Independent Contractor And Consultant Rules Tightened In Massachusetts

Determining when a worker can properly be treated as an independent contractor, rather than an employee, has long been challenging for businesses that depend on outside consultants and contractors.

The outcome of traditional analyses depended largely on the degree of financial and behavioral control an employer had, the permanency of the relationship and a variety of other factors related to the economic realities of the arrangement.

But changes to Massachusetts labor law have radically altered the equation. Many outside contractors must now be treated as employees.

Last July, as part of sweeping public construction reform bill, the Massachusetts Legislature enacted a tough new law that imposes strict standards limiting the ability of all employers to classify individuals as independent contractors. The new regulations strengthen the law that creates a presumption that any person performing services for another in Massachusetts is an employee.

Businesses now bear the burden of demonstrating that its consultants are not employees. Employers who are unable to meet this burden of proof face substantial financial exposure, or worse, criminal liability.

The Independent Contractor Law is more than a decade old, but it had been irregularly enforced and little known by those other than wage and hour law specialists. Notably, at least one trial court found an older version of the statute to be unconstitutionally vague. With its recent amendment, the statute has become arguably the most significant, and certainly the toughest, of the handful of different legal standards used to test independent contractor status in various legal contexts.

Three-Part Test

The Independent Contractor Law has been incorporated into the Massachusetts statutes regulating employment and wage payment practices. It contains an inflexible three-part test for evaluating whether a worker may be treated as an independent contractor.

In many respects, its elements are similar to the “ABC” unemployment insurance test, but with a few important differences. First and foremost, however, an employer must be prepared to demonstrate that its independent contractors meet each of the following three parts of the test.

Freedom from direction and control. First, the worker must be free from an employer’s control and direction. Like the better known Internal Revenue Service 20 Factor Test, the Fair Labor Standards Act Economic Realties test, and common law control tests, this analysis is necessarily fact-driven.

In its advisory to the public on the new law, the Massachusetts Attorney General acknowledges that the first part of the new test is similar to these traditional standards. Accordingly, any analysis of an independent contractor’s duties must begin by using these traditional tests.

Outside the employer’s usual business. Part two requires the contractor to deliver a service that is “outside the usual course of business of the employer.” If the contractor provides a service that is identical, or perhaps even similar to that provided by the employer’s business, the worker cannot be treated as an outside contractor. For businesses seeking to keep consultants off their payrolls, this element will often be the most difficult to surmount.

Contractor has independent trade or business. Third, the worker must work regularly in an independently established trade, occupation, profession or business. Also, the service provided to the employer must be similar in nature to this trade, occupation or business.

Courts have made clear that the crucial question here is whether the worker can perform the service for anyone who wishes to use them, or whether the “nature of the business compels the worker to depend on a single employer.” A crucial question to be answered is whether the worker is truly financially independent of the employer.

Significant Legal Liability

There is substantial potential liability under the statute, including civil fines up to $25,000 per violation in civil enforcement actions brought by the state attorney general. It bears noting, however, that employers are liable under the law only, if as a result of the worker misclassification, they also violate a wage and hour or workers compensation standard.

Workers are authorized to bring private civil litigation and may recover triple damages, and their litigation costs and attorney fees. Misclassified employees may sue individually or bring class actions on behalf of others who are similarly situated. Thus, there can be potentially sizeable damages when improperly classified independent contractors are not paid overtime premiums, hours records are not kept, or earned wages are not paid promptly. Also, officers and agents of corporations can be held individually liable for violations.

Five Traditional Legal Standards

Even before Massachusetts’ newest legislation was enacted, there were no less than five different state and federal independent contractor tests covering various discreet areas of the law affecting employment relationships.

The Internal Revenue Service, the U.S. Department of Labor, Wage and Hour Division, the Social Security Administration, the Massachusetts Department of Industrial Accidents, and the state Division of Unemployment Assistance each have separate multi-part contractor standards.

None are as strict as the new statute. However, to properly apply Massachusetts’ new Independent Contractor Law, one must also be familiar with, and understand each of the older independent contractor tests.

Legislative Background For New Law

Several factors appear to have motivated the Massachusetts Legislature to tighten independent contractor standards. Capturing lost tax revenue, controlling spiraling unemployment taxes, curbing workers compensation premium avoidance, and deterring underground economic activity have been long-standing concerns for policymakers.

A 2004 study conducted by Harvard University and the University of Massachusetts, entitled “The Social and Economic Costs of Employee Misclassification in Construction,” focused on independent contractor misclassification in the construction industry, but found that the problem to be pervasive throughout the economy.

The authors estimate that between 125,000 and 248,000 Massachusetts workers annually were improperly classified as independent contractors under the old standards.

The study suggests that between $103 million and $187 million in annual withholding and unemployment tax revenue are lost in Massachusetts alone. At a forum at which they unveiled the study, the authors conceded that they had probably dramatically underestimated the amount of lost tax revenue.

Likewise, the insurance industry has identified worker’s compensation premium avoidance as a major problem. Most states, including Massachusetts, have industry-funded insurance fraud bureaus that focus on prosecuting insurance fraud, including worker’s comp insurance premium avoidance through independent contractor misclassification.

On its website, the Massachusetts Insurance Fraud Bureau, posts a press release trumpeting the criminal prosecution of a Merrimack Valley temp agency for just this kind of fraud.

Independent consulting arrangements offer an array of advantages to employers, who may need to maintain organizational agility and flexibility, while containing payroll and other overhead expenses. Many workers also prefer the arrangement, particularly those who do not desire benefits, and seek a measure of autonomy.

However, the risks associated with hiring outside consultants have grown considerably. Increased care and planning are now essential to successfully structuring any independent contractor relationship.