Construction payroll is somewhat unique due to the way workers are classified. Your typical construction site is abuzz with various contractors and subcontractors, some of whom employ their workers directly. The thing is that not every worker is an employee. Some are independent contractors hired only for that particular job.

The nature of construction worker classification is one of the things that makes construction payroll so challenging. It also presents difficulties for municipalities that should be collecting payroll tax revenues from new construction projects but fear said revenues are just a fraction of what they should be. A case in point is South Euclid, Ohio.

Local Payroll Taxes

South Euclid has ordinances in place to generate payroll tax revenue from local construction projects. Construction companies and their contractors with employees on the books are required to apply withholding to worker pay in order to cover local payroll taxes. The withholding requirement does not apply to independent contractors. Therein lies the problem.

Just as with the federal government, local municipalities cannot require withholding payroll taxes from independent contractors. Independent contractors are essentially self-employed. As such, they are responsible for paying payroll taxes themselves. There is speculation in South Euclid that construction companies have been improperly classifying workers so as to avoid payroll taxes.

The issue dates back to a prominent construction project reviewed in 2013. Back then, a local news media organization brought to light the fact that the project, estimated to have cost upwards of $10 million, only generated $4,400 in tax revenue. That project was completed in 2012.

A string of other construction projects since then have resulted in similarly low income tax revenues. This has city leaders wondering if construction companies are purposely misclassifying workers in order to avoid taxes.

Not as Easy as It Sounds

There are those in South Euclid more than willing to contend that construction companies are intentionally and illegally misclassifying workers. But according to Dallas-based BenefitMall, worker classification in the construction industry is not as easy as it sounds.

For starters, worker classification depends entirely on IRS guidelines. And unfortunately, those guidelines are ambiguous. There are more than a dozen criteria the IRS suggests employers utilize to determine whether a worker is an employee or independent contractor. Yet there is no litmus test. There is no black and white definition of an independent contractor.

As such, it is quite easy to say that construction workers are employees because they have to follow certain rules – like when to show up for work, how to get the work done, etc. But site rules alone do not determine worker classification. If they did, nearly every subcontractor with an established and licensed business would automatically fall under the builder’s control under an employment sharing model.

A Clear Definition Needed

While city leaders in South Euclid attempt to figure out whether they’ve been short-changed or not, the challenges of correctly classifying construction workers will continue throughout the country. The solution to the problem is not to put construction companies under the microscope and haul them into court over minor details. The solution is to come up with a clear definition that can be applied uniformly across every industry.

Expecting employers to make sense of ambiguous IRS guidelines, and then holding them accountable when their interpretation of the guidelines doesn’t match a taxing authority’s interpretation is just not reasonable.

In the meantime, working with a payroll provider like BenefitMall can help. A provider with a specialized payroll solution tailored to the unique needs of the construction industry can increase compliance and reduce the risk of incurring taxing authority scrutiny.

Paul Petersen