Regulatory Insurance Services receives $1 million per month from the Delaware Department of Insurance, but former staffers say the well-connected firm has been misclassifying its employees to avoid paying federal and state taxes for more than 16 years.
By Lee Williams
John Tinsley III is known as the “shadow commissioner” of Delaware’s Department of Insurance.
He’s been the behind-the-scenes shot caller for two of the last three insurance commissioners.
Tinsley is a principal at INS Regulatory Insurance Services (InsRis), a Pennsylvania-based financial services firm whose name has morphed over time, while its power and political connections have grown.
Three of the four InsRis principals, including Tinsley, have all at one time been employed by the Delaware Department of Insurance.
At a joint hearing of the House and Senate insurance committees held last month, Delaware Insurance Commissioner Karen Weldin Stewart introduced Tinsley to the lawmakers as her “special deputy for examinations” even though he is a contractor and not a state employee – a fact Stewart omitted from her testimony, until she was questioned about the relationship by lawmakers.
Tinsley is copied on nearly every significant issue at the Department of Insurance – even issues that do not involve his contract – according to e-mails obtained by the Caesar Rodney Institute through a Freedom of Information Act (FOIA) request. He often accompanies Stewart and her staff on trips to law firms in New York and elsewhere.
Stewart’s department pays InsRis more than $1 million per month to audit insurance companies based in Delaware, a requirement paid for by the insurance companies themselves. The costs of the audits vary depending upon the size of the firm and the complexity of the probe. The larger firms can pay more than $1 million per audit. InsRis, their examiner and the insurance department divide the fees according to set rates.
Several former InsRis examiners told the Caesar Rodney Institute that the firm intentionally misclassified them as independent contractors rather than actual employees, to avoid paying payroll taxes, operating costs and other benefits, including state taxes.
The practice, which they say first began in 1993, has already cost taxpayers, and could cost InsRis millions in penalties, back taxes and interest.
Neither Stewart nor Tinsley were willing to be interviewed for this story.
Going after firms that intentionally misclassify their workers to avoid paying their fair share of taxes is one of the top investigative priorities for the Internal Revenue Service, according to Special Agent Shauna Frye, spokesperson for the agency’s Philadelphia Field Office’s criminal investigation unit, which oversees Delaware.
It’s an investigative priority that can result in lengthy prison sentences.
“From a criminal standpoint, the sentences are generally guided by the amount of tax loss,” Frye told the Caesar Rodney Institute. “If you’re talking about an employer who has tax evasion, the number of years the illegal act has been occurring, and the amount of taxes evaded, are the driving force in determining the length of the sentence.”
The IRS has a responsibility to clearly establish willfulness – knowledge of the difference between an employee and an independent contractor, Frye explained.
“An individual purposefully misclassifying an employee as a contractor would definitely result in some sort of jail time,” she said. “We really only work cases that have potential of jail.”
Nationally, firms that intentionally misclassify their staff to save money are seeing increased scrutiny from both the IRS and the U.S. Department of Labor.
The “Misclassification Initiative”
U.S. Department of Labor Secretary Hilde L. Solis said her agency’s FY 2011 budget request “makes new investments in programs that protect workers’ rights, safety and health in the new economy.”
Solis’ $117 billion budget includes $25 million for the “Misclassification Initiative,” which will allow the Department of Labor to hire 100 additional enforcement personnel to target firms that willfully misclassify their workers as independent contractors, and provide grants and incentives for the states to address the problem.
“When employees are misclassified as ‘independent contractors,’ they are deprived of benefits and protections to which they are legally entitled,” Solis said in a written statement. “For example, independent contractors do not receive overtime and are ineligible to receive unemployment benefits.”
Delaware has made some effort to prevent intentional misclassification of some workers, but only those employed in the construction industry. Meanwhile, other more lucrative industries were ignored.
In July 2009 Gov. Jack Markell signed the Workplace Fraud Act into law.
The Act states: “An employer shall not improperly classify an individual who performs work for remuneration provided by an employer as an independent contractor.”
It provides civil penalties of up to $5,000 for every violation, but it applies only to the construction industry.
The IRS uses an 11-point test to determine whether a worker is an independent contractor or an actual employee. According to the former InsRis staffers, it is a test their former firm fails miserably.
The criteria for the test consist of establishing the amount of control a firm has over their workers: behavioral, financial and relationship control.
Nicholas A. Mirkay is an associate professor at the Widener University School of Law. Mirkay received his J.D. from University of Missouri – Columbia School of Law in 1992, and an LL.M. in Taxation, with distinction, from Georgetown University Law Center in 1996. He spent two years in the IRS’ Office of Chief Counsel. His private practice has focused on federal, state and local taxation of business.
Misclassification, Mirkay said, is an issue the IRS has been fighting for decades, but one that’s relatively simple to understand.
“The issue is all about control – how much control the purported employer has over the purported employee,” Mirkay said. “The more control the employer has over their time, manner and work product, the more likely they’re an actual employee.”
The former staffers said InsRis controlled nearly every aspect of their job.
InsRis, they said, hired them, brought their names to the commissioner and scheduled all of their audits. The firm told them where to be, who to contact and even what type of dress was appropriate for the workplace.
The firm provided paid training and once a year scheduled an annual conference for all of the examiners. They were directed to contact an InsRis principal if they had questions, and were warned against going outside the company’s chain of command.
No aspect of their job was as rigidly controlled as their audit reports. The examiners submitted them to InsRis, and their supervisors went over them in great detail before submitting them to the insurance department. Sometimes these reviews could take several months.
InsRis reimbursed their expenses, and paid them with company checks. The examiners were paid based on an hourly rate. In theory, they said their time was broken into daily/eight-hour blocks. In practice, this amounted to an hourly rate of pay.
The employees said InsRis had strict rules about the amount of time they could spend on each audit, and questioned them when they exceeded this limit. They were also questioned if they finished an audit early, because the firm would receive less money.
Once hired, their relationship with InsRis was one of permanence. They went from one audit to another, indefinitely, without signing new contracts. The contracts themselves do not specify an end date, and can only be terminated by both parties in writing.
The Caesar Rodney Institute obtained a copy of a contract signed by one of the former staffers and InsRis. The first line of the document states, “Examiner is engaged as an ‘Independent Contractor,’ and not as an employee or agent…”
Published guidance from the IRS, however, suggests that the existence of a contact proves little when weighed against the other criteria in the test: “Although a contract may state that the worker is an employee or an independent contractor, this is not sufficient to determine the worker’s status.”
Mirkay said misclassification-related issues are found in more industries than just the construction trade.
“Ten years ago, the biggest abusers were accounting firms and law firms,” he said. “It’s not just your lower-paid employees. We see big service providers involved, because it triggers fewer taxes.”
Mirkay pointed out that the IRS is not the only agency likely to be interested in this possible misclassification.
“The State of Delaware’s withholding tax could be being skirted here as well,” he said. “The Delaware Department of Revenue should be interested in seeing their withholding taxes collected.”
CRI research fellow Sara Clark contributed to this story. Contact investigative reporter Lee Williams at (302) 242-9272 or firstname.lastname@example.org
The Caesar Rodney Institute is a 501(c)(3) non-partisan research and educational organization and is committed to being a catalyst for improved performance, accountability, and efficiency in Delaware government.
© Copyright May 11, 2010 by the Caesar Rodney Institute
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