The Dangers of Misdassifying “Employees”: Microsoft Litigation Emphasizes Distinctions Between Employees and Nontraditional Workers

The Dangers of Misdassifying “Employees”: Microsoft Litigation Emphasizes Distinctions Between Employees and Nontraditional Workers

In the past decade, businesses, for reasons such as greater flexibility and lower total costs, have increased their use of nontraditional workers such as independent contractors and temporary agency employees. The Internal Revenue Service’s crackdown on misdassify- ing “employees ” slowed this growth. Additionally, recent lawsuits by nontraditional workers against employers such as Microsoft Corporation have resulted in some client employers being forced to pay more beneflts to nontraditional employees because of employment mis- classiflcation and coemployment rulings. Such rulings might reduce or even eliminate the use of some types of nontraditional employees. This paper analyzes the vast array of types of workers that have evolved into the nontraditional workforce and the difficulty ofdefln- ing “employee ” with respect to entitlement to employer benefits. Possible recommendations for employers include auditing present use of nontraditional workers, accurately classifying employees, and taking proper actions to minimize problems in the future.

KEY WORDS: Microsoft permatemp litigation; nontraditional worker; employee misclassification; employee benefits; coemployer.


In the 1990s, some nontraditional workers sued Microsoft Corporation for benefits that Microsoft was paying to its regular employees but not to them even though they were doing the same or similar work. Recently, Microsoft agreed to pay a record $97 million settlement in that case. The Microsoft settlement “is expected to have far-reaching consequences for corporate America… it could be a ‘nightmare.'” (Lawrence & Robinson, 2001, p. 8). This paper will look at the types of nontraditional workers, problems in defining what is an “employee,” the Microsoft lawsuits and similar legal cases, and what can be done to minimize problems in this area.

A number of recent forces have converged to produce concerns for employers who use nontraditional workers. One, a historically lengthy period of economic expansion in the

‘Dr. Robert B. Pamplin, Jr., School of Business Administration, University of Portland, Portland, Oregon. ^To whom correspondence should be addressed at Dr. Robert B. Pamplin, Jr., School of Business Administration, University of Portland, 5000 N. Willamette Boulevard, Portland, Oregon 97203; e-mail:


0892-7545/01/1200-0165/0 © 2002 Plenum Publishing Corporation

166 Kondrasuk, Reed, and Jurinski

United States during the 1990s created an unprecedented need for additional employees in our labor force. This spawned the strong growth of different types of nontraditional workers (often referred to as “the contingent labor force”). Second, the Internal Revenue Service (IRS) is cracking down on employers trying to pay fewer taxes by classifying their workers as other than regular full-time employees. And third, some of the nontraditional labor force workers have filed lawsuits seeking benefits that their regular employee counterparts receive, and, in the famous Microsoft case, they have prevailed.

The IRS has estimated that 14% of employers misclassify workers to cut their taxes (Staff, 2000). Boes and Ransom (1998) have pointed out that the IRS is increasingly ruling against employers for misclassifying workers as nontraditional workers such as “indepen- dent contractors” when they should be classified as “employees.” The IRS prefers to have workers classified as “employees” because (1) efforts to collect money for taxes from in- dependent contractors are delayed and harder than from employees (because employers withhold money for taxes from employee paychecks) and (2) independent contractors can pay less in taxes than do traditional employees (because of advantages in deductions and costs of doing business).

The most famous lawsuit regarding misclassifying workers is the Microsoft case. In this paper, we will look at options for classifying workers and the specifics of that Microsoft case, as well as other recent case developments and proposed federal legislation that could have a large impact in this area. (Please note that although the court cases, legislation, and examples are all from the United States of America, the implications are truly international.)


The legal term for a traditional, regular employee is a “common law employee.” Basi- cally, a common law employee “performs services subject to the will and control of another party [the employer]” (Boes & Ransom, 1998, p. 13). The employer controls the employee regarding both results and methods of achieving those results.

Unfortunately, there is confusion in defining “employee.” The Internal Revenue Ser- vice Code, National Labor Relations Act, Fair Labor Standards Act, Civil Right Act, and the Employee Retirement and Income Security Act all have different definitions of “employee.” The IRS adopted a list of criteria it uses to determine whether an employer/employee rela- tionship exists for federal employment tax purposes (Rev. Rul. 87-41, 1987). These criteria include the right of the hiring party to require the worker’s compliance with instructions, whether a continuing relationship exists, whether the worker must be devoting substantially full time to the business of the hiring party, and whether the worker must follow the hiring party’s established work routines and schedules. The classification of a worker as a regular, traditional employee will depend on an overall consideration of all of the factors present in the working relationship rather than a specific, clear-cut test.

