In January, the United States Supreme Court refused to consider Microsoft Corporation's appeal of a lower court decision requiring Microsoft to pay damages to a substantial class of "non-permanent" workers whom Microsoft had denied employee stock option benefits. Vizcaino v. Microsoft Corp., 97 F.3d 1187 (9th Cir. 1995)(Vizcaino I), aff'd, 120 F.3d 1006 (9th Cir. 1997)(en banc)(Vizcaino II), Vizcaino v. Microsoft Corp., 173 F.3d 713 (1999)(Vizcaino III), cert. denied, 120 S. Ct 844 (January 10, 2000). The clear message of the Vizcaino rulings, and similar rulings in other cases against ExxonMobil Corporation and ABC-Capital Cities, is that employers must exercise great care in classifying workers as independent contractors, freelancers, contingent workers, temporary workers or some other type of non-employee.
The dispute between Microsoft and its "freelancers" first arose after the Internal Review Service (IRS) determined that Microsoft was required to pay back withholding taxes for the freelancers because they were deemed "common law employees" for withholding and employment tax purposes. In response to the IRS ruling, Microsoft changed the way it dealt with the freelancers by converting some into permanent employees and offering others the option of terminating their employment or continuing to work at Microsoft as employees of an independently owned and operated temporary staffing agency. Those workers who elected to become temporary employees through the staffing agency continued to work the same hours, on the same projects, and under the same supervisors as they did when they held freelance positions before the IRS ruling.
After the IRS's determination, several workers who had been classified by Microsoft as freelancers sought certain benefits that Microsoft provided to its regular employees, including the right to participate in Microsoft's tax-qualified Employee Stock Purchase Plan (ESPP). The workers asserted that they met the eligibility requirements under the subject benefit plans, because the workers met the definition of common law employees. Microsoft denied their claims, and the workers filed a class action lawsuit.
The United States Court of Appeals for the Ninth Circuit agreed with the former freelancers that they were eligible to receive benefits. The Ninth Circuit held that the class of plaintiffs entitled to seek damages must be defined broadly to include any Microsoft worker who worked 20 hours per week or more for at least five months in any year since the end of 1986. This plaintiff class could total well over 10,000 workers. As a result of the Vizcaino rulings, Microsoft is exposed to million of dollars in damages, since the workers are claiming entitlement to purchase Microsoft's stock at a 15-percent discount during a period when the price of Microsoft stock has skyrocketed.
To avoid similar exposure to costly litigation, damages and sanctions that could result from worker misclassifications, employers must exercise care in drafting and administering benefit plans to make sure that all types of workers are properly defined and classified for eligibility purposes. Courts have fashioned different tests for determining which workers qualify as "employees" under various tax and employment statutes.
For example, in determining whether an employer-employee relationship exists under the American with Disabilities Act (ADA), the Internal Revenue Code, Employee Retirement Income Security Act (ERISA) and the National Labor Relations Act (NLRA), courts apply the common law "right to control" test. The right to control test is also adopted by the United States Equal Employment Opportunity Commission in "Enforcement Guidance: Application of EEO Laws to Contingent Workers Placed by Temporary Employment Agencies and Other Staffing Firms." Under the right to control test, determining who is and who is not an employee requires an evaluation of several factors, including:
- whether the worker or the company has the right to control when, where, and how the job is performed
- whether the worker is paid by the hour or the task
- the investment requirements and profit opportunity for the worker
- the level of skill required
- the ability of the worker to work for more than one company at a time, and
- whether the worker or the company supplies the tools and materials
It is important to note, however, that this list is not exhaustive because other factors may be deemed relevant to determining employee status in a particular case.
The second most commonly applied test for an employer-employee relationship is known as the "economic reality" test, which is used to determine employer-employee status under the Fair Labor Standards Act (FLSA) and the Social Security Act and other related statutes. The economic reality test permits a broad examination of circumstances to determine whether the worker is treated as other employees and is dependent on a company for work. A worker is likely to be classified as an employee under this test when:
- performance requires limited investment in facilities and equipment
- the company exercises a high degree of supervision and control
- the worker has limited opportunities for profit and loss
- the worker is required to exercise minimal initiative, judgment and foresight
- the worker's relationship with the company has a high degree of permanence, and
- the worker's services are an integral part of the company's business
Some courts give greater weight to the second "control" factor in applying this test.
Employers considering nontraditional staffing arrangements must engage in a careful analysis of whether to classify the new workers as independent contractors or employees for purposes of complying with various tax and employment statutes as well as the terms of their own benefit plans. The Vizcaino rulings against Microsoft and other similar rulings demonstrate that employers who are not careful in their classification decisions may expose themselves to liability for back taxes, wages and benefits as well as civil and criminal sanctions for years after a simple labeling mistake was made.
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