Independent Contractor Classification

The classification of independent contractors is garnering increased attention at both state and federal agencies and courts, in order to ensure government revenue and a way to level the playing field for businesses that play by the rules. In light of this heightened emphasis, employers should re-evaluate their practices for classifying workers as independent contractors. This article outlines some general guidelines based on recent state and federal court decisions.

Employee or Contractor?

Courts consistently find that there is a presumption that workers are employees. The burden of showing that an individual is an independent contractor instead of an employee rests with the employer. While there is no uniform test for determining how to classify a worker, there are certain standards to guide employers through these murky waters. Ultimately, employers should think twice ' and perhaps a third time ' before treating an individual as an independent contractor if that person performs tasks that are typically assigned to one of its employees. The current regulatory environment militates in favor of employers' judicious use of independent contractor status.

Recent Federal and State Efforts

On Sept. 19, 2011, U.S. Secretary of Labor Hilda L. Solis signed a memorandum of understanding with the U.S. Internal Revenue Service (IRS) to work cooperatively to address the practice of misclassifying employees. Secretary Solis also signed memoranda of understanding with labor commissioners and agency leaders from seven states (Connecticut, Maryland, Massachusetts, Minnesota, Missouri, Utah and Washington), and announced plans to enter into similar agreements with four other states (Hawaii, Illinois, Montana and New York). The Department of Labor (DOL) couched its increased enforcement in pro-business terms, noting in a press release that misclassification can “create economic pressure for law-abiding business owners” who have to compete with businesses that skirt federal and state laws. In its FY 2011 budget request, the DOL sought $25 million to pursue its employee misclassification initiative, including hiring 100 full-time employees to conduct investigations, pursue litigation and issue grants to states for increased enforcement efforts. President Obama's 2011 budget emphasized both the deprivation of benefits to improperly classified employees, and the budgetary impact.

In another notable development, California enacted new legislation effective Jan. 1, 2012, prohibiting the willful misclassification of individuals as independent contractors, and the deduction of compensation, charging of fees, or assessment of fines against individuals misclassified as independent contractors. (See the sidebar on page 8.) Senate Bill No. 459 provides for civil penalties ranging from $5,000 to $15,000 for each violation, with penalties of between $10,000 and $25,000 for employers engaged in a “pattern or practice” of violations. These fines are exclusive of any civil damages that may be assessed. In addition to these fines, an employer determined to be in violation of the law will be reported to the California State License Board (if the employer is a licensed contractor), and will be required to post on the company website (or, if the company does not have a website, in a prominent public area) that the employer committed an infraction and subsequently changed its business practices. Except for practicing attorneys, persons who knowingly advise an employer to misclassify an individual will be held jointly and severally liable. Finally, the penalties will remain in effect for successor entities.

Guidelines for Classification

Both federal law and state law outline factors that aid in determining whether an individual is an employee or an independent contractor. Additionally, state and federal agencies use different tests to determine worker classification. Therefore, a worker's proper classification will depend upon the forum and test being applied.

For example, under the federal wage and hour law, the Fair Labor Standards Act (FLSA), an employee is defined in very broad terms as “any individual employed by an employer” (“employ” includes “to suffer or permit to work”). 29 U.S.C. ' 203. This expansive definition embodies the FLSA's purpose and informs judicial decisions when courts make determinations concerning how individuals are classified. Independent contractor status appears almost as an exception to the rule of classifying an individual as an employee.

The IRS, which previously used a 20-factor test in determining whether a worker is an employee or an independent contractor for federal tax purposes, revised its guidelines in 2010 to include three categories of factors: 1) behavioral control (whether the business has a right to direct or control how work is done through instructions, training or other means); 2) financial control (whether the business has a right to direct or control the financial and business aspects of the worker's job); and 3) the type of relationship (how the worker and business owner perceive their relationship). Under these three categories, the IRS lists 11 factors to consider: 1) instructions the business gives the worker; 2) training the business gives the worker; 3) the extent to which the worker has unreimbursed business expenses; 4) the worker's investment; 5) whether the worker makes services available in the relevant market; 6) how the business pays the worker; 7) extent to which the worker can realize a profit or loss; 8) written contracts describing the relationship the parties intended to create; 9) whether the business provides the worker with employee-type benefits; 10) permanency of the relationship; and 11) the extent to which services performed by the worker are a key aspect of the company's regular business.

