Employee or Independent Contractor

Employee or Independent Contractor? A Primer on U.S. Law – The Microsoft Case (October 3, 2025)

ANDREW MARQUARDT Chief Executive Officer and General Counsel, Advantage Tech Inc, USA, as published in the International In-House Counsel Journal, January 2025.

In the late eighties and nineties Microsoft’s stock and popularity was soaring. At that time, it was arguably the hottest tech company in history. Microsoft was employing thousands of tech employees and independent contractors to fulfill its business objectives. It was inevitable that Microsoft would be scrutinized for some legal misstep. Hence, the Internal Revenue Service (IRS) started to review Microsoft’s employment records in 1989 and 1990. The IRS wanted to determine if the agency was getting paid the appropriate amount of employer taxes. It would be a problem for Microsoft if the IRS wasn’t getting its fair share of taxes due to Microsoft potentially misclassifying independent contractors. The court determined Microsoft’s independent contractors were employees for withholding and employment tax purposes. Thus, Microsoft would be required to pay withholding taxes and the employer’s portion of Federal Insurance Contribution Act (FICA) tax. Vizcaino v. Microsoft Corp., 97 F.3d 1187 (9th Cir. 1996).

Due to the IRS’s decision, Microsoft strategized how it could avoid this problem in the future. Like many tech companies, it wanted a flexible workforce, so it switched some independent contractors to full-time employees. As for the others, Microsoft offered them working gigs, but through a temporary employment agency. This third-party agency would provide payroll services, perform federal withholdings and pay the employer’s part of FICA taxes. Most individuals accepted the temporary employment option, but some refused and were discharged.

Plaintiffs asserted they were also entitled to Microsoft’s retirement plan benefits due to its misclassification. Microsoft argued paying employer taxes was the extent of its obligation for the misclassification. The court disagreed and ruled the class of plaintiff was also entitled to retirement benefits. Vizcaino v. Microsoft Corporation, 120 F.3d 1006 (9th Cir. 1997) (plan administrator’s reason for denying ERISA benefits determined to be erroneous). This ruling, in part, led to the proliferation of a cottage industry of temporary employment agencies hiring tech employees, then leasing them to corporations who didn’t want the employment obligations. As long as temporary agencies’ benefits came close to mirroring those of the company, the company generally avoided liability. The temporary technical (IT) placement agency business has exploded in that last 35 plus years and boasts billions of dollars in temporary staffing revenue.

FAST FORWARD TO 2025

The U.S. has millions of temporary workers. Most agencies and employers are acutely aware of the Microsoft case and have taken measures to avoid similar financial exposure. The remedy has remained largely the same: hire temporary workers through temporary employment agencies that handle the tax withholdings and provide similar benefits. End of story, right? No. Millions of workers are still classified as independent contractors. The question remains: what can companies do to ensure they are not misclassifying workers? This dilemma arises even if companies are using temporary agencies.

What should companies do to control the narrative around your workers’ employee versus independent contractors’ status? Fundamentally the companies’ best practices should incorporate a combination of written policies, contracts, indemnification clauses, training, and day-to-day treatment of the workers. This paper is intended to help an employer and/or independent contractor to better recognize and resolve potential issues before they become real problems.

Independent contractors are workers who are not dependent on one client for all of their work, they offer their services to a wide range of prospective clients and are not classified as a W-2 employee. Generally, independent contractors control their own work, including when and where to perform it, while using their own equipment. Independent contractors pay their own taxes and are not protected by local, state and federal laws which apply to employees. Furthermore, independent contractors don’t receive company benefits from a client, including health, vacation, and retirement benefits that are afforded to employees.

Contrast these variables with employees. Employees receive many of the items mentioned. These include wages, company benefits, long term employment, oversight and direction from the company, performance evaluations, and are protected by local, state and federal laws protecting employees.

How these individual workers are classified depends on the facts of each specific situation. This involves several tests which have been implemented over the years by various federal agencies and the courts. The application of the tests has become more challenging as the world continues to move from a brick-and-mortar economy to a service-based economy.

THE TESTS

Control Test – IRS

Let’s start with the IRS test. The IRS examines three main factors to determine how the worker should be classified for federal tax purposes. The IRS would never be interested in pursuing these types of claims as long as someone is paying employer taxes, either employer taxes or self-employment taxes. When it files a case, the IRS looks at behavioral control, financial control, and the type of relationship.

