Alert March 30, 2005

Recent Opinions Clarify New Massachusetts Law Regarding Independent Contractor Classifications

Last year, in a little-noticed amendment to the Massachusetts Weekly Payment of Wages Law (“MWPWL”) embedded within “An Act Further Regulating Public Construction,” the Commonwealth changed the standard for determining whether workers designated by Massachusetts employers as independent contractors are classified properly. The new law, which replaced Massachusetts General Laws, Chapter 149, Section 148B, creates a much narrower standard than the common law “right to control” test or the IRS’s twenty factor test for assessing independent contractor status. It applies to all Massachusetts employers (not just those in the public construction industry). 

There was considerable ambiguity as to the context of the new law’s application. In particular, there was confusion over whether the new standard applied to the classification of workers for state income tax withholding purposes, as suggested by the Office of the Massachusetts Attorney General late last year. A draft Technical Information Release issued by the Massachusetts Department of Revenue (“DOR”) earlier this month indicates that, for state wage withholding purposes, the status of workers as employees or independent contractors will continue to be governed by the twenty factor test used by the Internal Revenue Service. For certain other purposes, such as personnel record-keeping and overtime premium requirements, the more restrictive state standard will apply. Further, according to the Attorney General, the new standard applies to workers’ compensation as well. Workers’ eligibility to participate in their employers’ benefit plans will continue to be governed by the terms of the plans, and plans that define eligibility by W-2 payroll status will not be affected. However, some plans, including plans that define eligibility by reference to the employer’s records of its employees, will be affected by the new state law standard. 

Regardless of which standard applies, the new law significantly increases the consequences of misclassifying workers as independent contractors. 

The MWPWL’s New Independent Contractor Standard  

The statute provides that, in order to be considered an independent contractor: 

  1. the worker must be “free from control and direction in connection with the performance of the service, both under his contract … and in fact”; and
  2. the service must be “performed outside the usual course of the business of the employer”; and
  3. the individual must be “customarily engaged in an independently established trade, occupation, profession or business of the same nature as that involved in the service performed.”

The law creates a presumption that a work arrangement is an employer-employee relationship unless the employer can establish that all three of the above factors are met. The most significant change in the standard is in the second prong of the test – that the work in question must be “outside the usual course of business of the employer.”  Satisfying this test will be practically impossible in circumstances where contract workers are employed on tasks similar to those performed by regular employees.

The IRS Twenty Factor Test

As noted above, the IRS twenty factor test, set forth in IRS Revenue Ruling 87-41, will continue to set the standard for distinguishing an employee from an independent contractor for tax withholding purposes. These factors are designed to measure the degree of independence a worker actually possesses. They include: the nature of the worker’s instruction and training; integration of the worker’s services into the company’s business; whether the services must be rendered personally; whether there is a continuing relationship; how the hours of work are established; whether the work must be performed on the company’s premises; whether regular reports are required; how the worker is compensated; who bears the responsibility for business-related expenses; who furnishes needed tools and materials; whether the worker makes an investment in his enterprise and may realize a profit or a loss; whether she works for more than one firm at a time; whether the worker’s services are available to the general public; and the parties’ respective rights regarding termination of the relationship. A detailed discussion of these factors may be found in our publication entitled “Employing Contingent Workers” which can be accessed via our website at http://www.goodwinprocter.com/publications/LE_contingworker_9_97.pdf. This material also discusses the benefit plan implications of misclassifying workers as independent contractors.

The DOR has indicated that it will accept IRS determinations regarding the status of workers. These determinations are made in response to requests submitted on IRS Form SS-8 (Determination of Employee Work Status for Purposes of Federal Employment Tax Obligations).

MWPWL’s Civil and Criminal Enforcement Provisions

Section 148B(d) provides that if an employer fails to properly classify a worker as an employee “according to this section” and “in doing so fails to comply with” the payment of wages law or any other provision of Chapter 149 (including the state personnel records law, c. 149, Sec. 52C), the minimum wage and overtime provisions of Chapter 151, the workers’ compensation insurance requirements of Chapter 152 or the state tax withholding provisions of Chapter 62B, the employer shall be subject to criminal and civil penalties. Such penalties include debarment from state contracts and fines of up to $25,000 or imprisonment for not more than one year for a first offense. Second offenses can result in fines of up to $50,000 and imprisonment of up to two years. Moreover, the president, treasurer and “any officer or agent having management of the corporation” may be held liable for violations of the law.