Over time, adjectives were developed to delineate different types of employees. We use terms like “employee” versus “worker.” We have “full-time” versus “part-time,” and “regular,” “traditional” versus “nontraditional,” “nonstandard,” “contingent,” and “altemative.” There is no universal agreement on the terminology. This makes it difficult to decide what to term the different types of people who work for pay from an employer We will use “worker” to refer to all who work for pay and “employee” as the IRS does. Kundu (2000)

The Dangers of Misdassifying “Employees” 167

describes anyone not a regular, traditional, full-time employee as a “nontraditional worker”; that definition can include jobs from laborer to executive.


The United States General Accounting Office (USGAO) estimates the size of the nontraditional labor force at about 30% of the total labor force. According to the USGAO, the size ofthe nontraditional labor force cannot be accurately determined because there is no unanimous agreement on exactly who should be included in that category. The USGAO did recently list the following groups in the nontraditional or contingent labor force (USGAO, 2000):

1. Self-Employed Workers: Individuals who own their own businesses such as physi- cians but are not independent contractors.

2. Leased Workers: Individuals, such as machinists, who work for employers who do not presently need their services or for leasing companies, some of which are termed “professional employer organizations” (Pianko, 2000).

3. Contract Company Workers: Individuals who work for employers that provide services to other firms such as landscaping, janitorial, and security services.

4. Day Laborers: Individuals who get work by going directly to potential employers to work for that day such as low-skill construction workers.

5. On-Call Workers: Individuals who are called in only to work as needed such as substitute teachers and construction workers provided by union hiring halls.

6. Part-Time Workers: Workers who regularly work fewer than 35 hr per week for a given employer.

7. Independent Contractors: Individuals who obtain their own customers for which they provide a product or service such as management consultants, realtors, engineers, child-care providers, or maids. Boes and Ransom (1998) state that an independent contractor is subject to control by the employer for results but not for methods to achieve those results. Often, the independent contractor previously worked for the employer as a regular full-time employee.

8. Temporary Agency Workers: Individuals who work for temporary help employ- ment agencies and are assigned by those agencies to client employers often to work on special projects or fill-in for employees on vacation. These employees range from unskilled laborers, semiskilled operatives, office and clerical staff, to professionals and executives (Staff, 1999).

9. Direct-Hire Temps: Workers direcdy hired by the employer to work for a specified period of time such as seasonal workers and those who work on special projects.

10. Other possible designations for workers include “statutory employees” (such as commission drivers, full-time life insurance salespeople, real estate salespeople; Boes & Ransom, 1998), “Consultants,” and “Free Lancers.”

Employers use nontraditional workers for a variety of reasons. Employers, in a survey reported by Houseman (1997), stated that they use nontraditional workers to accommo- date fluctuating workloads, fill temporary employee needs, supplement part-time employee needs, assess candidates for longer-term regular employment, and pay less for employee benefit expenses. In addition, there is little need or expectation to increase wage costs.

168 Kondrasuk, Reed, and Jurinski

there is also no need nor expectation to promote the nontraditional worker to higher-level jobs, the worksite employer can avoid employment and training costs, the nontraditional worker often comes in with new and creative ideas, and employers have lower administra- tive costs (Boes & Ransom, 1998). On the other hand, worker advocacy groups contend that employers hire nontraditional workers to avoid paying voluntary but common benefits like health insurance and pensions, to reduce worker compensation and unemployment com- pensation costs, to prevent worker unionization, and to be able to lay off workers with fewer adverse consequences (USGAO, 2000). The latter reasons could be viewed as manipulation of the workforce that could raise ethical as well as legal questions.

It should be pointed out that temporary help agency workers actually work for and are paid by the temporary help agency even though they work at the site of the “client or worksite employer” who receives their services. Some client employers decide to keep the temps on for longer than the initial short project assignments and hire them as tradi- tional employees. This “temp-to-hire” arrangement has become commonplace. Worksite employers have found it expedient to let the temporary help agency recruit, screen, and train workers, so that the employer can observe the screened workers for a pedod of time (think of it as a probation period rather than a temp assignment). Another common scenario occurs when the client employer retains the temps beyond the original project, oftentimes treat- ing the temporary workers quite similarly to regular employees regarding work direction, but without officially changing the status or the benefit treatment of the temps. Today this new breed of workers is referred to as “permatemps.” These temps got their start during the restructuring ofthe 1980s and 1990s when businesses needed extra help but were wary of hiring full-time employees in case the economy deteriorated rapidly. The result was that temporary employees stayed longer, developed more skills, and became overall more adept at all aspects ofthe business (American Management Association, 1999).