The IRS summarizes its position on worker classification as follows: If the business has the right to control or direct not only what is to be done, but how it is done, then the workers are most likely employees. If the business can direct or control only the result of the work done ' and not the means and methods of accomplishing the result ' then the workers are probably independent contractors. Under many states' laws, the scale is tipped in favor of classifying an individual as an employee rather than an independent contractor. Many states take the position that an expansive conception of the term “independent contractor” would limit the individuals who receive benefits and protections intended for most workers, with the exception of those who are legitimately outside the meaning of the term “employee.” In Massachusetts, for example, employees are entitled to certain overtime and minimum wage protections under its wage and hour laws. Independent contractors are not entitled to those protections. The Massachusetts laws permit an aggrieved party to bring a lawsuit for injunctive relief and damages; an award of treble damages, costs, and attorneys' fees to a successful plaintiff is mandatory.

Consistent with the goal of broadly applying these benefits and protections to workers, the presumption under Massachusetts law is that an individual performing services is an employee, and the employer has the burden of showing otherwise. To meet this burden, an employer must prove each of the following conditions by a preponderance of the evidence:

• The individual is free from control and direction in connection with the performance of the service, both under his contract for performance of service and in fact;
• The service is performed outside the usual course of the business of the employer; and
• The individual is customarily engaged in an independently established trade, occupation, profession or business of the same nature as that involved in the service performed. M.G.L. c. 149, ' 148B. Somers v. Converged Access, Inc., 454 Mass. 582, 589 (2009).

A Recent Opinion

A recent Federal District Court opinion recites various factors for distinguishing between employees and independent contractors under the FSLA, including: 1) the degree of the employer's right to control the manner in which the work is to be performed; 2) the alleged employee's opportunity for profit or loss depending upon his managerial skill; 3) the employee's investment in equipment or materials required for his task, or his employment of helpers; 4) whether the service rendered requires a special skill; 5) the degree of permanence of the working relationship; and 6) whether the service rendered is an integral part of the employers business. Secretary of Labor v. Cascom, 3:09-cv-257 (S.D. Ohio Sept. 21, 2011) (Rose, J.).

In Cascom, the court held that cable installers hired by the defendant Cascom to install cable in connection with its contract with Time Warner were employees entitled to overtime under the FLSA. In making this finding, the court observed that Cascom forbade its installers to hire their own helpers, asserted control by requiring installers to wear the company's logo, provided training for unskilled installers, and kept installers employed for substantial periods of time ' all factors indicating that the installers were employees.

Based on Cascom and related cases, certain questions arise that can assist in determining whether individuals should be classified as employees or independent contractors. If the answer to the question is “yes,” then the individual is more likely an employee; if the answer is “no,” then it is more likely that a person is an independent contractor.

• Does the individual lack other customers, clients or contracts?
• Does the business control the individual contractually ' e.g., did he or she fill out an employment application?
• Does the individual lack employees or subcontractors of its own?
• Does the individual perform no work for and receive no compensation from other entities?
• Does the business control the person throughout the day? Does the person check in? Is he or she given detailed instructions? Must the person request leave time? Is it mandatory that the individual work on certain days?
• Does the individual perform the same duties as regular employees?
• Does the business make the decisions concerning routes, acquisition of materials, or other facets normally associated with the operation of an independent business?
• Does the individual lack any opportunity to increase his or her profit or loss through the person's own managerial skill?
• Does the person not hold himself/herself out separately as an independent business person?
• Does the business supply all inventory and the person make no investment in equipment or materials?
• Are there no special skills required to render the services? Can a person learn the skills required in a few weeks of training?
• Is there an indefinite period of employment?
• Are the services performed by the individual integral to the business (e.g., cable installation for a cable company)?
• Does the individual lack his or her own liability and/or workers' compensation insurance?

Words of Caution

Employers face stiff penalties for improperly classifying workers. In addition to future fines and legal repercussions, government agencies can levy immediate penalties that interfere with a business's ability to conduct its operations, as dozens of companies working at construction sites in Connecticut recently learned. Between August and October 2011, the Connecticut Department of Labor ' Division of Wages and Workplace Standards issued Stop Work orders to companies at various sites for misclassifying employees as independent contractors. Stop Work orders result in the halting of all work at the company's worksite, and a penalty of $300 per day for each day that the company does not carry the workers' compensation coverage as required by law. As the result of just 28 Stop Work orders, the Department collected $123,000 in penalties.

Federal and state officials are armed with both the tools and the desire to enforce vigorously stringent laws against employee misclassification. In such a regulatory environment, a prudent employer will carefully evaluate its decisions on how to classify its employees.

Rosanna Sattler, a member of this newsletter's Board of Editors, is a partner at Posternak Blankstein & Lund, LLP. Her practice includes business litigation, environmental, employment, and insurance coverage disputes. She may be reached at [email protected]. Nancy Puleo is a partner in the firm's Employment and Litigation Department, and focuses on employment disputes. She may be reached at [email protected]. James E. Kruzer is an associate at the firm. He may be reached at [email protected].

