OPERATIONS

Behind the Times

The problems of outmoded labor laws are detailed by a CEO who explains that they must be brought up-to-date.
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Most of us find ways to work around outmoded labor laws, but let's face it -- they're hurting U.S. companies' ability to compete in the new economy. It's time to bring them up-to-date

At a recent White House briefing for Inc. 500 chief executives, I had the chance to ask Commerce Secretary Ronald Brown a question. Why, I asked, does our government spend so much time working to open foreign markets to U.S. goods and so little time opening our closed domestic labor market? Brown paused, said he sympathized, and then added that as a victim of Nannygate, he knows firsthand that many of our current employment laws are out of touch with reality.

I couldn't agree more. Today's thinking about labor laws originated hundreds of years ago in the common laws governing master-servant relationships, and despite a radical shift in the way people work, those ideas continue to underpin how we define an employee. But paternalistic corporations with lifetime employees no longer dominate our economy. The past decade has seen the number of freelance knowledge workers who sell their intellectual capital as vendors, not as employees, grow substantially -- yet the legal framework for this new economy is archaic and ambiguous, designed for a different class of work and intended to generate tax revenues rather than empower an efficient modern workplace.

Take the issue of independent contractors versus employees. When I started my company, seven years ago, I had no idea how important this arcane aspect of employment law was. M2 Inc. is a broker of consultants. We maintain a network of more than 4,000 independent consultants whom we introduce to clients who need their expertise. Our consultants have helped to locate semiconductor plants, manage ISO 9000 certification, and launch products in Japan. As independent contractors they file 1099 tax forms at year's end.

In our role as brokers of consultants, we shouldn't run afoul of employment regulations. But the primary regulations governing independent contractors today are contained in the IRS's "20-Factor Test," a common-law trial to determine employment status. These rules matter because they determine who (payer or payee) is responsible for withholding income tax and paying employment taxes. Unlike a simple-to-understand pass-fail test, the 20 points can be interpreted subjectively by the IRS.

The common-law test makes sense when applied to the tradespeople -- such as a carpenter working on a deck -- for whom it was initially designed. According to the 20 points, an independent contractor is defined as someone who supplies his or her own tools, is paid by the job (not by the hour), and need not do the work personally. Now consider the consultant working on a client's proprietary on-site computer system. It is impossible for that consultant to supply his or her own tools. Furthermore, clients are accustomed to paying professional advisers, such as accountants and lawyers, by the hour, not by the job.

My company's growth has been slowed by these anachronistic regulations. Many companies are deciding not to engage consultants because of the ambiguity in applying the IRS rules. In December 1994 alone six major high-tech companies told me they would not risk hiring independent contractors. That's because the IRS holds companies who misclassify employees as independent contractors liable for enormous penalties, including income taxes -- whether the contractor paid them or not -- as well as employment taxes. And the IRS has been going after employers with a vengeance. One recent study estimated that since the mid-1980s, the IRS has reclassified 439,000 independent contractors and collected $678 million in fines and taxes.

My company has responded by forming a new company called Consultant Billing Inc. This affiliate of M2 acts as an employer for a consultant when the client does not want to construe the project as an independent-contracting relationship. Consultant Billing pays employment taxes, withholds income taxes, and pays for workers' compensation insurance. Employees, who must sacrifice some of the general benefits of being independent contractors, are given access to 401(k) plans and cafeteria-style benefits.

Needless to say, creating that solution to address the IRS's anachronistic mind-set has run us up against equally archaic Department of Labor (DOL) regulations. With our new company we are a lessor of senior-level talent -- "exempt" employees, in the jargon of the trade. We charge our clients an hourly rate for the consultants' time, which varies from week to week, and in turn pay those employees on an hourly basis. It sounds simple and logical -- but not to the DOL. That august agency does not recognize an hourly management-level, or exempt, employee. To the DOL, exempt employees can be only salaried.

That distinction may seem semantic, but it is critical. Wage and hour regulations are governed by the exempt/nonexempt distinction -- in fact, exempt means "exempt from overtime." My consultant employees understand that they are not subject to overtime. They're high-priced professionals. And my clients understand that they are hiring senior people who won't be getting time and a half if they work nine hours a day. But the DOL doesn't get it.

We're not breaking any laws in how we run the business. We're just on a new frontier, with a model that has no legal precedent. At one point we considered getting a ruling letter from the DOL on the issue, but we were told it would take upwards of two years. That's part of the problem. Governing bodies work on issues from years past and base their assumptions on old ways of working. They haven't heard that workplaces have changed.

They also don't know that union models no longer prevail. In many high-performance companies, in fact, progressive work arrangements that empower frontline employees to take greater responsibility have blurred the line between exempt and nonexempt workers. The DOL's rigorous exempt/nonexempt mind-set won't acknowledge that. The DOL prefers to penalize companies that attempt new forms of work. For example, the DOL cited CEO Harry Quadracci of Quad/Graphics for failure to pay workers -- some of whom supervised $100-million departments -- as nonexempt employees on an hourly basis, simply because they worked at computers as part of their jobs. Finally, the laws concerning the portability of pensions also have yet to enter the age of the portable manager.

There are some signs that Washington is coming around. Recently, Representative Jon Christensen (R-Nebr.) introduced a bill, cosponsored by 100 of his colleagues in the House, to simplify the IRS's 20-Factor Test, and hearings are being held on that issue. But many issues remain to be addressed. The fact is, new forms of work call for new forms of legislation. We aren't asking for modern ways to exploit people. We're simply saying that the laws that govern the workplace need to reflect how the workplace works.

* * *

Marion McGovern is president of M2 Inc., a $3-million employee-leasing company in San Francisco.

Last updated: Oct 1, 1995




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