Illegal Subcontracting: Bad Apples
By Becky Mollenkamp
It’s been nearly a year since federal agents arrested 245 allegedly illegal workers on contract cleaning crews at 58 Wal-Mart stores across the United States. The arrests followed a five-year investigation and caused the country’s largest private employer to now use its own workers to clean its floors.
The raid put an unwanted spotlight on the contract cleaning industry. It was the first most Americans had heard about illegal activities in this industry. It was not a shock, however, to most building service contractors, who have seen these problems escalating for years.
The pressure to lower costs, coupled with an increase in outsourcing, has led to an unsettling trend—companies choosing low-ball bids from contractors who reduce costs with illegal or unethical practices.
In general, hiring out cleaning services protects the customer from legal woes. They have “good faith” that the BSC will do all necessary work eligibility checks. Of course, saving lots of money is an incentive for customers not to ask too many questions.
“Some companies hire legitimate custodial subcontractors at an extremely low price, knowing that those prices could not be achieved without some illegal or unethical practices taking place,” says Steve Hendrickson, president and CEO of Porter Industries in Loveland, Colo. “These companies like the low pricing, so they look the other way or figure that it is not their problem.”
Like many BSCs, Hendrickson has lost bids to companies that hire illegal workers. These competitors pay lower wages and avoid taxes, resulting in lower bids.
Haven’t yet lost a job to a dirty contractor? Think it doesn’t affect you? Think again. Not only do these shady businesses exploit workers, cheat taxpayers, and tarnish the industry’s reputation, they also leave legitimate BSCs fighting an uphill battle to turn a profit in the face of customers’ lowered cost expectations.
“I cannot imagine any BSC who is not materially affected by illegal contractors in the industry,” says Mike Farman, president of the Pacific Association of Building Service Contractors (PABSCO). “Perhaps, some just more directly than others.
We have seen a number of small and large contractors exit the business in the last few years and I expect that trend will continue until the market is sorted out,” Farman continues. “It is extremely difficult for legitimate contractors to make a living in the current industry environment.”
Although there have been some high-profile legal actions, like the 2003 Wal-Mart raids, the problem of unethical BSCs remains extensive and creates competitive problems for contractors who are trying to do the right thing.
There are many questionable practices a BSC can use to gain competitive and economic advantage. Some of these include hiring off-the-books illegal workers, misclassifying employees as subcontractors, underreporting payroll, and paying workers cash under the table. Paying less-than-standard wages and avoiding mandatory taxes can certainly save a company money—but the practices are unethical and, in most cases, illegal.
The U.S. government imposes responsibilities (and liabilities) on employers. Any company with employees is responsible for several federal, state, and local taxes.
“There have always been issues in the area of employment taxes and it’s an area we follow very closely,” says Anthony Burke, a spokesperson for the IRS. “There are penalties for failures in this area.”
There are also federal laws, enacted in 1986, which specifically prohibit companies from knowingly employing illegal immigrants. Employers must require new employees to prove they’re legally eligible to work in the U.S. and must examine their proof of identification documents. Employers must also complete Form I-9, the official employment verification form.
Worker turnover among contract cleaning firms can range from 50 to 300 percent a year. Desperate contractors sometimes hire illegal unwittingly, falling victim to forged immigration documents.
“In my experience, the majority of cleaning contractors believe that as long as they collect two forms of I.D. and have a properly completed I-9 form, they have complied with the law,” Hendrickson says. “There are custodial contractors who do not purposely break the law; they just haven’t taken the time to be thoroughly trained in the proper identification of work documents. They have no idea how many illegal workers they may have hired, because their screening process is inadequate.”
Others blatantly disregard the law, perhaps because the lure of beating out the competition is too strong to ignore. They also believe that many customers will turn a blind eye because they’re happy to save money with low-ball prices. This may explain why industry experts say as much as half of all contract cleaning in the U.S is now done by illegal workers.
“We know that many of our competitors hire illegal worker because many of their workers come and apply for jobs with our company and a majority of these individual cannot produce legal documents,” Hendrickson says. “I’m sure that many of these applicants are excellent workers, but until the laws are changed, it is illegal to hire them.”
The most complicated employment law — one that many employers break, either mistakenly or purposefully — is that covering independent contractors. Companies must withhold income taxes, withhold and pay Social Security and Medicare taxes, and pay unemployment tax on wages paid to an employee. This is not the case with an independent contractor.
“Some companies skirt employment taxes, insurance costs, and wage and hour requirements by hiring custodial workers as independent contractors rather than employees,” Hendrickson says. “This practice, in nearly every case, is unethical, illegal, and very detrimental to our industry.”
It’s essential for the cleaning and maintenance industry to know the rules and how they’re enforced. In general, an employee is anyone who performs services for you when you can control what will be done and how it will be done. If you can control or direct only the result of the work, but not the means and methods, then the worker is probably an independent contractor. For specific information, refer to IRS Publication 15-A.
