Publications

Minnesota to Require Certification for Construction Independent Contractors

by Janet Ampe, Esq.
Henningson & Snoxell, Ltd.

Attention construction contractors!

A new law[1] is scheduled to take effect on January 1, 2009 requiring all construction workers who are working as independent contractors to acquire a certificate issued by the Minnesota Department of Labor and Industry or else they will be classified as employees by default. The distinction has significant financial ramifications for construction companies. The new law applies to workers on both public and private projects, whether residential or commercial.

Why is this happening?

As many companies have learned, by classifying a worker as an independent contractor instead of an employee, they may avoid many expenses, including:

• Retirement Savings (401k) Plans
• Health/Dental/Life Insurances
• Paid Time Off (vacation/sick leave/holidays)
• State and Federal Unemployment Taxes
• Workers' Compensation Insurance
• FICA and Medicare payments and withholdings

Workers classified as independent contractors give up substantial rights in addition to the above benefits, including some of the following:

• Protection by governmental agencies against wage payment violations
• Overtime compensation
• Coverage under the FMLA and other employee leaves
• Certain discrimination protection

Given the many benefits to companies and the relative lack of power individual workers have to demand employee status, many companies have been mistakenly misclassifying workers as independent contractors when they should be classified as employees, at the expense of the workers and Minnesota's tax coffers.

According to a report issued November of 2007 by the Minnesota Office of the Legislative Auditor, an estimated 14 percent of Minnesota employers erroneously misclassified at least one worker in 2005. Real estate, rental, and leasing industries were listed as the biggest problem areas, with an estimated misclassification rate of around 33 percent. In the construction industry, misclassification appeared notably higher in the roofing, drywall, and residential remodeling areas. The report stated that the various state departments capable of investigating misclassification - the Department of Employment and Economic Development (DEED), the Department of Labor and Industry (MDOLI), and the Department of Revenue (MDOR) - were not effective in deterring misclassification, partially because they were poorly coordinated in their efforts.

Further, a November 21, 2007 article in The Wall Street Journal indicated such misclassification was a nation-wide problem that contributed to the nation's "tax gap" (taxes that are owed each year but never paid). The article detailed a plan by the Internal Revenue Service to begin information-sharing efforts with twenty-nine states, including Minnesota, in an effort to reduce rampant misclassification. The new requirements could flow from these efforts.

What is required under the new law?

The new law is currently limited to construction and remodeling contractors,[2] and gives all workers[3] the default status of employees, making their wages subject to applicable employment taxes. If a company wishes to classify a worker as an independent contractor, the company must require the worker to apply for status as an independent contractor with the MDOLI and obtain a certificate of exemption. The application fee is $150.[4] The application requires significant documentation, including credentials, employment information, tax returns for 2 years, workers' compensation policies, copies of contracts, and more.[5] The application also includes a sworn statement that the applicant meets a list of nine conditions that certify the worker as a genuine independent contractor, as listed below. The law requires a bona fide independent contractor do all of the following:

1. Maintain a separate business with the independent contractor's own office, equipment, materials, and other facilities;
2. Hold or apply for a federal employer identification number (EIN) or file business or self-employment income tax returns with the IRS based on work performed in the previous year;
3. Operate under contracts to perform specific work for specific amounts of money and under which the independent contractor controls the means of performing the services or work;
4. Incur the main expenses related to the work the independent contractor performs under contract;
5. Be responsible for the satisfactory completion of work the independent contractor contracts to perform;
6. Receive compensation for work performed under a contract only on a commission, per-job or competitive bid basis;
7. Realize a profit or suffer a loss under contracts to perform work;
8. Be responsible for continuing or recurring business liabilities or obligations; and
9. Have the success or failure of the independent contractor's business depend on the relationship of business receipts to expenditures.

If any of the above criteria are not met, the worker will be classified as an employee, and the employer will be liable for all employment taxes.

