Highlighting a broad national trend toward stricter enforcement of employee misclassification, the Illinois Department of Labor on December 10 announced that it had imposed a $328,500 civil penalty against a Chicago-area contractor, finding that the contractor had misclassified 18 of its employees as independent contractors. The penalty represents the largest enforcement finding to date under the Illinois Employee Classification Act. The Act, which became effective January 1, 2008, specifically targets misclassification of employees as independent contractors in the construction industry.

While the construction industry has come under special scrutiny for perceived widespread worker misclassification, federal and state agencies have been stepping up their enforcement efforts on this front across a spectrum of industries, and recent and pending legislation seeks to strengthen these efforts.

At the federal level, legislative efforts include The Taxpayer Responsibility, Accountability and Consistency Act of 2009, introduced in the House of Representatives in August. The legislation seeks to target misclassification by allowing individuals classified as independent contractors to petition the IRS for a determination of the propriety of their classification, dramatically increasing penalties for misclassification, and striking the Safe Harbor provision contained in Section 530 of the Revenue Act of 1978. The bill is similar in form to the Independent Contractor Proper Classification Act of 2007, originally sponsored by then-Senator Barack Obama, which died in the Senate the following year.

In addition to these legislative efforts, the Government Accountability Office (“GAO”) in August 2009 issued a report titled “Employee Misclassification: Improved Coordination, Outreach, and Targeting Could Better Ensure Detection and Prevention.” As its title suggests, the Report calls for increased focus on misclassification enforcement by the Department of Labor’s Wage and Hour Division during its targeted investigations, and encourages increased information sharing between the IRS and DOL and between the IRS and state agencies, purportedly in an effort to protect workers and to increase tax revenues. The IRS had already recently signed information sharing agreements with state labor and workforce agencies in 29 states, agreeing to share the results of misclassification-related audits. Beginning in February 2010, the IRS will commence a National Research Program that will involve auditing 6,000 employers over three years, and which will in part focus on quantifying the revenue shortfalls created by employer misclassification of employees as independent contractors.

At the state level, in addition to Illinois, several states, including Colorado, Maryland, Massachusetts, New Jersey, and New Mexico have passed recent legislation targeting misclassification in the construction industry. Other states, including Iowa, Michigan, New York and Wisconsin, have created taskforces charged with rooting out misclassification and recommending new legislation. In its 2009 annual report, the New York taskforce reported that it had uncovered 12,300 instances of misclassification, resulting in assessments of approximately $6 million in employment taxes and workers’ compensation fines and penalties.

As the federal government and state governments struggle with revenue shortfalls, they will predictably continue to increase enforcement in the area of worker misclassification in an effort to fill revenue gaps. Moreover, continued legislative reform in this area will likely facilitate increased private enforcement through civil lawsuits seeking back pay, benefits, and other damages related to misclassification.

Employers should consider using the increased activity in this area to assess their classification practices and to make adjustments as necessary.