The common law test used by the IRS has been implemented by many jurisdictions. It’s a 20-factor test. Career Dev. Ctr. v. Va. Emp’t Comm’n, No. 0420-21-2 (Va. Ct. App. Dec. 14, 2021); and Murray v. New York State, 604 F. Supp. 2d 581 (W.D.N.Y. 2009). The factors are: (1) instructions; (2) training; (3) integration; (4) services rendered personally; (5) hiring, supervising, and paying assistants; (6) continuing relationship; (7) set hours of work; (8) full time required; (9) doing work on employer’s premises; (10) order or sequence of work; (11) oral or written reports; (12) payment by hour, week, month; (13) payment of business and/or traveling expenses; (14) furnishing of tools or materials; (15) significant investment; (16) realization of profit and loss; (17) working for more than one firm at a time; (18) making services available to general public; (19) right to discharge; and (20) right to terminate. IRS, Rev. Rule. 87-41.

The Economic Realities Test

Additionally, several courts have tried to simplify the 20-point control test to a more manageable set of criteria. Courts look to the “economic reality” of the relationship between the alleged employee and alleged employer to determine whether that relationship demonstrates dependence. This inquiry is not governed by the “label” put on the relationship by the parties or the contract controlling that relationship, but rather focuses on whether “the work done, in its essence, follows the usual path of an employee.” Scantland v. Jeffry Knight, Inc., 721 F.3rd 1308, 1311-12 (11th Cir. 2013). The following six factors serve as guides in applying the economic reality test:(1) the nature and degree of the alleged employer’s control as to the manner in which the work is to be performed; (2) the alleged employee’s opportunity for profit or loss depending upon his managerial skill; (3) the alleged employee’s investment in equipment or materials required for his task, or his employment of workers; (4) whether the service rendered requires a special skill;(5) the degree of permanency and duration of the working relationship; and (6) the extent to which the service rendered is an integral part of the alleged employer’s business. Id. Furthermore, the Scantland court noted: No one factor is controlling, nor is the list exhaustive…The weight of each factor depends on the light that it sheds on the putative employee’s dependence on the alleged employer, which in turn depends on the facts of the case. Id. at 1312 n.2. The Scantland court made clear that “the overarching focus of the inquiry is economic dependence.” Id. at 1312. See also,Vaughan v. Document Grp., Inc., 250 F.Supp. 3d 236, 242 (S.D. Tex. 2017); Kiseleva v. Greenspan, 23-CV-9496 (VEC), at *2 n.2 (S.D.N.Y. Oct. 31, 2024) and Hopkins v. Cornerstone Am., 545 F.3d 338, 343 (5th Cir. 2008); and Fares v. H, B, & H, LLC, No. 21-CV-753 (E.D. Wis. June 14, 2023).

The Common Law Darden Test

A third, yet similar, test is one that examines the traditional master servant agency laws in determining if a worker is an employee and thus has standing to file a discrimination claim. Nationwide Mut.Ins.Co. v Darden, 503 U.S. 318, 323, 112 S.Ct. 1344 (1992); O’Connor v. Davis, 126 F.3d 112 (2d Cir. 1997). These include claims under Title VII, the Americans with Disabilities Act (ADA), the Age Discrimination in Employment Act (ADEA), the Affordable Care Act (ACA) (Mohammed v. Sidecar Techs. Inc., No. 16 C 2538 (N.D. Ill. Nov. 10, 2016)), and the Employee Retirement Income Security Act (ERISA). See Shah v. Deaconess Hospital, 355 F.3d 496 (6th Cir. 2004); Bredesen v. Tenn. Judicial Selection Comm’n, 214 S.W.3rd 419, 430 (Tenn. 2007); and McFarland v. W. Express, Inc., 3:23-cv-00630 (M.D. Tenn. Oct. 23, 2023).

The relevant factors include: (1) the skill required; (2) the source of the instrumentalities and tools; (3) the location of the work; (4) the duration of the relationship between the parties; (5) whether the hiring party has the right to assign additional projects to the third party; (6) the extent of the hired party’s discretion over when and how long to work; (7) the method of payment; (8) the hired party’s role in hiring and paying assistants; (9) whether the work is part of the regular business of the hiring party; (10) whether the hiring party is in business; (11) the provision of employee benefits; and (12) the tax treatment of the hired party. Darden, at 323.

The State ABC Test

This can be a narrower test than the federal equivalents. The presumption is that there is an employment relationship, and the burden is on the company to show otherwise. Considered are:

A. Absence of Control. The worker is free from control and direction over performance.

B. Business of the Worker. The worker is either outside of the normal course of business for the client company or performed outside of any of that company’s places of business.

C. Customarily engaged. The worker is usually engaged in an independently established trade, occupation, profession or business.

