In general, an independent contractor is an individual or firm who performs work for a person or entity, but who is not an employee of that person or entity. The question whether an individual is in fact an independent contractor or, rather, an employee of the person or entity for whom he or she is performing work is a frequently contested issue, particularly in Massachusetts. As discussed herein, there are a number of statutory and common-law “tests” that federal and state agencies and courts may apply, depending on the circumstances, to analyze whether a particular worker is an independent contractor or an employee. Therefore, while an employer may rightfully classify a worker as an independent contractor under one law, the individual may not fit the definition under another.
In Massachusetts, the most commonly referenced and most restrictive independent-contractor test is codified in what is called the Massachusetts Independent Contractor/Misclassification Law. This law has given rise to significant litigation and has proved particularly burdensome for employers. The Misclassification Law creates a presumption that an individual is an employee unless the individual meets three stringent factors (often referred to as “prongs one, two and three” or the “A, B, C test”). This law also applies to the relationship between franchisees and franchisors. The three-prongs in the ABC test includes
The employer bears the burden of proving each of these three prongs with respect to an individual classified as an independent contractor, and an insufficient showing on any of the prongs will result in a finding of employee status. Each of the prongs poses unique challenges when an employer attempts to apply them in the workplace, but employers generally have found prong two in particular (the “outside the usual course of business of the employer” element) to be the most difficult. There is very little guidance as to what constitutes “the usual course of business” and the Massachusetts Attorney General’s Office, the agency charged with enforcing the Misclassification Law, has taken an expansive view.
Another aspect of the Misclassification Law that makes it particularly troublesome for Massachusetts employers is that it establishes a private right of action with only a minimal administrative filing requirement. Once an individual has filed a complaint with the Massachusetts Attorney General’s Office, he or she may then pursue his or her claim in court after receiving what is typically called a “right to sue” letter from the Massachusetts Attorney General’s Office. In practice, the requirement that an allegedly aggrieved individual file first with the Massachusetts Attorney General’s Office is a relatively minor administrative hurdle.
Additionally, in Massachusetts, employees who prevail in their Wage and Hour lawsuits, including lawsuits brought under the Misclassification Law, are entitled to receive automatic treble damages, reasonable attorneys’ fees, and litigation costs. The availability of automatic treble damages and attorneys’ fees and costs makes wage and hour litigation in Massachusetts particularly attractive to plaintiffs and particularly risky for employers.
This introduction and the discussion in this section provides only an overview of this complex topic. Employers would be well advised to consult knowledgeable employment-law counsel before making a determination as to whether a particular individual should be classified as an independent contractor.
Although there are many risks associated with the misclassification of independent contractors, there are also numerous advantages to an employer’s proper use of independent contractors. Federal and state laws do not require an employer to pay certain benefits and taxes on behalf of independent contractors, and generally, many state and federal employment laws do not apply to them. However, an employer must be certain that it accurately classifies its workers as independent contractors rather than employees, because the consequences of misclassification are severe. In recent years, courts have carefully scrutinized employers’ classifications, and have seriously penalized employers for misclassifications, particularly when there is evidence that the employer knowingly misclassified the workers to obtain the advantages of an independent workforce.
An employer must withhold and deduct from employees’ wages for federal taxes. In addition, an employer must withhold from employees’ wages for Social Security and Medicare. These withholdings do not apply to independent contractors. Accordingly, the Internal Revenue Service (IRS) has a strong interest in an employer’s legitimate classification of independent contractors and employees.
The IRS uses the common law “right to control” test to determine whether an employer correctly classified an independent contractor. For this test, the IRS examines a number of factors organized into three groups:
The IRS uses these factors to determine whether the business has “the right to direct and control the means and details of the work.” Employers should conduct a similar analysis before claiming that an individual is an independent contractor. The employer should be mindful that the importance of each factor varies depending on the type of work and the circumstances of the specific case. In close cases, an employer should consult a tax professional or request an IRS determination of the worker’s status.
The IRS considers these factors in the “right to control” test:
The IRS assesses whether the business has a right to direct and control how the worker does the task for which the employer hired the worker, including:
The amount of instruction needed varies among different jobs. In some cases, a business may lack the knowledge to instruct highly specialized professionals; in other cases, the task may require little or no instruction. Even if no instructions are given, sufficient behavioral control may exist if the employer has the right to control how the individual achieves the results. The key consideration is whether the business has retained the right to control the details of a worker’s performance or has relinquished that control to the individual.
The IRS assesses whether the business has a right to control the business aspects of the worker's job, including:
Facts that indicate the parties' type of relationship include:
Congress has enacted a “safe haven” rule to minimize employers’ uncertainty in the classification of workers as employees or independent contractors for employment taxes. According to this rule, an employer cannot be penalized for its characterization of particular workers as independent contractors if three requirements are met:
If workers are independent contractors under common law rules, they may nevertheless be employees by statute (that is, “statutory employees”) for certain employment tax purposes if they fall within any one of four categories:
The salesperson must sell merchandise for resale or supplies for use in the buyer’s business operation. The work performed for the employer must be the salesperson’s principal business activity.
If workers fall into one of these categories, they must also meet the following three conditions to be statutory employees:
The tax code exempts certain occupations from employee tax withholding requirements, regardless of any contract involved or the labels attached to the parties. For an occupation to fall within the category of “statutory non-employee,” the worker must be at least one of the following:
Direct sellers and licensed real estate agents are treated as self-employed for all federal tax purposes, including income and employment taxes, if both of the following conditions are true:
Direct sellers include individuals falling within any of the following three groups:
Direct selling includes activities of individuals who attempt to increase direct sales activities of their direct sellers and who earn income based on the productivity of their direct sellers. Such activities include:
This category includes individuals engaged in appraisal activities for real estate sales if they earn income based on sales or other output.