Another issue that has arisen recently is when a court rules that the worksite employer is a “coemployer.” If that is the case, then the worksite employer may be paying a temp agency an above-average wage for the temp and now also has to pay the employee benefits offered to its present regular employees. This could be more expensive than going out and hiring traditional employees.

The preceding has pointed out issues regarding coemployment, confusion in defining “employee,” the lack of employee benefits for nontraditional workers, and raised questions about ethics in hiring nontraditional workers. These were issues that could be seen in the litigation against Microsoft Corporation.


Litigation regarding Microsoft Corporation’s (“Microsoft”) temporary workers and independent contractors is among the most protracted U.S. court cases of the last decade {Vizcaino v. Microsoft Corp., 1995, 1997, 1999). The case itself started after the IRS ex- amined Microsoft’s 1989 and 1990 payroll records. Microsoft, in addition to its regular traditional employees, also employed “freelancers” and “temps,” classifying both as inde- pendent contractors. On the basis of familiar common law rules of 20 factors, IRS auditors reclassified a number ofthe independent contractors as common law employees. As a result of the audit, Microsoft hired some of the same workers as traditional employees. Others were allowed to remain independent contractors or return through a temporary help agency

The Dangers of Misdassifying “Employees” 169

(receiving their paychecks from the agency rather than Microsoft). The traditional emplo- yees, but not the workers working under the temporary employment agency, were eligible for Microsoft’s benefits, including participation in its Savings Plus Plan and its Employee Stock Purchase Plan (collectively referred to as the “Plans”).

The workers who were excluded from participation in the stock programs sued, arguing that on the basis ofthe IRS audit, they had been Microsoft employees and should be eligible to participate in the Plans {Vizcaino v. Microsoft Corp., 1995, 1997). If the independent contractors or employees ofthe temp agency could prove they were common law employees of Microsoft, they would enjoy a federally mandated right to participate in the lucrative stock plans.

In Vizcaino III, the Ninth Circuit Court of Appeals held that “even if for some purposes a worker is considered an employee of the agency, that would not preclude his status of common law employee of Microsoft” (Vizcaino v. Microsoft Corp., 1999, p. 723). The court noted that other cases in the labor law area and also the Restatement of Agency, section 227, had held that employees of one firm that permitted the workers to perform services for another firm could become the employees of that second firm. This would be true even if the two employers were not joint employers. The Ninth Circuit court squarely held that even though certain workers received paychecks from their temp agency rather than from Microsoft, that factor was not conclusive as to their employment status. The court noted that the IRS had concluded that workers in certain positions were Microsoft employees because Microsoft either exercised or retained the right to exercise direction over the services performed. For example, these workers worked on a succession of projects after completing the projects that were the basis of their original contracts, they worked for Microsoft for over a year (most worked for well over 2 years), they worked on teams with regular employees, they had security access to the office and supplies, and in several other ways were treated almost identically to the regular employees. This control—rather than the payor named on the worker’s paycheck—determines whether or not a worker is an employee {Vizcaino v. Microsoft Corp., 1995, 1999). Thus, the Microsoft case involved a situation of coemployment. “Coemployment” has been defined as that

which occurs when contract workers, especially over an extended period of time, assume the roles and responsibilities of host company employees—even though they remain in the contractor’s employ. As a result, they do not have the benefits and privileges that customarily accrue to host company employees. (Allen & Chandrasheker, 2000, p. 29)

In Vizcaino, the court held that a determination of whether an employee provided by a temp agency is also the employee of the hiring company is determined under the usual common law factors. These factors scrutinize the relationship for indicia of control of the worker by the employer, such as

the source ofthe instrumentalities and tools; the location ofthe work, the duration ofthe relationship between the parties; whether the hiring party has the right to assign additional projects to the hired party; the extent of the hired party’s discretion over when and how long to work; the method of payment…; [and] the provision of employee benefits and tax treatment of the hired party. {Vizcaino, 1999, citing Nationwide Mutual Insurance Co. v. Darden, 1992, pp. 318, 323-324)

Because the IRS had already concluded that the relationship between Microsoft and these workers was tantamount to the relationship between Microsoft and its regular workforce, the Vizcaino court easily found these workers to be common law employees once it embraced the concept of joint employers for these purposes.

