Construction companies broke Florida law and cheated on their taxes in order to gobble up a slice of the federal stimulus money that kept the building industry afloat during the recession.
And around the nation — in plain sight of regulators — thousands of companies avoided state and federal taxes, exploited vulnerable workers, and undercut law-abiding competitors, a Miami Herald and McClatchy Newspapers investigation has found.
A review of public records in Florida and 27 other states revealed that companies commonly violated the law by treating workers as independent contractors instead of employees, allowing the companies to evade taxes. The scheme persists in federal contracting even as government officials acknowledge the exploitation of hourly wage workers and steep losses to the U.S. treasury.
In Florida, a McClatchy analysis shows nearly $400 million a year in lost tax revenue from the construction industry alone. In North Carolina, nearly $500 million a year. And in Texas, a staggering $1.2 billion.
As a result, cheaters win, the U.S. treasury goes wanting and workers pay the price.
To understand the national scope and impact of the scheme, reporters spent a year reviewing payroll records, obtained under the Freedom of Information Act and state public records laws, for federal housing projects in 28 states. Most of the projects were paid for in part with stimulus money.
Reporters from eight McClatchy newspapers, including the Miami Herald, and McClatchy’s Washington bureau, along with ProPublica, a nonprofit investigative news organization in New York, visited work sites, spoke with hundreds of workers and dozens of company owners, and interviewed economists, union leaders, policymakers and some of the highest-placed government overseers in Washington, D.C.
The investigation found:
The scam is so simple, it can be done with the scrawl of a pen. Here’s how it works:
Companies doing public business declare on a routine form that the hourly wage earners working for them are not employees, as laws and several federal regulations stipulate, but rather independent subcontractors. Those companies don’t withhold income tax or file payroll taxes. They don’t pay unemployment tax.
The workers don’t always know they are classified as independent and frequently pay only a fraction of the taxes they owe.
The temptation for companies is obvious: less hassle, big savings. Rule-breakers save 20 percent or more in labor costs by treating employees as independent contractors. But misclassification exploits workers and deprives the government of tax revenue. It is also against the law and can carry stiff penalties.
No single factor determines whether a worker should be treated as an employee or as an independent contractor. McClatchy reporters showed samples of the records to more than a dozen current and former labor investigators, IRS auditors and lawyers who handle labor disputes. They all doubted that company owners would be able to justify treating the workers as independent contractors.
In Florida, the Herald analyzed certified payroll records for 29 major government-backed construction jobs between 2009 and 2013, mainly to build or improve low-income housing. The Herald’s analysis found that one in five companies were misclassifying their workers. Of the more than 3,200 workers on the 29 projects, 502 appear to have been misclassified.
Those working to rid the construction industry of the practice were astonished that this practice passed muster on federal jobs.
“No wonder the bad guys are running roughshod over the industry,” said Matt Capece, an attorney with the United Brotherhood of Carpenters and Joiners of America, after reviewing payroll records collected by reporters.
‘No one told me I was wrong’
Alton Duhart was walking down the street in Liberty City when he saw workers sawing wood and nailing planks. It was the spring of 2012, and while the economy had improved, Duhart, a 40-year-old carpenter, was still struggling to find steady work. He talked to a foreman and was given a job on the spot. The project, at 721 NW 56th St., was a 16-unit apartment building for homeless veterans and other low-income people.
Duhart had never heard of J.E. Galloway Construction, the company that hired him. He’ll never forget them now. “I’ve been in this field for 17 years and I’ve never worked a job like that, and I never will again,” Duhart said.
Company executive Ivason Galloway promised a weekly check, Duhart said. But Galloway soon insisted on paying in cash. Then he stopped paying Duhart altogether, citing legal fees for a personal matter. “That whole job was a mess,” Duhart said.
Galloway classified Duhart as an independent contractor. These contractors are usually highly skilled, independent businessmen. They set their own schedules and work without the close supervision of a foreman. They are often licensed electricians, mechanics and plumbers.
Sitting in his small apartment just a few blocks from the project, his tools behind his bed and infant daughter at his feet, Duhart said that none of those conditions applied to his carpentry job with Galloway. Ivason’s cousin, Bernard Galloway, supervised the project as a hands-on foreman. “He told us what to do every step of the way, and I just did it,” Duhart said. “He told us when to show up and when to leave.”
J.E. Galloway hasn’t responded to messages left at its Miami and Montserrat offices.
Independent contractors should generally have high levels of training and education. But the Herald’s analysis showed that employers were far more likely to treat workers in basic trades as independent contractors rather than workers in more skilled trades.