The classification of independent contractors is garnering increased attention at both state and federal agencies and courts, in order to ensure government revenue and a way to level the playing field for businesses that play by the rules. In light of this heightened emphasis, employers should re-evaluate their practices for classifying workers as independent contractors. This article outlines some general guidelines based on recent state and federal court decisions.

Employee or Contractor?

Courts consistently find that there is a presumption that workers are employees. The burden of showing that an individual is an independent contractor instead of an employee rests with the employer. While there is no uniform test for determining how to classify a worker, there are certain standards to guide employers through these murky waters. Ultimately, employers should think twice ' and perhaps a third time ' before treating an individual as an independent contractor if that person performs tasks that are typically assigned to one of its employees. The current regulatory environment militates in favor of employers' judicious use of independent contractor status.

Recent Federal and State Efforts

On Sept. 19, 2011, U.S. Secretary of Labor Hilda L. Solis signed a memorandum of understanding with the U.S. Internal Revenue Service (IRS) to work cooperatively to address the practice of misclassifying employees. Secretary Solis also signed memoranda of understanding with labor commissioners and agency leaders from seven states (Connecticut, Maryland, Massachusetts, Minnesota, Missouri, Utah and Washington), and announced plans to enter into similar agreements with four other states (Hawaii, Illinois, Montana and New York). The Department of Labor (DOL) couched its increased enforcement in pro-business terms, noting in a press release that misclassification can “create economic pressure for law-abiding business owners” who have to compete with businesses that skirt federal and state laws. In its FY 2011 budget request, the DOL sought $25 million to pursue its employee misclassification initiative, including hiring 100 full-time employees to conduct investigations, pursue litigation and issue grants to states for increased enforcement efforts. President Obama's 2011 budget emphasized both the deprivation of benefits to improperly classified employees, and the budgetary impact.

In another notable development, California enacted new legislation effective Jan. 1, 2012, prohibiting the willful misclassification of individuals as independent contractors, and the deduction of compensation, charging of fees, or assessment of fines against individuals misclassified as independent contractors. (See the sidebar on page 8.) Senate Bill No. 459 provides for civil penalties ranging from $5,000 to $15,000 for each violation, with penalties of between $10,000 and $25,000 for employers engaged in a “pattern or practice” of violations. These fines are exclusive of any civil damages that may be assessed. In addition to these fines, an employer determined to be in violation of the law will be reported to the California State License Board (if the employer is a licensed contractor), and will be required to post on the company website (or, if the company does not have a website, in a prominent public area) that the employer committed an infraction and subsequently changed its business practices. Except for practicing attorneys, persons who knowingly advise an employer to misclassify an individual will be held jointly and severally liable. Finally, the penalties will remain in effect for successor entities.

Guidelines for Classification

Both federal law and state law outline factors that aid in determining whether an individual is an employee or an independent contractor. Additionally, state and federal agencies use different tests to determine worker classification. Therefore, a worker's proper classification will depend upon the forum and test being applied.

For example, under the federal wage and hour law, the Fair Labor Standards Act (FLSA), an employee is defined in very broad terms as “any individual employed by an employer” (“employ” includes “to suffer or permit to work”). 29 U.S.C. ' 203. This expansive definition embodies the FLSA's purpose and informs judicial decisions when courts make determinations concerning how individuals are classified. Independent contractor status appears almost as an exception to the rule of classifying an individual as an employee.

The IRS, which previously used a 20-factor test in determining whether a worker is an employee or an independent contractor for federal tax purposes, revised its guidelines in 2010 to include three categories of factors: 1) behavioral control (whether the business has a right to direct or control how work is done through instructions, training or other means); 2) financial control (whether the business has a right to direct or control the financial and business aspects of the worker's job); and 3) the type of relationship (how the worker and business owner perceive their relationship). Under these three categories, the IRS lists 11 factors to consider: 1) instructions the business gives the worker; 2) training the business gives the worker; 3) the extent to which the worker has unreimbursed business expenses; 4) the worker's investment; 5) whether the worker makes services available in the relevant market; 6) how the business pays the worker; 7) extent to which the worker can realize a profit or loss; 8) written contracts describing the relationship the parties intended to create; 9) whether the business provides the worker with employee-type benefits; 10) permanency of the relationship; and 11) the extent to which services performed by the worker are a key aspect of the company's regular business.

