By Jenifer M. Mortell, Esquire
Many of you engage independent contractors one way or another in operating your business. Historically, businesses used a twenty (20) factor test issued by the IRS to determine whether a person would be treated as an employee or an independent contractor. In July of 2004, the Massachusetts Legislature passed a new law to govern independent contractors. We are waiving the flag; this law has significant ramifications for any business that uses independent contractors. The law clarifies which workers may be classified as independent contractors and expands the presumption of employee status. The new Independent Contractor Law excludes far more workers from independent contractor status, and is far more stringent than the federal law that considers twenty (20) factors to determine whether an employee/employer relationship exists for federal tax withholding purposes. It is a tough law that impacts all employers. The new law clearly applies to unemployment compensation contributions, worker's compensation contributions and wage and overtime laws, however, at this time, we are still unsure as to whether or not it applies to Massachusetts' withholding taxes. Confused? Keep on reading.
The new Independent Contractor Law creates a presumption that a work arrangement is an employer-employee relationship unless the party receiving the services (employer) can establish that three factors are present.
1. Freedom from Control. The worker must be free from the presumed employer's control and direction in performing the service, both under a contract and in fact. To be free from an employer's direction and control, a worker's activities must actually be carried out with independence and autonomy. For instance, the independent contractor completes the job using his or her own approach without instruction and also dictates the hours that he or she will work on the job.
2. Service Outside the Employer's Usual Course of Business. The service provided by the worker must be outside the employer's usual course of business. Therefore, a worker providing the same type of work that is part of the normal service delivered by the employer may not be treated as an independent contractor. If you own a trucking company and hire a truck driver, he may not be classified as an independent contractor. If you have a CPA firm and hire an additional CPA during tax season, he or she may not be classified as an independent contractor.
3. Independent Trade, Occupation or Business. The worker must be customarily engaged in an independent trade, occupation, profession or business. An independent contractor will usually represent him or herself to the public as being in business to perform the same or similar services. Ordinarily, an independent contractor has characteristics of an independent business enterprise. For instance, the independent contractor uses their own supplies, has business cards for their services, and makes their own hours.
This rigid, three-part test requires proof that the worker meets all three of its requirements. Obviously many independent contractors are not going to meet these tests and will be deemed employees. If he or she is an employee, it is for purposes of Massachusetts' worker's compensation, unemployment compensation and wage laws. An employer's failure to contribute to unemployment compensation, or provide worker's compensation may not be considered when analyzing whether an employee has been appropriately classified as an employee or independent contractor. Therefore, an employer's subjective belief that a worker should be classified as an independent contractor has limited relevance under the Independent Contractor Law.
The rationale behind the new law is that employers that improperly classify employees as independent contractors deprive these workers of proper Social Security contributions, worker's compensation insurance and other benefits, while also unfairly reducing the employers' state and federal tax withholding, and related obligations. The Commonwealth of Massachusetts wants to be able to collect as much tax as possible, and protect businesses that bear higher costs in complying with the law.
The Massachusetts Department of Revenue (DOR) has issued a Technical Information Release (TIR) draft that indicates that the new narrower view of independent contractors will not be used for state wage withholding purposes. As the TIR was only a draft, we will keep you informed of the final decision from the DOR. The DOR release only relates to the withholding of tax on wages, it does not impact whether or not an employer will be required to abide by unemployment compensation, worker's compensation and other wage laws.
An employer violates the law when he or she classifies or treats a worker as an independent contractor although the worker does not meet each of the criteria identified in the three-factor test, and, in receiving services from the worker, the employer violates one or more of the wage and hour and/or worker's compensation statutes.
The Attorney General is authorized under the new law to issue a civil citation or institute criminal prosecutions for both intentional and unintentional violations of the Independent Contractor Law. Violations carry a potential maximum penalty of up to Fifty Thousand ($50,000) Dollars per civil violation, as well as prison time and criminal fines for criminal violations, and debarment from work on public projects. The Independent Contractor Law creates broad liability for both business entities and individuals, including corporate officers, and those with management responsibility over the workers impacted. Employees may also institute private civil actions for themselves and others similarly situated for triple damages, attorneys fees and costs.
At this point, we do not know how the Massachusetts courts will interpret the new law, in particular the "usual course of business" prong of the test. The Supreme Judicial Court of Massachusetts has not yet ruled on any cases that involve the new law. If the SJC does rule on the new law, it may provide employers with additional guidance. We will continue to follow any and all developments.
Employers need to re-evaluate their current independent contractors to determine if the worker meets the three-factor test. The Attorney General recommends that, for each worker an employer treats as an independent contractor, a signed contract is in place that addresses each of the three factors mentioned above. Employee handbooks and benefit documents may need to be amended to describe a new category of employment status: "limited purpose employee." Such an employee would not receive health benefits or 401k contributions, however, the employer would need to contribute to worker's compensation, unemployment insurance and follow wage and overtime laws for the employee. If you have questions or are confused, please call us for guidance.