“We are constantly being underbid by companies that hire cleaners on a subcontract basis, avoiding all the mandatory taxes, insurances, background checks, I-9 forms, etc.,” says Ken J. Galo, owner of L & K Facility Services in Brookfield, Wisconsin. “They don’t care and they don’t know if the cleaners are illegal or not. It enables them to bid on jobs at 15 to 25 percent less than the competition.”
Cheating the system is not new, but many in the cleaning industry feel the problem is getting worse. There are plenty of reasons for the worsening situation, but probably the biggest is economic woes.
A poor economy in recent years has created an environment that rewards contractors for lowering prices, even to below what is legally possible.
“This forces other companies to believe that the only way to compete is to cheat, creating a spiraling effect,” Farman says.
Fewer workers willing to accept low-paying cleaning jobs, coupled with rising health and other insurance costs, have also contributed to higher payrolls. This gives an even more significant competitive advantage to contractors who cheat.
“In a day when the majority of businesses are seeking the lowest price it is tempting for custodial contractors to look the other way or avoid securing proper training because they do not want to disqualify a good worker, even though they might be illegal,” says Hendrickson. “The motivation for companies to resort to these practices is to secure a cheaper work force. This often enables them to present a much lower bid for their services.”
Another trend in the industry that contributes to the problem is consolidation and franchising. National cleaning companies bid on a large number of chains with multi-state offices and then use small, local service firms as subcontractors to complete the work. The problem is that many of these big players want the work done for impossibly low rates.
L&K Facility Services gets frequent bid requests from national companies. Recently, one asked them to clean a cell-phone store five times a week for $230 a month. Working just one hour per visit totals about 21.5 hours a month, which comes to $10.69 per hour.
“Out of that you have to pay for your taxes, insurance, cleaning supplies, and fuel costs,” Galo says. “You would have to be illegal, working by yourself, or desperate to take a job like that. At best you would only realize $7.16 an hour doing it yourself. I pay my staff $9 an hour.”
U.S. Immigration and Customs Enforcement (ICE), the largest investigative arm of the Department of Homeland Security, combats illegal immigration to remove employers’ access to undocumented workers.
Law-breaking employers face ICE raids, which can prompt embarrassing media attention, future government scrutiny of their hiring and employment practices, and fines of up to $2,000 per illegal worker.
Critics say there hasn’t been significant enforcement of the many laws about illegal workers and tax fraud. Companies that operate illegally can create a competitive advantage over their legitimate competitors — and many feel it is worth the legal risk, thanks to spotty law enforcement and limited financial repercussions.
“There is a lack of enforcement of the myriad laws that these companies are violating,” Farman says. “Additionally, where some enforcement action has been taken, there is a lack of follow through to prevent the individuals from doing it all over again.”
So what can you do to help affect change? First, educate yourself so you don’t unwittingly violate the law.
Porter Industries has had INS (now ICE) agents train its management and human resources personnel on proper screening and identification of workers.
“Even though the INS does not appear to be actively investigating BSCs for their use of illegal workers, we still choose to do very careful screening,” Hendrickson says. “It is the right thing to do, hiring undocumented workers is still illegal, and we have a responsibility to our customers to never expose them to any potential embarrassment, should a raid occur on their premises.”
Legitimate BSCs can also share information about companies they suspect are operating illegally (see sidebar), educate key state and local officials regarding what to look for, and lobby legislators to take action.
“We realize, it is very unusual for an organization of business owners to ask for more regulation and enforcement of their industry,” Farman says. “But we reached the point where we understand that this is what’s needed to get control of the underground and illegal part of the industry and to level the competitive playing field.”
Although Farman doesn’t think these problems can ever be completely eliminated in a low-wage, labor-based industry, he does believe contractors can mitigate the impact.
“I think it will take continued, vigorous efforts on the part of legitimate contractors to help clean up their industry and to insist that regulators assist in that effort,” Farman says. “It is also going to take educating the customers on their role in enabling these activities and for them to take responsibility for not continuing to promote illegal business practices.”
Becky Mollenkamp is a business writer based in Des Moines, Iowa. She is a frequent contributor to Contracting Profits.
| Take Action
|Think your competition is skirting tax laws? If you have proof, report the fraud to the Internal Revenue Service (IRS). Download Form 211 to report fraud and to claim a reward for turning over the information. You may also report fraud by calling the IRS at 800-829-0433.
Tips from law-abiding contractors or employees can also trigger raids on competitors who are using illegal workers. Report illegal workers to the U.S. Immigration and Customs Enforcement agency at 866-DHS-2ICE.
Other resources to consult include the Building Service Contractors Association International, which has been working to combat illegal subcontracting in recent years; your state’s attorney general; or the Better Better Business Bureau.