Companion sitters are individuals who furnish personal attendance, companionship, or household care services to children or to individuals who are elderly or disabled. A person engaged in the trade or business of putting the sitters in touch with individuals who wish to employ them (that is, a companion sitting placement service) will not be treated as the employer of a sitter if that person or placement service:
Companion sitters who are not employees of a companion sitting placement service are generally treated as self-employed for all federal tax purposes.
Massachusetts wage and hour law creates an even greater incentive for employers’ to classify employees and independent contractors accurately. In 2004, as discussed earlier, the legislature created a presumption in favor of finding individuals to be employees rather than independent contractors for purposes of Massachusetts wage and hour laws. This means that when the evidence does not clearly indicate whether the worker is an employee, the court may presume that she or he is one. The Massachusetts Attorney General has issued advisory statements indicating its ongoing focus on this issue.
The Fair Labor Standards Act (FLSA) regulates wage and overtime requirements for employees. The FLSA defines employee very broadly as “any individual employed by an employer.” Because this definition is broad, state and federal courts typically apply an “economic realities” test to determine a worker’s status under the FLSA.
The “economic realities” test generally concerns around the amount of monetary risk the worker has in the job. In other words, the worker is an independent contractor if she or he finishes the job with a monetary loss. Although the economic realities test focuses on the worker’s monetary risk, the courts also look to whether the employee has the right to control how she or he performs the work. Thus, both economic reality and the right to control are relevant measures. In applying the economic realities test, the courts assess the following factors based on the specific facts of the relationship between the worker and employer:
Some courts refer to this test as the “hybrid test” (particularly in the employment discrimination context) because it includes elements of both monetary loss and right to control.
The Employee Retirement Income Security Act of 1974 (ERISA) safeguards employee benefit plans, such as pension plans, profit-sharing plans, and health insurance plans. The classification of a worker as an independent contractor or employee determines that individual’s coverage under ERISA. ERISA covers employees but not independent contractors.
Independent contractors may not participate in an employer’s ERISA-covered employee benefit plan. In 1992, the Supreme Court set forth standards to determine whether a person is an employee or an independent contractor for purposes of ERISA. The Supreme Court held that the underlying consideration is whether the employer has the right to control the manner and means by which the work is accomplished. The Supreme Court further set forth the following additional factors to evaluate for this test:
Massachusetts anti-discrimination law does not protect independent contractors. The Massachusetts Commission Against Discrimination (MCAD) analyzes the relationship between the employer and worker to determine, practically, whether the worker is an employee. The key inquiry in the determination is whether the employee is subject to control by the employer, not only as to the result to be accomplished, but also as to the means to be used. In addition, the court assesses the following factors:
Federal anti-discrimination laws, such as the Age Discrimination in Employment Act (ADEA), the Americans with Disabilities Act (ADA), and Title VII of the Civil Rights Act of 1964 (Title VII), only apply to employees. Typically, courts apply a hybrid test to determine when a worker is an employee.
The hybrid test is a combination of the factual economic realities test and the basic common law agency right to control test. Under hybrid test, courts focus on the right to control, but also consider economic realities, as needed. Specifically, courts focus on the following factors:
Employers should note that although these anti-discrimination laws do not cover independent contractors, Section 1981 of the Civil Rights Act of 1866, as amended by the Civil Rights Act of 1991, does cover independent contractors. Section 1981’s prohibition on racial discrimination applies to all types of employment-related decisions, including hiring, pay, promotions, demotions, discipline, and termination. See Chapter 12: Discrimination, for more information.
The National Labor Relations Act (NLRA) protects workers against unfair labor practices and allows them to organize or support labor organizations without fear of retaliation by the employer. The NLRA specifically excludes from its definition “any individual having the status of independent contractor.” The National Labor Relations Board (NLRB) applies the common law agency test (page 147) to determine whether an individual is an employee subject to the NLRA. Although there is no shorthand formula associated with the test, the NLRB assesses the following factors to determine whether a worker is an employee or independent contractor:
The NLRB reviews these factors in light of the facts and circumstances of the specific case. No one factor determines the employment status of the individual in its analysis. Therefore, this list of factors is not exclusive or exhaustive, and the Board’s application of the factors depends on the specific facts of each case.
Recently, the NLRB and the courts have moved the focus away from an employer’s right to control, and instead rely on entrepreneurial factors based on the worker’s ability to generate a profit or loss.
Massachusetts workers’ compensation law applies to employees. By statutory definition, an employee is “every person in the service of another under any contract of hire, express or implied, oral or written.” Courts that have interpreted this definition have held that independent contractors are not within the scope of the law.
To determine whether an individual is an employee subject to workers’ compensation, the court applies a common law agency test. The focus of the inquiry is on the right of the employer to direct and control the worker in the detail of the work. If the employer retains such control, the individual is an employee for workers’ compensation.
Massachusetts employers are not obligated to pay unemployment taxes for independent contractors, and independent contractors may not receive unemployment benefits when employers terminate their services.
In Massachusetts, the Division of Unemployment Assistance presumes that an individual providing services to an employer is an employee unless:
An employer should carefully analyze whether its workers are employees or independent contractors. While the designation of a worker as an independent contractor has many benefits, the misclassification as such has serious consequences. An employer should devote special attention to these designations because improper classification may lead to significant tax penalties, civil liabilities, and other costs for the employer.
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