Employers treated 31 percent of carpenters, drywallers and painters as independent contractors on the payroll records examined by the Herald. Just 2 percent of electricians, plumbers and heavy equipment operators were listed as independent contractors.
To do business with the government, companies had to file certified payroll records each week to prove they were paying their workers prevailing wages as required by a 1930s-era labor law called the Davis-Bacon Act. The feds decide fair pay for each job in each community.
For companies misclassifying, the space on the payroll documents for listing deductions is often left blank. Some owners scribble in an explanation: “pays own taxes” or “1099,” the tax form given to independent contractors.
The Herald contacted several companies that misclassified their employees. Some said they didn’t know that treating their workers as independent contractors was illegal.
“I didn’t think I was doing anything wrong,” said Lazaro Villar. His painting company won a bid to work on Leisure Villas, a low-income housing development in Homestead, in late 2012.
Villar said he had to keep his costs low to win the bid. He saved some by pushing taxes onto his workers. He said he took the silence of the project’s general contractor, Lynx Construction Services, and the Miami-Dade Department of Public Housing and Community Development, which oversaw the project, as an indication that he was doing things right.
“No one told me I was wrong,” Villar said.
Lynx Construction President Chris Moran said Villar’s workers really were independent contractors as far as his company was aware. “All of those employees were properly certified according to the rules of the county,” Moran said. (Both the general contractor and the housing agency are required to review payrolls.)
But Dorve Gedeon, a 61-year-old Haitian immigrant who worked on the Leisure Villas project as a painter, said he never considered himself an independent businessman. Villar supplied all his tools, including paint and brushes. Gedeon said Villar gave him a 1099 form at the end of the job so he could file his own taxes. Self-employed workers pay higher taxes than employees of companies. “It didn’t seem right, no. But when someone pays you money, you take the money,” Gedeon said. “You don’t complain.”
Losers far outnumber winners
The federal government says it collects a fraction of the taxes owed by the self-employed work force; it captures nearly all it is owed from employees of companies. Construction workers don’t make much money, and one by one, their tax evasion doesn’t amount to much. But the aggregate cost is staggering.
Nationally, the tax loss amounts to billions. If just 20 percent of the 10 million construction workers in the United States are misclassified, that tops $8.5 billion each year in federal payroll, income and unemployment taxes, McClatchy estimates.
Sen. Charles Grassley, an Iowa Republican, said McClatchy’s findings show that the White House wasn’t minding its own store.
“This would be an administration talking out of both sides of their mouth,” Grassley said.
For years, the Department of Labor in Washington has been sharpening its rhetoric about companies that cheat on the backs of their workers when it comes to private contracts. A section of the agency’s website is filled with press releases touting efforts to curb misclassification. They call the practice “alarming” and “unfair” and describe the workers as “vulnerable.”
When it came to teaching local officials how to enforce labor laws on stimulus jobs, however, federal labor officials said little. During a daylong training seminar streamed over the Internet to more than 5,000 community officials monitoring payroll records in 2011, a labor official spent less than 15 seconds describing the practice and offered no instruction on how to stop it.
Regulators knew the potential for companies to cheat workers on stimulus jobs. The Department of Labor devoted $80 million in stimulus funds to ensure that workers were paid prevailing wages on these projects. Of all 1,278 investigations that Labor Department wage and hour officials opened for stimulus projects from 2010 to 2013, investigators found wage and other violations 62 percent of the time.
Not eight blocks away, Labor’s counterparts at the U.S. Department of Housing and Urban Development distributed stimulus money to thousands of companies to build housing for the poor. Only a few of these projects had inspectors who were HUD-trained to spot wage violations checking behind the local officials.
Jared Bernstein, former chief economic adviser to Vice President Joe Biden, said the administration is serious about confronting misclassification and has taken steps to address the practice on federal contracts. He pointed to the executive order Obama signed this summer, after McClatchy reporters began sharing their findings with administration officials, that forbids federal agencies from doing business with companies that have histories of labor problems. The order also forces company owners to tell workers in writing if bosses consider them to be independent contractors.
“So firms that misclassify under this new executive order should be at a distinct disadvantage when it comes to getting federal contracts. I think that’s an important advance,” Bernstein said.
The rules for the order are still being written, and it’s not clear to regulators whether it would cover contracts such as the nearly 200 housing projects McClatchy reviewed.
Many have much to gain by by misclassifying workers. Contractors make a heftier profit. Workers get jobs. Consumers get cheaper homes.
But the losers outnumber the winners. Taxpayers are picking up the tab while cheating businesses prosper. Many honest employers are struggling.
‘You can 1099 them’
The construction industry rests on the backs of small operators. Most of the companies — 68 percent — have fewer than five employees, according to Census data.
