NC’s $467 million problem: Abuse of workers, failure to collect taxes

Posted Friday, Sep. 05, 2014  comments  Print Reprints
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By the numbers

278,919 Construction workers in North Carolina in 12 specialties we analyzed

102,310 Estimated number of those workers who were misclassified as independent contractors

$3,961 Lost federal and state tax revenue per year estimated for a $12-an-hour worker who received a 1099 tax form for independent contractors

$5,313 Estimated annual lost tax revenue per worker if worker received no tax form

$467 million Federal and state tax revenue lost annually because of misclassification, according to the estimate by The N&O and The Charlotte Observer

The series

Today

A huge tax drain

Monday

Under government’s nose

Tuesday

Workers feel pinch

Wednesday

Companies that cheat

Thursday

Getting it right

Expensive places, too

Over the past several years, luxury apartments – outfitted with granite countertops and stainless steel appliances – have popped up along hip urban centers and highways surrounding office parks in both the Triangle and Charlotte.

Records show that despite the high-end prices, the projects relied on companies able to shave costs by treating workers as independent contractors.

Two market-rate apartment projects insured by the federal government show widespread misclassification of workers, according to records obtained from the U.S. Department of Housing and Urban Development.

At Phillips Research Park, a complex in the Research Triangle Park area, nearly 60 percent of the 62 companies that worked on the project failed to withhold taxes from many workers.

Near the University of North Carolina’s campus in Charlotte, Mallard Creek Apartments, another high-end apartment complex, was built by workers of 44 companies, 18 of which listed hourly workers as independent contractors, according to payroll records.

Labor compliance officers at HUD’s regional office in Atlanta reviewed these payrolls. They referred none of the records to the Internal Revenue Service for review.

Who’s in charge?

•  Gov. Pat McCrory

McCrory influences agencies that handle many issues touching misclassification, including appointing Industrial Commission leaders and overseeing the Division of Employment Security.

By email: pat.mccrory@nc.gov

By phone: 919-814-2000

•  Commissioner of Labor Cherie Berry

Berry’s department investigates overtime and minimum wage violations for workers in North Carolina. The department also investigates workplace safety.

By email: cherie.berry@labor.nc.gov

By phone: 919-807-2796

•  Secretary of Revenue Lyons Gray

Gray’s agency investigates companies and workers negligent in tax duties; some of these violations arise from misclassification of employees as independent contractors.

By email: Communications.HQ.MAIN@dornc.com

By phone: 1-877-252-3052

•  Industrial Commission Chairman Andrew Heath

Heath’s department ensures companies carry proper workers’ compensation insurance and that injured workers are properly compensated.

By email: andrew.heath@ic.nc.gov

To report fraud: 888-891-4895, fraudcomplaints@ic.nc.gov

•  Dale Folwell, assistant secretary, Division of Employment Security

Folwell’s agency ensures companies pay unemployment tax so employees may receive benefits if laid off; investigators there commonly audit businesses that misclassify employees as independent contractors. Its audits last year found $57 million in unreported payroll from more than 5,000 misclassified workers.

By phone: 919-707-1010

By email: dale@nccommerce.com

Workers misclassified on Charlotte projects

About 38 percent of the 1,700 workers on 11 affordable housing projects in Charlotte were likely misclassified as independent contractors rather than employees, the Charlotte Observer and (Raleigh) News & Observer found in an examination of the construction industry.

The 11 projects were overseen by either the Charlotte Housing Authority or the city’s Neighborhood & Business Services division. Subcontractors were required to submit weekly payroll reports to the agencies under the 1930s-era Davis-Bacon law, which requires contractors on federal projects to pay prevailing wages.

Officials with the Charlotte agencies said they reviewed the payroll forms, but weren’t checking whether workers were classified as independent contractors or employees. They received no instructions from the U.S. Department of Housing and Urban Development to do so, they said.

Instead, the agencies focused on whether workers were being paid appropriate wages for the type of work they did.

“In the event that HUD makes any changes to these regulations, CHA will certainly make any necessary revisions to our internal processes,” CHA corporate communications officer Zenica Chatman said. Rick Rothacker

Employee or contractor?

The IRS has a voluntary process in which workers and employers can solicit its opinion as to whether workers fit the bill for employee status.

Consider this scenario.

At one low-income housing project in North Carolina, two-thirds of the workers hired to pour concrete, paint, shingle roofs and hang drywall were treated as independent contractors. Here’s what would have needed to happen with these 100 workers to pass the federal tests:

• Each worker could come and go as he pleased, setting his own hours and schedule.

• Each worker owned and used his own tools and supplies and had enough of a line of credit with vendors to buy the necessary materials, such as HVAC equipment and siding.

