Misclassification itself is not a violation of any federal labor law, but it can  result in violations of federal and state laws. 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). 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. 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. 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 Questionable Employment Tax Practices (QETP) program, through  which IRS and states share information on worker classification-related  examinations and other questionable employment tax issues. 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. 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, many of these agencies did not have  information sharing relationships with IRS. Some state workforce agencies surveyed noted that IRS’s QETP  information sharing and communication practices could be improved. Some states have passed legislation related to  misclassification. ,  While these task forces are relatively recent innovations, state officials  told us that they have already been effective in uncovering  misclassification. No Option Had Unanimous Support or Opposition

Stakeholders did not unanimously support or oppose any of the 19  options. 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. 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. 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. We also obtained data from IRS’s Classification Settlement Program. 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.
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.