See Olson v. California, 104 F.4th 66 (9th Cir. 2024); Cal. Trucking Ass’n v. Bonta, 996 F.3d 644 (9th Cir. 2021);Gonzalez v. XPO Last Mile, Inc., 579 F. Supp. 3d 252 (D. Mass. 2022);; Ludlow v. Flowers Foods, Inc., 18cv1190-JO-JLB (S.D. Cal. July 5, 2022). See also, Patel v. 7-Eleven, Inc., 240 N.E.3d 765 (Mass. 2024)(ABC test codified into state law); Sw. Appraisal Grp., LLC v. Adm’r, Unemployment Comp. Act., 324 Conn. 822 (Conn. 2017)(ABC test codified into state law).

Reconcile the Various Tests

Is there a need for so many tests? No. At their core, they examine two issues: (1) control by the employer weighed against (2) the workers’ independence. Many courts argue the ABC test is much narrower than IRS control test, and thus creates a higher burden for the company. The IRS test is still cited more than most other tests and thus is the best default test to use. It contains a number of fact specific considerations and considers the whole relationship. Like most court decisions, the chosen test depends on the makeup of the court. A jurisdiction which is more business friendly will attribute greater significance to facts which help the company, and the inverse is true as well. Employee friendly courts grant greater weight to facts which favor the employee. This leads to forum shopping which is nothing unique in American jurisprudence. Even so, there is plenty companies can do to insulate itself from the legal blows associated with the issue.

BEST PRACTICES

Any company under the right set of circumstances could be caught in the crosshairs of an investigation. Normally these cases are brought by a federal agency representing hundreds if not thousands of workers, or they could be a single plaintiff looking to reap the benefits of employee status. While no one is exempt from suit, there are several industries which are more prone to be investigated. These include the following: childcare; home health care; internet services; restaurant and catering services; staffing services; hotels and motels; construction; transportation; cable companies; janitorial services; landscaping and nurseries; delivery drivers; security services; and nurses.

There are several steps a company should take to cement its defense. Clearly written documents are a good start. It’s important to state that the relationship is an independent contractor arrangement in an engagement agreement. Several courts have reminded the public a written designation alone is not dispositive but is given significant weight. See William Two v. NAPA Transp., Civil No. 1:17-CV-02222, at *12 (M.D. Pa. Sep. 8, 2020)(The agreement, while not dispositive of the plaintiff’s employment status, is strong evidence that she was an independent contractor); Holtzman v. World Book Co., Inc., 174 F.Supp.2d 251, 256 (E.D.Pa. 2001); see also Adcock v. Chrysler Corp., 166 F.3d 1290, 1293 (9th Cir. 1999); and Brown v. J. Kaz, Inc., 581 F.3d 175, 181 (3d Cir. 2009). The company should include some references from the IRS 20-point test such as ownership and control of tools, control of schedule, and a description of work milestones. For example, construction subcontractors are not generally controlled by the general contractor, rather they are tasked with completing a description of work and get paid when the work is done. Some might get paid half up front and half upon completion, but none are getting paid by the hour. If they are, that fact would obviously lean in favor of the worker. Think of Uber drivers. There have been cases where the drivers wanted to be labeled as “employees”, but the courts have denied the claims stating the drivers use their own cars and control their own schedules.

As part of the agreement, require independent contractors to complete a W-9 Form. This provides an upfront acknowledgement the payment will be 1099 income and the workers will have to file their own self-employment taxes. Then require them to produce their tax returns so you can validate self-employment taxes are being paid. If your subcontractor employs another layer of subcontractors in its chain of workers, ask them to identify which ones are w-2 versus 1099 subcontractors. It’s doubtful a subcontractor working for your general contractor would have the ability to run a claim up the chain past their employer and get to the top company.

Next, the agreement should contain an indemnification clause. For example, staffing companies are frequently required to sign master services agreements with their clients which state in the event the client is determined to be liable for any employer obligations resulting from personnel placed by the agency at the client site, the agency will indemnify and hold the client harmless. This is a direct result of concern clients have about being a considered a “joint employer” with the staffing agency and thus liable for employer obligations.

Beyond the scope of the engagement agreements are several practices which would help. First, keep contractor and employee files separate. Second, don’t reimburse independent contractors for business expenses. Third, do not provide employee-like benefits (ie, don’t invite contractors to company events, do not provide them uniforms). Fourth, provide training to managers which provide distinctions regarding what can be managed or not managed. Fifth, provide guidelines distinguishing the employee handbook from independent contractor agreements. Sixth, do not provide business cards or job titles. Seventh, avoid using anyone from the human resources department to initiate or end the independent contractor arrangement. Eighth, review independent contractor performance as if it’s a basic breach of contract problem. Ninth, perhaps review what the competition is doing. Tenth, be sure to audit the agreements from time to time. Eleventh, focus on the result, the milestone articulated in the agreement, not hourly review. On balance companies should do their best to have written documents, policies, and practices to ensure compliance and avoid disruption to culture and business which can result from treating contractors as employees.