• Each worker tackled the work as he saw fit, not heeding direction and correction from superiors.

• Each worker secured enough compensation to allow him to earn a living and cover the overhead that a self-employed person has.

Mandy Locke and Franco Ordoñez

Have more to add? News tip? Tell us

North Carolina has become a breeding ground for construction companies willing to break rules at the expense of honest business owners, vulnerable workers and unsuspecting taxpayers.

The costs are staggering, a yearlong investigation by The News & Observer and Charlotte Observer reveals: nearly a half-billion dollars each year in uncollected federal and state tax revenue.

The newspapers’ analysis of thousands of payroll records shows that more than a third of 8,713 workers hired by private companies to build government-backed housing since 2009 were treated as independent contractors, rather than employees as the law and regulations require.

The burdens touch everyone.

The state and federal governments fail to collect nearly $470 million in revenue in North Carolina each year, the newspapers found. The analysis applied the rates of misclassification from the payroll records to the state’s construction industry as a whole and found $134 million in missing state income and unemployment taxes. The other $333 million came from uncollected federal income and payroll taxes.

For the thousands of common laborers and specialized mechanics listed as contractors on payroll forms, businesses paid no unemployment taxes. They withheld no federal or state income taxes and paid no Social Security or Medicare taxes.

While construction workers are typically paid modest wages, their reduced or lost tax payments add up. Workers issued 1099 forms given to independent contractors or no tax forms at all pay a fraction of the taxes they owe, under-reporting their income by 56 percent, according to IRS compliance reports.

Treating workers as independent contractors isn’t a choice employers are allowed to make to suit their needs. The federal government has tests to determine whether a worker should be an employee.

The rules center around control: Who’s in charge and who’s making a profit?

To justify the workers’ status as independent contractors, companies would have to prove that each of the 3,068 laborers on the government-backed projects – including roofers, painters, framers and masons – shown in the payroll records came and went as they pleased on the projects and made enough money to pay the overhead a self-employed person bears. On the payroll forms reviewed, these laborers earned between $7.25 and $25 an hour.

“You don’t pay an independent contractor by the hour,” said Ross Eisenbrey, a former U.S. Department of Labor official and a lawyer with the Economic Policy Institute in Washington, D.C.

He said he was surprised the forms passed muster with regulators.

“The extent, the open, brazen way that people are filling out forms and saying ‘I’m breaking the law’… the flagrancy of it does surprise me,” Eisenbrey said.

Who cares about workers?

State, federal and local regulators have largely ignored the issue, while taxpayers must subsidize scofflaws and the workers they push into an underground economy.

The employers who follow the law find themselves shut out of contracts, unable to match the prices of competitors who can shave 20 percent or more from their labor costs by misclassifying employees as contractors.

Workers, meanwhile, labor in a dangerous and fickle industry, many without the protections of insurance if they are injured on the job or laid off.

The problem persists, in part, because of the large number of immigrants who came to the country illegally and flocked to North Carolina through the 1990s and 2000s. They are willing to suffer unsavory working conditions for the chance to make a life here.

“They will take a little more abuse. They will not complain,” said Alvin Warwick, president of the N.C. Building and Construction Trades Council and a member of the AFL-CIO’s state executive board. He said workers worry their grievances will get them fired.

Their fears are legitimate. Only 3 percent of the workforce in North Carolina belong to a union – the lowest rate in the country – and there are few advocates for workers. The pay rate for carpenters and roofers on federal residential construction projects is $7.25 an hour in all but seven counties, unchanged by federal labor officials since 1983.

A broader McClatchy investigation shows persistent misclassification of employees across the nation, with deeper concentrations in high-growth Southern states such as Texas and North Carolina. While regulators in other business-friendly states such as Tennessee and Florida have set out to tackle the problem, North Carolina’s attempts have been feeble.

Even federal officials recognize low wages make North Carolina a destination for companies looking for opportunity.

“The economy is so bad, you see contractors in North Carolina from all different states,” Dondra Merrell, a HUD labor relations officer, told a group of local government officials during a training session in Cary this spring. “I don’t know how you fix that. When they see $7.25 an hour, of course they are going to bid on every apartment project that’s being built.”

Pushing bids down

In 2010, as the nation remained frozen in a sluggish housing market, North Carolina’s metro areas saw a surge of apartment construction.

More than 6,000 units were built from 2010 to 2013 in the Triangle; Charlotte saw a similar upswing. Apartment developers and investors from as far away as New York and Atlanta found the state an ideal place to invest.

The federal government also spent heavily. President Barack Obama sent millions of stimulus dollars to North Carolina in 2009 to prop up a beleaguered construction industry through affordable housing development.