The IRS summarizes its position on worker classification as follows: If the business has the right to control or direct not only what is to be done, but how it is done, then the workers are most likely employees. If the business can direct or control only the result of the work done ' and not the means and methods of accomplishing the result ' then the workers are probably independent contractors. Under many states' laws, the scale is tipped in favor of classifying an individual as an employee rather than an independent contractor. Many states take the position that an expansive conception of the term “independent contractor” would limit the individuals who receive benefits and protections intended for most workers, with the exception of those who are legitimately outside the meaning of the term “employee.” In Massachusetts, for example, employees are entitled to certain overtime and minimum wage protections under its wage and hour laws. Independent contractors are not entitled to those protections. The Massachusetts laws permit an aggrieved party to bring a lawsuit for injunctive relief and damages; an award of treble damages, costs, and attorneys' fees to a successful plaintiff is mandatory.

Consistent with the goal of broadly applying these benefits and protections to workers, the presumption under Massachusetts law is that an individual performing services is an employee, and the employer has the burden of showing otherwise. To meet this burden, an employer must prove each of the following conditions by a preponderance of the evidence:

• The individual is free from control and direction in connection with the performance of the service, both under his contract for performance of service and in fact;
• The service is performed outside the usual course of the business of the employer; and
• The individual is customarily engaged in an independently established trade, occupation, profession or business of the same nature as that involved in the service performed. M.G.L. c. 149, ' 148B. Somers v. Converged Access, Inc. , 454 Mass. 582, 589 (2009).

A Recent Opinion

A recent Federal District Court opinion recites various factors for distinguishing between employees and independent contractors under the FSLA, including: 1) the degree of the employer's right to control the manner in which the work is to be performed; 2) the alleged employee's opportunity for profit or loss depending upon his managerial skill; 3) the employee's investment in equipment or materials required for his task, or his employment of helpers; 4) whether the service rendered requires a special skill; 5) the degree of permanence of the working relationship; and 6) whether the service rendered is an integral part of the employers business. Secretary of Labor v. Cascom, 3:09-cv-257 (S.D. Ohio Sept. 21, 2011) (Rose, J.).

In Cascom, the court held that cable installers hired by the defendant Cascom to install cable in connection with its contract with Time Warner were employees entitled to overtime under the FLSA. In making this finding, the court observed that Cascom forbade its installers to hire their own helpers, asserted control by requiring installers to wear the company's logo, provided training for unskilled installers, and kept installers employed for substantial periods of time ' all factors indicating that the installers were employees.

Based on Cascom and related cases, certain questions arise that can assist in determining whether individuals should be classified as employees or independent contractors. If the answer to the question is “yes,” then the individual is more likely an employee; if the answer is “no,” then it is more likely that a person is an independent contractor.

• Does the individual lack other customers, clients or contracts?
• Does the business control the individual contractually ' e.g., did he or she fill out an employment application?
• Does the individual lack employees or subcontractors of its own?
• Does the individual perform no work for and receive no compensation from other entities?
• Does the business control the person throughout the day? Does the person check in? Is he or she given detailed instructions? Must the person request leave time? Is it mandatory that the individual work on certain days?
• Does the individual perform the same duties as regular employees?
• Does the business make the decisions concerning routes, acquisition of materials, or other facets normally associated with the operation of an independent business?
• Does the individual lack any opportunity to increase his or her profit or loss through the person's own managerial skill?
• Does the person not hold himself/herself out separately as an independent business person?
• Does the business supply all inventory and the person make no investment in equipment or materials?
• Are there no special skills required to render the services? Can a person learn the skills required in a few weeks of training?
• Is there an indefinite period of employment?
• Are the services performed by the individual integral to the business (e.g., cable installation for a cable company)?
• Does the individual lack his or her own liability and/or workers' compensation insurance?

Words of Caution

Employers face stiff penalties for improperly classifying workers. In addition to future fines and legal repercussions, government agencies can levy immediate penalties that interfere with a business's ability to conduct its operations, as dozens of companies working at construction sites in Connecticut recently learned. Between August and October 2011, the Connecticut Department of Labor ' Division of Wages and Workplace Standards issued Stop Work orders to companies at various sites for misclassifying employees as independent contractors. Stop Work orders result in the halting of all work at the company's worksite, and a penalty of $300 per day for each day that the company does not carry the workers' compensation coverage as required by law. As the result of just 28 Stop Work orders, the Department collected $123,000 in penalties.

Federal and state officials are armed with both the tools and the desire to enforce vigorously stringent laws against employee misclassification. In such a regulatory environment, a prudent employer will carefully evaluate its decisions on how to classify its employees.

Rosanna Sattler, a member of this newsletter's Board of Editors, is a partner at Posternak Blankstein & Lund, LLP. Her practice includes business litigation, environmental, employment, and insurance coverage disputes. She may be reached at [email protected]. Nancy Puleo is a partner in the firm's Employment and Litigation Department, and focuses on employment disputes. She may be reached at [email protected]. James E. Kruzer is an associate at the firm. He may be reached at [email protected].