The Commissioner of the MDOLI (the "Commissioner") must either grant or deny the application within 30 days and, once granted, the certificate remains in effect for two years, unless revoked or cancelled. Certificates are not transferable, and may not be altered or falsified. The Commissioner may revoke a certificate if it determines the individual no longer meets the conditions set forth above or if the individual fails to cooperate with an investigation. If the Commissioner denies an application or revokes a certificate, the individual has 30 days to make a written request for a hearing.

What are the penalties for non-compliance?

Workers are prohibited from performing services as independent contractors without holding a current certificate and from misrepresenting their status as an independent contractor. Companies are prohibited from requiring any worker to obtain independent contractor status through coercion, misrepresentation or fraudulent means, or to misrepresent that an individual is properly working under the statute. Companies are required to obtain a copy of any independent contractor's certificate prior to allowing that individual to perform services. Any violation of these provisions is subject to a penalty of up to $5000.00 per violation.

In addition to fines, the new law grants the Commissioner a wide array of additional powers in enforcing these provisions. For example, the Commissioner can issue subpoenas, take possession of any necessary material, or enter any public or private territory, without notice, to investigate suspected violations under the statute. The Commissioner also may adopt, amend and repeal rules for use in carrying out the goals of the statute. In addition, the law requires the Commissioner notify the Commissioners of Revenue and of Employment and Economic Development of suspected violations, enabling the various departments to work together to ensure enforcement of the law.[6]

When do contractors have to comply?

The new law went into effect July 1, 2008, although it does not affect workers and companies until January 1, 2009. Starting January 1, 2009, all workers in the construction industry will be required to hold a current independent contractor exemption certificate and perform work pursuant to the requirements governing certification. According to the MDOLI's website,[7] the application will be available on the website beginning September 1, 2008, and the processing of applications will begin on September 1, 2008. Applications may be submitted by mail or fax. Individuals applying for or renewing a contractor or remodeling license may simultaneously apply for the Independent Contractor Exemption Certificate, and the combined fee will be $150.00.

Where do we go from here?

The statute requires contractors take action or risk significant fines. We recommend the following steps:

• Audit the workforce to ensure workers are properly classified.
• Implement hiring department procedures to be sure certifications are obtained and properly maintained. This may require setting up a separate filing system.
• Apply early for certification, if required, to avoid backlogs in the approval process and expensive delays on the job.[8]

As with any new law there are sure to be some growing pains with compliance and enforcement. Henningson & Snoxell, Ltd. will continue to monitor this new law and its effects on the construction industry. If you have any questions about the independent contractor certification program, do not hesitate to contact one of our business law attorneys.

[1] Minnesota Statutes § 181.723.

[2] The law excludes landscaping services, and individuals involved in product manufacture, sale and supply.

[3] It may be the law will impose an unintended burden on some workers. The law applies to individuals and not corporate entities. Thus, companies may require workers previously considered independent contractors to incorporate or organize entities under which to perform work. The workers will still have to obtain a certificate, but the worker's own company will be responsible for holding the certificate.

[4] The law is silent on whether a company can pay the fee on behalf of the worker.

[5] The list is provided in proposed MDOLI rules, which are not yet final.

[6] The Business Tax Education Partnership (BTEP), a cooperative partnership of the MDOR, the Minnesota Employment Insurance Program, DEED, and the IRS have combined to enforce the statute. BTEP has stated the agencies "do share information, so if one agency audits your records and changes the status of the class of workers from 'independent' to 'employee,' the other agency will probably contact you regarding the same class of workers. A reclassification can cost you a great deal in back taxes, so it is important to check with each agency before you decide to classify workers as independent contractors." Introduction to Employment Taxes and Employer Issues and Responsibilities Guide, revised January 2008.

[7] http://www.doli.state.mn.us/ic.html.

[8] Under the proposed rules, certificates obtained prior to 3/1/09 will be valid through 3/1/11, so there is no penalty for early application.