The Department of Housing and Urban Development backed or helped fund at least 64 new construction or rehab projects valued at $1 million or more in the state from 2009 through 2013. On these projects, companies had to file payroll forms to prove they paid wages that federal regulators deemed fair.

It is these records that reveal the depth of misclassification in North Carolina, and the costs associated with it. Of the 826 companies that submitted payrolls, nearly 45 percent withheld no taxes from hourly workers they listed.

The surge of multifamily construction against an otherwise slow market brought major benefits to developers and general contractors. Subcontractors desperate for work lowered their bids dramatically to be able to secure the jobs.

“Because of the lack of activity, there were lots of subcontractors hungry for work,” said Bill Chamblin, development coordinator for Connelly Builders of Lexington, S.C. His company built Cherry Gardens, a low-income senior housing development near uptown Charlotte where 29 percent of workers were treated as independent contractors.

“We were able to get good bidding on jobs,” Chamblin said. “In the affordable housing industry, we were really very successful during that period.”

Some subcontractors say their bids weren’t realistic or sustainable, tempting them to bump employees from their payroll.

Sal Ortiz, who owns a Hope Mills painting business, won a job at an affordable housing complex in Fayetteville. He said he couldn’t afford to treat his crew as employees.

During the recession, Ortiz watched the going rate for painting drop from $3.35 to $1.50 a square foot. Ortiz found it impossible to afford payroll taxes, unemployment insurance and workers’ compensation.

“The builders are abusing the market,” Ortiz said. “People have no choice but to do whatever they have to do to survive.”

Though general contractors are expected to collect and review certified payroll records collected for these projects, some say they don’t have the resources to catch every problem.

“We’re trying to do the best we can to make sure our subcontractors are accurate, and they’re paying their prevailing wage rates and those things,” said Chamblin of Connelly Builders. “If you’re going to watch everybody, then you’ve got so many watchdogs that you’re paying more money for the watchdogs than you’re paying for the construction.”

Other general contracting firms leave the decision on employees to subcontractors – even when those subcontractors were building for government agencies.

“If they’ve got contract employees that they’re not taking taxes out on, it doesn’t make any difference to us,” said Katie Tyler, chief executive of Tyler 2 Construction of Charlotte, which handled renovations for a new office for the Charlotte Housing Authority. “How they run their business is kind of up to them.”

Each general contracting firm commissioned to handle a HUD-backed project signed a contract saying it would adhere to all laws, and ensure the subcontractors they hired did the same.

“We’re taking it at face value,” Tyler said. She said the company expects its subcontractors to know and follow the law on using independent contractors.

Government officials collected the payroll forms reviewed by the newspapers. But they didn’t stop general contractors from allowing the subcontractors they hired to treat laborers as independent contractors.

“How are we supposed to know?” asked Judy Goodwin, a labor compliance officer for the Smithfield Housing Authority, who collects the forms and interviews random workers only to verify the hourly rates of pay. “I was told (by HUD) to check this against … interviews. If it matched, we were good to go and put it in the filing cabinet. It would have been nice to know the whole picture.”

A surge of immigrants

North Carolina has managed to remain an affordable place to live, in part, because of immigrant laborers who flooded the state over the past two decades. Bit by bit, Hispanic workers supplanted Americans who had made their living laying bricks or hanging shingles.

In 2012, Hispanic workers accounted for 19 percent of construction workers in the state, up from just 1 percent in 1990, according to the census. The majority of workers in payroll records reviewed by the newspapers have Hispanic surnames.

Zabad Santana, a former HVAC mechanic from Durham, remembers the vans filled with Mexican immigrants arriving at construction sites across the state in the early 2000s. They were eager to work long hours in hot and dirty conditions.

Santana said no one asked questions; supervisors just handed them tools and sent them to work hanging drywall or painting rooms. Bosses paid them cash on Friday evenings; sometimes they didn’t pay at all, Santana said.

In interviews, Hispanic workers described being paid off the books, sometimes far less than what they were promised. Because many came to the country illegally, they often feel grateful for the chance to earn whatever they can.

“Where are they going to go complain?” asked Santana, a California native born to Mexican parents. “They don’t have any papers.”

The workers who came here illegally often made no secret of their status to their employers. Payroll records show some ITIN numbers, a taxpayer identification that allows the workers – who often can’t get authorization to work in the U.S. – to pay taxes. Workers who came here illegally said bosses never ask them for any paperwork, even on government jobs.

In March, Martin Rios lived in a shed behind a small house in the Triad. He stood in the rain holding his toddler daughter and explained how he came to the country illegally from Mexico eight years ago.

