When to Classify People as Independent Contractors
Employers beware. Hiring people as ‘independent contractors’ may provide a competitive advantage that seems tempting. However, the risks of misclassifying employees as independent contractors may far outweigh the benefits.
By classifying a worker as an independent contractor rather than an employee, a business may reap certain advantages. For example, the business may not be held vicariously liable to third parties in court for the negligent acts of an independent contractor as it would for an employee. The business may also avoid paying payroll tax, including the Federal Insurance Contribution Act (FICA) and Federal Unemployment Tax Act (FUTA), and also avoid payments toward state unemployment and workers’ compensation insurance. The business may also save substantial costs by not having to enroll the individual in any employee-benefit plans.
Unfortunately, the use of independent contractors carries with it the inherent risk that the federal or state government will determine that a business should have treated a particular person, or class of persons, as employees for tax, wage-hour, unemployment, workers’ compensation, or employee-benefit-plan purposes. To avoid running afoul of state and federal law regarding misclassification of workers, businesses need to examine their independent-contractor relationships, understand the risks, and consider taking appropriate steps to reclassify or restructure their relationships with these individuals.
In determining whether an individual is an employee or an independent contractor, the most important factor is the employer’s right to direction and control over the individual. The more direction and control that the employer has, the more likely it is that the individual will be deemed to be an employee. Some of the factors to consider are whether the employer sets hours, provides an office and equipment, and gives instructions on how to perform tasks as opposed to the individual making his or her own schedule, being self-directed, and furnishing his or her own equipment and supplies. This is the test that has traditionally been applied by the IRS to determine whether a worker is an employee or independent contractor for federal employment-tax purposes.
Many states, including Massachusetts, apply different tests for determining a worker’s status. The Massachusetts Independent Contractor Law (MICL) is among the strictest in the country and creates a presumption that an individual performing any service is an employee. To overcome this presumption, the party receiving services must establish that:
• The worker is free from its control and direction in performing this service, both under a contract and in fact;
• The service provided by the worker is outside the employer’s usual course of business; and
• The worker is customarily engaged in an independent trade, occupation, profession, or business of the same type.
The first part of the test looks at the degree of control and direction retained by the employer over the services performed by the individual. It is the employer’s burden to demonstrate that the services at issue are performed free from its direction or control and carried out with minimal instruction. An independent contractor completes the job using his or her own approach with little direction and dictates the hours that he or she will work on the job.
The second part of the test requires that the service the individual performs be “outside the usual course of business of the employer.” This requirement impacts any business that hires independent contractors to supplement its regular workforce. In 2003, for example, the Supreme Judicial Court of Massachusetts found that a newspaper had misclassified its newspaper carriers as independent contractors when the carriers were performing the usual course of business of the newspaper.
The third part of the test requires that the individual be customarily engaged in an independently established trade, occupation, profession, or a business of the same nature as that involved in the service performed. In other words, is the worker wearing the hat of an employee of the employing company, or is he or she wearing the hat of his or her own independent enterprise? This requirement may be difficult to satisfy if the independent contractor works only for one company.
The MICL is enforced by the Fair Labor Division of the Office of the Attorney General of the Commonwealth. The Attorney General’s 2008 advisory concerning the MICL states that an employer’s failure to withhold taxes, contribute to unemployment compensation, or provide workers’ compensation for an individual is not considered when analyzing whether an employee has been misclassified. Nor is the existence of an independent-contractor agreement (although, according to the attorney general, the MICL requires that all independent-contractor relationships be reflected in written agreements or job descriptions). In other words, just because an employer believes that a worker should be an independent contractor and treats that worker as such does not make it so in the eyes of the law.
The attorney general can issue civil citations and institute criminal prosecutions against businesses and individuals for both intentional and unintentional violations of the MICL. More significantly, private citizens may file civil actions in court for themselves and others similarly situated, claiming that they have been misclassified as independent contractors but are, in fact, employees entitled to all the rights and protections under the Massachusetts Wage Act. The Wage Act is a particularly potent weapon since it imposes personal liability on officers and managers of companies who violate its provisions, including the MICL. In addition, the 2008 amendments to the Wage Act require a court to award treble (three times) damages plus attorney’s fees and costs to an employee who prevails on his or her claim.
Misclassifying employees as independent contractors may also subject a business to:
• Income-tax liability for monies that should have been withheld from the ‘wages’ of the ‘employees’;
• Employer FICA and FUTA contributions;
• Potential overtime pay and other wage claim liability;
• State unemployment-insurance payments;
• Workers’ compensation insurance premiums and potential liability for workplace injuries; and
• Other civil and criminal liability. Additionally, workers may be entitled to coverage and benefits under existing employee benefit plans.
There are several approaches a business can take to address these risks. It might:
• Evaluate relationships with independent contractors to determine whether the classification is proper under the MICL three-part test;
• Review all written independent-contractor agreements and modify them where appropriate;
• Ensure that all independent-contractor relationships are reflected in written agreements or job descriptions correctly describing the relationship and the party’s respective obligations;
• Begin treating misclassified independent contractors as employees; and
• Maintain independent-contractor relationships but take steps to limit potential exposure (for example, ensure that no independent contractor works more than 40 hours per week so that the business does not face potential overtime liability).
Keith A. Minoff is a Springfield-based attorney specializing in employment law and business litigation; (413) 301-0866.