According to the Attorney General’s advisory, in addition to civil or criminal proceedings instituted by Attorney General, “[e]mployees also may institute private actions for themselves and others similarly situated for treble damages, attorneys’ fees and costs.”

In light of this significant potential liability, employers should make sure that workers who are classified as independent contractors are timely paid, receive at least the minimum wage, receive one and one-half times their regular rate for hours worked over forty (unless they are paid a fixed salary and are performing work that is exempt from federal and state overtime requirements), and are covered by their workers’ compensation policies (unless covered by the policy of a staffing agency). In such circumstances, assuming correct application of the IRS twenty factor test for tax withholding purposes, a misclassification under the new Massachusetts standard would not result in any liability.

Ambiguities Regarding Tax Withholding Issue Clarified

As noted above, the statute sets forth penalties for employers which fail to properly classify an individual as an employee according to the new standard “and in so doing so fail to comply” not only with Chapter 149 (timely wage payment and record keeping), Chapter 151 (minimum wage and overtime), and Chapter 152 (workers’ compensation), but also with Chapter 62B (the Massachusetts wage withholding law). In his advisory interpreting the new law, the Attorney General appeared to indicate that the law controls worker classifications for purposes of the state tax withholding law. The advisory also alluded to the “improper[] … depriv[ation] of … Social Security contributions and … unfair[] reduc[tion] of federal tax withholding.”

The DOR’s draft Technical Information Release points out that the state tax withholding law (Chapter 62B) has its own definition of “employee,” with specific reference to the definition of that term in the Internal Revenue Code. The DOR reasons that, since the new independent contractor law did not amend Chapter 62B, the definition did not change for state tax withholding purposes.

Potential Implications of New Independent Contractor Standard for Employee Benefit Plans

While the new independent contractor law may, in some cases, have an impact on employee benefit plans, that impact will in any case be indirect and will depend upon a number of factors. By its terms, the law does not purport to require employers to extend benefit plan coverage to individuals who do not satisfy the three-part test (and are therefore considered to be employees for purposes of Chapter 149, Section 148B). Indeed, any such direct attempt to require benefit plan coverage through a state statute would be preempted by federal law in the case of pension plans or other benefit plans covered by the federal Employee Retirement Income Security Act. However, adjustments to employment practices that employers make in response to the independent contractor law could conceivably have a collateral effect on benefit plan coverage depending on the wording of the relevant plan documents. For example, an employer’s plan document may provide that it covers only “employees” who satisfy certain criteria, and may define “employee” for this purpose as any individual who is identified as an employee on the employer’s records. In this case, if the changes to the independent contractor law resulted in the employer identifying as “employees” on its records additional individuals who would not be considered to be employees under the traditional IRS test, those additional “employees” would become eligible for benefits under the terms of the plan document. It therefore is important for employers to review the terms of their plan documents to ensure that plan language will not result in the unintended extension of benefit coverage to these individuals. If employers do not wish to provide benefits to such workers, it may be necessary for them to amend their plans. It also typically would be helpful in this regard to have any agreement with a person classified as an independent contractor contain an express waiver of any right to be covered by any benefit plans of the employer.

Conclusions

Massachusetts employers may continue to classify workers as independent contractors by correctly applying the current federal IRS twenty factor test, provided that they comply with at least the requirements regarding timely wage payment, personnel record keeping, minimum wage, overtime and (according to the Attorney General) workers’ compensation insurance coverage. An incorrect application of the twenty factor test, however, could trigger greater liability under the penalty provisions of the Massachusetts law than would be available under federal law. Accordingly, employers should carefully review their classification of workers as independent contractors under the twenty factor test given the heightened consequences of non-compliance.

Workers’ eligibility to participate in their employers’ benefit plans will continue to be governed by the terms of the plans, and plans which define eligibility by W-2 payroll status will not be affected. Employers should carefully review their benefit plan documents to be sure that the application of the new law does not have unintended consequences in terms of benefit eligibility.

The new law should not have any impact on contract workers employed through staffing agencies, so long as the staffing agency complies with workers’ compensation, wage/hour, withholding and wage payment laws. Companies using these firms to supply workers should insist on evidence of compliance and indemnification for any liability arising out of a failure to comply with such laws.