In 2010, he found work with Brother’s Siding and Roofing, a Greensboro company hired to roof a low-income housing development in Caldwell County. The company paid him cash each week – $12.50 an hour – and no taxes were withheld, Rios said.

He said he hasn’t filed taxes since he has been in America, and though he’d like to, he said he doesn’t understand how. When Rios got hired to work for the company, he said no one asked him for any papers or identification. At year’s end, he said no one from the company sent him any tax forms to file.

Herman Mendoza, owner of Brother’s Siding and Roofing, could not be reached for comment.

Shorted on pay

Edwin Ozuna of Cabarrus County and his brother worked for a labor broker installing windows on a federally funded project in Charlotte in 2011; no taxes were withheld, he said. He said the broker cheated them out of wages for three of the five weeks they worked for $10 an hour.

When they complained, the broker said he’d been cheated by the company owner who hired him, Ozuna said. As immigrants who came to the country illegally, Eric Ozuna, Edwin’s brother, said they were afraid to push the issue.

“You stay quiet because you don’t want to have problems,” Eric Ozuna said. “It’s not our custom. We don’t like being part of a conflict.”

Jeff Parnell is the owner of Carolina Vinyl Windows in Stanly County, which listed the Ozuna brothers on its payroll reports. He said he had addressed the payment shortfall with a broker he paid and had been assured the payments had been settled. Parnell said he treated the workers on his payroll report as independent contractors because it made things easier.

“It keeps it kind of simple … not having to do payroll and taxes,” Parnell said. “It’s tough on an old working boy to keep up with.”

He said he wasn’t aware of laws that forbid the practice.

American workers also report being shortchanged by bosses. Many of them, too, are paid cash and receive no tax forms. Reporters’ interviews with dozens of misclassified workers on government low-income housing projects show nearly half were not issued tax forms.

Fermon Locklear Jr. of Robeson County said he was recruited to bring a crew of framers to help with an affordable housing project in Caldwell County in 2010. Locklear said the company owner who hired him disappeared before he received his final checks.

Other workers seem resigned to the hazards of working in the construction industry.

Barbara Lynch has coughed constantly since she worked for a cleaning company hired to dust and mop low-income housing built and renovated in Charlotte in 2010 and 2011.

Lynch earned $8 an hour working for All Things Professional Cleaning and never understood why her boss told her that she was “self-employed.”

Erica Everett Hubbard, owner of the company, defended her practice of treating Lynch and 22 others as independent contractors. She said the workers came and went as they pleased and that if she thought they did a bad job, she didn’t have the right to correct them. She said she hadn’t considered how the workers would have managed overhead and expenses as a self-employed person on the wages she paid.

Lynch doesn’t dwell on why she wasn’t an employee.

“She told me that’s how the rules worked,” said Lynch, who lives in public housing in Charlotte. “As long as I’m getting paid, I don’t care.”

McCrory is silent

North Carolina is a right-to-work state, where bosses can terminate employees at any moment for little cause. Legislation aimed at giving workers more protections or rights rarely advances in the state legislature, even while the Democrats reigned before 2011.

“It’s a pro-business environment. It’s not pro-labor, and it has been for some time because we’re all in a battle to secure as many jobs and as many companies as we can,” said Warwick, the union representative. “A job is a job for politicians – whether it’s minimum wage or $30 (an hour). It’s all about the numbers, the bottom line.”

A state bill aimed at criminalizing willful misclassification and providing protections to workers who report bosses that treat them as independent contractors never left a committee in 2011.

The state Department of Labor has a Wage and Hour Division equipped to handle complaints from employees treated as contractors and deprived of overtime benefits. When asked about misclassification in 2012, state Labor Commissioner Cherie Berry said she hadn’t heard much about the practice. This summer, a spokeswoman declined to make Berry or anyone else from the department available for an interview, saying they would only answer written questions.

The News & Observer highlighted problems of misclassification in a 2012 series, “The Ghost Workers.” In response, former Gov. Bev Perdue created a task force of state regulators to find solutions.

Gov. Pat McCrory, then a candidate, said The N&O’s reports showed how state government was broken, especially its ability to harness technology to mine data to find lawbreakers. He questioned whether some of the elected officials ought to report directly to him as governor. He vowed change.

In January 2013, state Insurance Commissioner Wayne Goodwin, head of the task force Perdue convened, sent the group’s report to McCrory and legislators. He asked for direction from McCrory and said he wouldn’t convene another meeting of the task force until then.

Goodwin said he has received no response. McCrory declined to be interviewed.

Editorial assistant Ann Lee contributed.

We want to know your thoughts and experiences with misclassification. Share your feedback directly with the reporters: mlocke@newsobserver.com or 919-829-8927; or on Twitter @mandylockenews.

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