Regular W-2 employees are entitled to numerous benefits and protections under the law, including overtime pay, unemployment insurance, sick leave and, for many employers, health insurance. Employers are also subject to punitive damages for breaking many of the laws applicable to W-2 employees. But independent contractor status has its benefits too – an oftentimes higher base pay in lieu of undesirable benefits, the ability to work as much or as little as one desires, and favorable tax treatment for employer and employee alike. Far too often, however, companies decide whether or not to classify their sales representatives as W-2 employees or 1099 contractors based strictly on financial considerations. Many companies are especially convinced that they can avoid the obligations due to W-2 employees by contracting for outside sales or marketing services with another incorporated business – even if the business is an individually-owned pass through entity with no other customers or employees. Unfortunately, this is simply not the case.
Massachusetts imposes one of the most restrictive tests in the country for determining whether a person can be legally classified as an independent contractor. All individual workers are presumed to be W-2 employees unless the employer can demonstrate that (1) the individual is free from control and direction in connection with the performance of the service both under his contract, and in fact, (2) the service is performed outside the usual course of the business of the employer; and (3) the individual is customarily engaged in an independently established trade, occupation, profession or business of the same nature as that involved in the service performed. Meeting the second prong of this test – that is, demonstrating that the alleged contractor’s service is not part of the employer’s usual course of business – is especially difficult with respect to sales and marketing representatives because generating sales is an integral part of most businesses.
The recent Massachusetts case of Valle v. Powertech Industrial Co. Ltd. implies that the only situation in which a sales or marketing representative may be properly classified as an independent contractor is when a company has moved its sales or marketing operations entirely “out of house.” In the Powertech case, the Court emphasized that product sales were squarely within the usual course of Powertech’s business, as the company employed seven regular W-2 employees within an “in- house” sales department that was responsible for the bulk of company sales. Their responsibilities were substantially similar to that of the plaintiff, who had signed an independent contractor agreement with Powertech in the name of his own incorporated business (which had few if any other clients, and no employees) and was paid purely off of sales commissions. The court ruled that the “realities of [Powertech’s] actual business operations” demonstrated that product sales were part of the company’s regular course of business, and that Powertech had unlawfully classified the plaintiff as an independent contractor. The Court’s ruling also meant that the plaintiff was free to pursue overtime claims and punitive damages for any unpaid commissions against Powertech.
The Powertech case is a helpful reminder that employers with any questions or concerns about employee classification should consult with a seasoned employment attorney before entering into any independent contractor arrangements that could come back to haunt them years later.