Some of the contractors are unsophisticated and said they didn’t know that they may have been breaking the law. Other realize they’re walking a fine line but feel justified doing it.
“You don’t understand how the business works,” Kenneth Capers, who runs a window installation company in Tampa, said to a reporter. “It’s all legit.”
Capers’ company, Kenstone Inc., worked on three different government projects during the recession using workers he classified as independent contractors
“They’re subcontractors,” Capers said. “You can 1099 them.”
But Capers said the general contractor for one of those projects — a 75-unit low-income building in Pahokee that had been severely damaged by hurricanes in 2004 and 2005 — told him he had to start treating his workers as employees.
No one said anything about the other two projects, and Capers was allowed to classify his workers as independent contractors for their duration.
Other contractors refused to discuss their 1099 workers. Two years ago, Anancy Fire Protection, a Miami company, installed fire sprinklers in the Harvard House Apartments, an affordable housing development for approximately 140 people at 2020 NE 169th St., in North Miami Beach. Owner Gene Grant told the Miami Herald that “everybody on that project was 1099 and paid their own taxes” before ending the call.
In 2009, the Government Accountability Office issued a report on misclassification, scolding the Department of Labor and the Internal Revenue Service for failing to coordinate and find violators. It identified federal contracts as a potential magnet for companies that misclassify. The Labor Department and IRS agreed to explore ways to share information more often, but agency barriers remain, several former employees say.
Labor officials are told how to refer cases of misclassification to the IRS, but nothing requires that they do, labor officials said.
And a major blind spot remains on federal contracts, said Jacque Riordon, a former IRS special assistant agent in charge of the Denver field office.
The reason is simple. No one specifically directs federal agencies to watch out for companies skirting labor laws by treating employees as contractors, Riordon said.
“You would think that common sense would lead you to believe … it should be done, but it’s not what happens,” Riordon said.
David Weil, an economist and new head of the Wage and Hour Division at the U.S. Department of Labor, said his agency must be able to rely on investigators in other federal agencies to detect and address the problem.
“In some industries, it starts becoming practice as more and more people are playing the game,” he said.
‘Should have raised red flags’
Of the 29 Florida projects examined by the Herald, one stood out: the Roosevelt C. Sands Jr. housing project in Key West. A storm-damaged, 70-year-old affordable housing complex, the Roosevelt Sands buildings showed their wear and tear in peeling coats of beige paint, dying palm trees and roofs shedding their tiles. In 2007, the city approved a $3.9 million renovation to modernize the project.
But the Housing Authority of Key West failed to demand that its contractors follow the law: Almost 60 percent of the project’s 262 workers were classified as independent contractors, the most on any project reviewed by the Herald.
Matt Capece, the carpenters’ union attorney, said the presence of so many independent contractors on a single project should have raised red flags.
“The level of coordination you need on a construction project like that is pretty much impossible if everyone on the work site is supposedly independent,” Capece said.
J. Manuel Castillo, the director of Key West’s housing agency, told the Herald that whether companies choose to deduct or not to deduct tax withholdings “is not under our purview.”
The worst offender on the Roosevelt Sands project was a Coral Gables company, VR Enterprises Group, which had 89 carpenters and laborers — all independent contractors — on its payroll.
One worker, a manual laborer who said he should have been classified as an employee, accused Victor Lavastida, the company president, of failing to provide workers with overtime pay. “His excuse was: ‘We’re paying you guys a good wage. We’re not paying taxes on you guys, we’re not withholding from your paycheck, so your wages are higher every week,’ ” said the worker, who asked for anonymity for fear of retaliation.
Many workers were afraid to report Lavastida because they were undocumented, he said.
Just a week before VR Enterprises began work in Key West, a former worker, Alison Gonzalez, sued Lavastida and his company for failing to pay overtime. A judge awarded Gonzalez $3,180. “That’s the price of doing business for these companies,” said the worker’s attorney, Jeffrey I. Jacobs of South Miami.
Sandra Morales was the project manager for VR Enterprises on the Roosevelt Sands job. She said everyone was paid fairly and that the project’s general contractor, Siltek Group, told VR to treat its workers as independent contractors. “That’s how the job was being done,” Morales said. “Siltek told us to 1099 them.”
Morales and Lavastida now run a new company, Brave Builders, which also subcontracts for Siltek. In January, six workers sued Brave Builders and Siltek, alleging that they were denied overtime pay and minimum wage. The case is ongoing.
Neither Siltek executive Rene Sierra nor VR Enterprises President Lavastida responded to questions from the Herald.
Evan Benn of the Miami Herald and David Raynor of The News & Observer in Raleigh, N.C., contributed to this report.