United States: For Massachusetts Employers: Distinguishing Between Independent Contractors And Employees

Employers are wise to heed the Fair Labor Division's advisory on compliance with the Massachusetts Independent Contractor Law.

In the midst of the current financial turmoil and uncertainty, many U.S. companies are looking for ways to cut costs. Some companies have considered reclassifying employees as independent contractors to cut payroll taxes and insurance costs. Reclassifying employees in this manner is not a good solution unless the employees legitimately qualify as independent contractors under U.S. state and federal law. In Massachusetts, it will be nearly impossible for employers to properly reclassify employees.

In May 2008, the Massachusetts Attorney General's Fair Labor Division issued an advisory to assist employers in complying with the Massachusetts Independent Contractor Law, M.G.L. c. 149, § 148B. The advisory came on the heels of the governor's March 2008 executive order establishing a new task force to aid the attorney general in enforcing the law. The law, which was revised substantially in 2004, provides that Massachusetts workers are presumed to be employees (rather than independent contractors) unless they are able to satisfy a rigorous three-prong test. While the revised law is now three years old, the attorney general and the governor have recently indicated that enforcement of the law is a top priority.

Employers are wise to heed the advisory, particularly given the new enforcement priority and the potential penalties for misclassifying an employee as an independent contractor, which include both fines and jail time for the offending employer. Businesses should be aware of the law's stringent three-prong test and should ensure that their workers are properly classified to avoid the harsh consequences of misclassification.

The Three-Prong Independent Contractor Test

The law's three-prong test provides that a Massachusetts worker is properly classified as an independent contractor only if the following apply:

• The individual is free from control and direction in connection with the performance of the service, both under his or her contract for the performance of service and in fact.
  
  
• The service performed is outside the usual course of the employer's business.
  
  
• 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.
  
  

In determining whether a worker passes this three-prong test, the attorney general's office will consider and balance numerous factors discussed below, but will always start with the presumption that each worker is an employee. The employer bears the burden of showing that the worker meets the requirements of an independent contractor.

First Prong – "Free from Control"

Under the first prong of the independent contractor test, the attorney general's office will consider factors such as whether and to what extent the worker is receiving instructions on how to perform his or her work, whether the employer is training the worker and whether the employer is dictating the hours during which the work must be performed. The more control and direction the employer exerts over the worker, the more likely it is that the worker will be considered an employee. Some employers attempt to prove that the worker is "free from control" by stating in the worker's contract or job description that he or she will be working without direction or supervision. While an employer can use such documents to help meet its burden under the first prong of the test, such documents alone will not provide sufficient proof. The attorney general's office focuses on the reality of the relationship between the employer and the worker, regardless of how it is described on paper.

Second Prong – Outside the Employer's Usual Course of Business

Under the second prong of the independent contractor test, the worker cannot be performing work that is similar to the type of work usually conducted by the employer. This very strict and bright line rule is a change from the pre-2004 statute. Under the prior rule, an employer could hire an independent contractor to perform work within the employer's usual course of business as long as the independent contractor worked in a space that was physically distinct from the employer. There is no longer any such provision in the statute, and any worker who performs work of the type regularly performed by the employer will be considered an employee. In determining whether an employer has met its burden under the second prong, the attorney general's office will consider whether the worker is carrying out services that are distinct, separate and incidental to those the employer provides in its usual course of business. If the worker's services are necessary to the employer's business, that will be a strong indication that the worker is an employee.

Third Prong – Available to the General Public

Under the third prong of the independent contractor test, the worker must conduct, or be able and available to conduct, the same type of work he or she is performing for the employer for others. The attorney general's office will consider whether the worker is able to work for more than just the employer and also whether the worker is dependent on the employer for continued services. In other words, would the worker survive financially if the relationship with the employer was terminated? In order to be an independent contractor, the worker must hold himself or herself out to the public as an independent contractor whose services are not available only to a single employer.

Indicators of Misclassification

In its recent advisory, the attorney general's office indicated that the following factors are "strong indications of misclassification" that will warrant investigation and, if necessary, enforcement:

• "Individuals providing services for an employer that are not reflected on the employer's business records;
  
  
• Individuals providing services who are paid 'off the books', 'under the table', in cash or provided no documents reflecting payment;
  
  
• Insufficient or no workers' compensation coverage exists;
  
  

• Individuals providing services are not provided 1099s or W-2s by any entity;
  
  
• Contracting entity provides equipment, tools and supplies to individuals or requires the purchase of such materials directly from the contracting entity; and
  
  
• Alleged independent contractors do not pay income taxes or employer contributions to the Division of Unemployment Assistance."
  
  

(See An Advisory from the Attorney General's Fair Labor Div. on M.G.L. c.149, s. 148B, 2008/1.)

The three-prong test is very strict, and fewer workers can legitimately be classified as independent contractors than could under the pre-2004 version of the law. In fact, it is so strict that some commentators have noted that the law as it is currently written could require that business-to-business relationships be reclassified as employer-employee relationships. For example, if a construction company subcontracts with another company to complete a project, the law could likely require that to be an employer-employee relationship because the subcontractor performs the same type of business as the construction company. Fortunately, the attorney general's office has indicated that, at this time, it does not intend to apply the statute to business-to-business relationships as long as the workers of both companies are properly treated as employees.

Penalties for Misclassification

The penalties for misclassifying an employee as an independent contractor can be very steep, and can include both civil and criminal penalties. For example, a willful misclassification is punishable under the law by a fine of up to $25,000 or up to one year in jail. Even a mistaken misclassification can result in a penalty of up to $10,000 or six months in jail for the first offense. Moreover, when an employer misclassifies an employee as an independent contractor, it also violates other Massachusetts and federal statutes, such as those that govern minimum wage and overtime, employer recordkeeping requirements, income tax withholding and workers' compensation insurance. The violations for these additional laws, and their accompanying penalties, can quickly add up for unsuspecting employers who inadvertently misclassify their employees.

For example, during the summer of 2007, the attorney general's office began investigating a large U.S. courier and freight company after one of its drivers filed a complaint. In December 2007, the attorney general's office fined the company more than $190,000 after concluding that it had intentionally misclassified 13 employees as independent contractors. The attorney general's office cited the company for misclassifying its drivers, failing to provide proper paystubs, failing to provide workers' compensation insurance, failing to compensate the drivers for overtime they worked and neglecting to make the appropriate state income tax deductions. In addition to the fine, the company was required to rectify the violations and pay restitution to the 13 drivers.

Misclassifying employees as independent contractors under Massachusetts law could have federal law consequences as well. The attorney general's office has indicated that, because employers do not pay taxes for independent contractors as they do for employees, it communicates the findings from its independent contractor investigations to the Internal Revenue Service (IRS). While the test for independent contractors in Massachusetts is not the same as the 20 Factor Test used by the IRS, information that an employer is misclassifying employees under the Massachusetts statute could prompt an independent investigation by the IRS that could have devastating financial consequences. For example, the IRS recently fined a large U.S. courier and freight company $319 million dollars for misclassifying employees as independent contractors.

Conclusion

The governor and the attorney general are focusing significant resources on enforcing the law. Given the serious consequences for misclassifying workers, employers in Massachusetts should not reclassify employees as independent contractors to save costs, and should consider re-evaluating any and all workers currently classified as independent contractors to ensure compliance with the law.

Click here to view the full text of the advisory.

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