Microsoft’s ongoing legal battle with the federal government over its right to bundle certain software products has become something of a spectator sport in some business circles. But a far-less-celebrated court case involving the classification of independent contractors, in which the software giant recently took it on the chin, probably has more implications for the prospects of most companies.
Last year, Microsoft lost a case brought in federal court by a group of workers who challenged the company’s classification of their services as independent contractors. They won their case in an appeals court despite the company’s explicit offer of higher-than-normal pay in exchange for not offering fringe benefits. When the U.S. Supreme Court recently refused to hear an appeal of that decision, it effectively left in place what some see as a worrisome new policy statement which could open Pandora’s box.
“The decision has sent a chill through the employee benefits community,” attorney Ron Kahn of the Cleveland law firm Ulmer & Berne LLP recently observed in the firm’s newsletter. What the decision might ultimately mean is that “the substance of an employment relationship will usually govern over the form in which it is packaged.”
In an interview, Kahn, chair of the firm’s business/tax department and a former general chairman of the Cleveland Tax Institute, notes that the case has serious implications not only for those companies that employ independent contractors but also for those which lease employees and even those that employ part-timers. But in most cases, the court decision suggests, the problem can be remedied simply through more careful drafting of employment plans and other documents.
The ruling, which technically establishes a precedent only in the western region where the San Francisco-based Ninth Circuit appeals court has jurisdiction, is also expected to reinvigorate the Internal Revenue Service’s 20-question test for judging whether a worker should be considered an employee for tax purposes (see box). First added to the tax code 20 years ago, the test actually has common-law roots which date back much further. Crucially, the tax-collecting agency has always taken the view that an employer need not actually exercise control over a worker in order for him or her to be classified as an employee, but merely retain the right to do so.
While Kahn agrees that the 20-question test will be given renewed attention in the wake of the Microsoft case, he argues that the key question of whether a worker is an employee under the law is even simpler than that. “Are they subject to the direction and control of the employer? If they are, then they’re likely to be classified as an employee.”
The IRS 20-question test
Is the person providing services required to comply with instructions about when, where and how the work is to be done?
Is the person provided training to enable him/her to perform a job in a particular method or manner?
Are the services provided integrated into the business’s operation?
Must the services be rendered personally?
Does the business hire, supervise or pay assistants to help the person performing the services under contract?
Is the relationship between the individual and the person he/she performs services for a continuing relationship?
Who sets the hours of work?
Is the work performed at the place of the business of the potential employer?
Who directs the order or sequence in which the work must be done?
Are regular written or oral reports required?
What is the method of payment-hourly, commission or by the job?
Are business and/or traveling expenses reimbursed?
Who furnishes tools and materials used in providing services?
Does the person providing services have a significant investment in facilities used to perform services?
Can the person performing the services realize both a profit and a loss?
Can the person providing services work for a number of firms at the same time?
Does the person make his/her services available to the general public?
Is the person providing services subject to dismissal for reasons other than nonperformance of contract specifications?
Can the person providing services terminate his/her relationship without incurring a liability for failure to complete a job?