Here is a list of companies evaluating various elements of the tests identified above and finding in favor of the company and their proper and appropriate treatment of workers as independent contractors. See Glascock v. Linn Cnty. Emergency Med., PC, 698 F.3rd 695, 698 (8th Cir. 2012) (Title VII and the ADEA cover only employees, not independent contractors); Alexander v. Avera St. Luke’s Hosp., 768 F.3rd, 756, 761 (8th Cir. 2014) (ADEA); Tipton v. Barr, No. 6:17-03179-CV-RK, at 3 (W.D. Mo. Dec. 11, 2019); Anyan v. New York Life Ins. Co., 192 F.Supp. 2d, 228, 238-39 (S.D.N.Y. 2002) (hired party was deemed an independent contractor where he was not required to work from hiring party’s offices, received no benefits and was not taxed as an employee); State ex rel. Curtin v. Ohio Pub. Emps. Retirement Sys., 10th Dist. No. 09AP–801, 2011-Ohio-2536, 2011 WL 2112498, ¶ 28 (assistant city income tax administrator was paid a fee for services, did not receive fringe benefits, provided many of his own supplies, and received form 1099 for tax purposes); State ex rel. Peyton v. Schumacher, 10th Dist. No. 00AP–78, 2000 WL 1715901, 2 (person who hauled gravel for two townships did not maintain regular hours, did not receive fringe benefits, was paid by the amount hauled and not an hourly wage or salary, and provided his own truck for hauling). Mitchell v. Tex. Farm Bureau, Civil Action H-20-3716, at 12 (S.D. Tex. May 26, 2022), citing Hickey v. Arkla Indus., Inc., 699 F.2d 748, 753 (5th Cir. 1983) (the ADEA does not protect independent contractors because they are not employees); Hargrave v. AIM Directional Servs., No. 21-40496, at 8 (5th Cir. May 11, 2022) citing Carrell v. Sunland Const., Inc., 998 F.2d 330 (5th Cir. 1993)(concluding pipe welders’ “specialized skills” supported independent contractor status) and Hargrave v. AIM Directional Servs., No. 21-40496, at *8 (5th Cir. May 11, 2022), citing Brown v. J. Kaz, Inc., 581 F.3d 175, 179 (3d Cir. 2009)(not an employee for Title VII purposes) and Brugh v. Mount Aloysius Coll., 432 F. Supp. 3d 566, 586 (W.D. Pa. 2020)(not an employee).

CONCLUSION

Don’t be overwhelmed! The application of the variables can be a dizzying experience. At its core the decision is based on the company’s legitimate levels of control while allowing independent contractors to control their work, schedule, tools, and independent thought. The more a company dictates the methods of work, the more the worker looks like an employee. Even so, the company should have its independent contractors sign indemnification agreements, which should be backed by insurance. That’s easier said than done but it helps. Finally, when all else fails, use your common sense.

#GeneralCounsel #Attorney #Lawyer #EmploymentAttorney #EmploymentLaw #IndependentContractors #CoEmployment #Executive #CEO #InternationalInHouseCounselJournal #AdvantageTech

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Andrew Marquardt has been an attorney for over 30 years. His experience includes litigating employment lawsuits representing plaintiffs and defendants. These cases included non-compete litigation, tort and contract claims, as well as discrimination suits. In addition to driving the claims through trial, most disputes were resolved through mediation and arbitration.

Mr. Marquardt is also the co-founder, CEO, and General Counsel of Advantage Tech for the past 26 years. In that capacity, he has drafted, executed, and implemented hundreds of employment agreements. The joint employment doctrine, non-compete law, and leadership are just a few issues Mr. Marquardt has addressed in his company and written about to assist clients and employees.

Advantage Tech, is an IT and professional services firm founded in 1997 by Andrew Marquardt and David O’Brien. Advantage Tech places on average 400 contract and full-time employees each year, which translates to several thousands of placements over the past 26 years. During that time, Mr. Marquardt has hired and terminated hundreds of employees and has drafted and overseen the implement of hundreds of employment agreements. Significant employment issues frequently materialize when dealing with a contingent workforce. Dozens of issues arise relating to any number of clauses. However, the one clause which has created the most consternation with the courts has been the non-compete clause in employment agreements.

*This content is for informational purposes only and is not legal advice.*

Andrew Marquardt, Founder, CEO and General Counsel Advantage Tech, Inc. 5330 College Blvd Overland Park, KS 66211

www.advantagetech.net

andrew@advantagetech.net