortfall.

The U.S. Department of Labor (DOL) commissioned a study in 2000 that found 10 to 30 percent of companies in nine states misclassified at least some employees. In Minnesota in 2005, the estimated percentage of abuses ranked from a low of 3 percent of employers in transportation and warehousing to a high of 33 percent in real estate, rental and leasing. An estimated 15 percent of employers in the construction industry misclassified at least one employee.

Misclassification also is an enormous problem in the language interpretation industry where companies provide services to all levels of government as well as the private sector, both of which increasingly interface with millions of limited English speakers. The Bureau of Labor Statistics in 2008 estimated there are "significantly more" than fifty thousand interpreters providing language services within the United States. Many of them are victims of widespread, wholesale abuse of the employee misclassification law by their respective companies.

A Maine study showed the state lost $18 to $36 million each year in income tax revenues between 1999 and 2002 because of employee misclassification. States desperately need these revenues even more than the federal government. And, studies show the rate of misclassification has grown significantly in the past few years.

The harm no one really talks about is the toll on American workers. As a result of being misclassified as contractors, they not only make less money and enjoy fewer benefits but lose or risk greatly reducing their Social Security payments during retirement.

The Obama Administration issued a directive on January 20, 2010 that will increase IRS scrutiny of federal contractor's tax obligations. It directs the IRS and Federal Contract Compliance Officers to bar companies from receiving new government contracts if they are not tax compliant. The IRS will review contractor filings to ensure companies are accurate in their reports about the taxes they have paid. The latest federal budget includes $25 million to help the DOL combat misclassification. Both measures are a good start, but might not be enough.

It's time for the IRS to attack misclassification with the intensity a multi-billion dollar problem deserves -- for the sake of our country's financial health and to restore order to the competitive landscape. The agency itself credits misclassification with 82 percent of all uncollected taxes. That is unacceptable. At the very least, government agencies procuring goods and services should require companies to abide by the law.

Work hard, play by the rules and make it big. That's what this country is about. Not cutting corners.

Louis Provenzano is President and Chief Operating Officer of Language Line Services, the world's leading provider of language-based services.