What can we learn from Microsoft's court loss on independent contractors?
Dateline: 07/28/97Last week the 9th Circuit Court of Appeals in San Francisco reversed the decision of a Seattle-based US district court judge. The Court ruled that Microsoft should have offered the same benefits to independent contractors and temporary employees as it provided its employees. The case was sent back to the District Court to decide which former workers should be included in the settlement.
Background
The ruling stems from a suit filed by eight former Microsoft workers in 1993 who wanted to participate in the company's lucrative stock purchase plan. The case was later certified as a class-action suit covering at least 800 former workers.
Microsoft had already accepted an Internal Revenue Service (IRS) ruling in 1990 that required it to pay withholding and Social Security taxes for employees incorrectly classified as independent contractors and free-lancers. Microsoft argued that these individuals were not entitled to participate in the employee stock purchase and 401K plans. These individuals then sued. That suit led to the current Court ruling.
Cost to Microsoft is uncertain
There is a difference of opinion as to how many individuals are covered by this ruling. Microsoft claims the ruling only applies to workers hired before 1990. The individuals who filed the suit were all hired between 1987 and 1990, but their attorney interprets the decision as covering every independent contractor and temporary employee at Microsoft.
Key issue
The IRS based its ruling on the type of work the workers did and how much control they had over how they did their work. The IRS tests for whether a worker is an employee or an independent contractor are spelled out in Section 530 of the tax code. (Here is a link to the IRS information about Section 530 and independent contractor status.)
If a worker has virtually no control over how his/her work is done, that worker is an employee. What title the company chooses to give them, i.e., independent contractor, does not matter.
Effect of this new ruling
For several years it has been apparent that incorrectly classifying workers as independent contractors can be expensive for companies who are "caught" by the IRS. In addition to having to pay back taxes, the companies have had to pay interest and penalty. This new ruling extends the potential costs.
In addition to past taxes, companies could now be held liable for any benefits provided to its employees and not extended to other workers. If those workers were later found to have been incorrectly classified, a company could be liable for medical payments, tuition assistance, retirement funding, etc., which it offered to its regular employees, but not to other workers.
Advice to Consider
This ruling increases the potential risk to a company of incorrectly classifying its workers, regardless of whether or not the error was intentional. Your company would be well advised to follow Microsoft's example. In 1990, Microsoft eliminated virtually all independent contractors.
Microsoft now hires those individuals through outside employment agencies ("job shops"). The only independent contractors left are specific consultants who overwhelmingly meet the IRS's Section 530 tests.
Take a hard look at the "consultants" your operation engages. Do they meet the 20 tests to be considered independent consultants for tax purposes? If not, the cost of keeping these workers as consultants rather than employees could be overwhelmed by the cost of back taxes, penalty, and interest.
John --
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