17″ Kondrasuk, Reed, and Jurinski


While the concept of coemployment is not new in the law, it had previously been confined to cases involving tort damages. Although the Restatement of Agency is not limited to the tort area, the Vizcaino opinion’s extension of coemployment into the employee benefits area, and perhaps the employment tax area, represents a novel and potentially major extension of the doctrine.

The Vizcaino court also noted that although the court had not addressed the specific issue, one prior recent case, Burrey v. Pacific Gas & Electric, was premised on the theory that workers “leased” from an employment agency could also be the common law employees of the recipient of their services, and that their status as employees must be determined using the Darden factors. In Burrey, the plaintiffs worked for Pacific Gas & Electric Company’s (PG&E) Marketing Processing Center as employees of an employment agency that leased employees to PG&E (Burrey v. Pacific Gas & Electric, 1988). The plaintiffs in Burrey had worked at PG&E for an extended time, were trained by and worked with PG&E employees, had PG&E business cards, and were even occasionally allowed to use PG&E company cars.

Recently, the Eleventh Circuit Court of Appeals applied Vizcaino and held that a temporary worker who had worked as a computer programmer and analyst at Coca-Cola Company for 6 years could be characterized as Coca-Cola’s common law employee even though the worker had been hired by Coca-Cola through an independent staffing agency (Wolfv. Coca-Cola Co., 2000). The court agreed that the worker’s relationship with Coca- Cola should be defined by looking at the substantive nature of that relationship using the Darden factors. Her relationship with the staffing agency was immaterial to this deter- mination. Even though the plaintiff had signed an employment contract with the staffing company in which she agreed that she was an “independent contractor” of the staffing company and did not have any written or oral agreements with Coca-Cola regarding her employment relationship with Coca-Cola, she could still be characterized as a Coca-Cola employee. However, the plaintiff in Wolf ultimately did not prevail in her attempt to be included in Coca-Cola’s benefits plans. Unlike Microsoft, Coca-Cola policies specifically excluded “leased employees” from participation in its employee benefits plans. Thus, the plaintiff’s status as a “leased employee” precluded her from participating in Coca-Cola’s plan, even if she should have been characterized as Coca-Cola’s common law employee under a coemployer doctrine.


In the summer of 2000, identical bills entitled the “Employee Benefits Eligibility Fairness Act of 2000” (2000a, 2000b) were introduced in both houses of Congress to amend the Employee Retirement Income Security Act of 1974. These bills address the mislabeling of nontraditional employees and seek to correct inequitable exclusion of some nontraditional employees from pension and welfare benefits. When introducing the Senate Bill, Senator Edward Kennedy discussed the findings of the USGAO report and stated.

As the GAO report tnakes clear, employers have economic incentives to cut costs by miscategorizing their workers as temporary or contract workers. Too often, contingent arrangements are set-up by employers for the purpose of excluding workers from their employee benefits programs and evading their responsibilities to their workers. Millions of employees have been denied the benefits and protections that they rightly deserve and worked hard to earn. (Congressional Record, 2000)

The Dangers of Misdassifying “Employees” 171

Both bills address mislabeling nontraditional workers and require enfiployee benefit plans to meet objective eligibility criteria based on actual terms and conditions of em- ployment rather than labels such as temporary or leased employees. If passed, these laws would force employers to define participation eligibility requirements according to objec- tive criteria and not rely on defining participation eligibility based on an employer’s labeling of its workers. These bills underscore the momentum toward more carefully scrutinizing employment relationships regarding employee benefit plans.


We recommend that employers (1) assess their present situation in regards to classifying their workers, (2) make sure they classify all workers accurately, and (3) develop the proper actions to deal with this situation. The first step employers should take is to audit their present situation. What percentage ofthe workforce is nontraditional? Are there any contracts with these workers or their representatives (such as temporary staffing agencies)? Are there any “permatemps” who have been doing the same job for years? Does the company control both method and results of work?

In light of Vizcaino and similar cases, employers hiring temporary workers (including independent contractors and leased employees, as well as temporary employment agency employees) would be well advised to become very familiar with the common law agency guidelines and craft their relationships with their nontraditional workers accordingly. In a recent article in Workforce magazine, Gillian Flynn (1999) suggests businesses carefully review all current contingent relationships. Each of these relationships should be scruti- nized under the guidelines used by the IRS and the courts (such as in the Vizcaino case). An agreement with a temporary worker that the employment relationship does not con- stitute common law employment will not convince the courts of such if the substance of that worker’s employment parallels that of a regular, full-time employee. The actions as well as the words must both convincingly show that the worker is not a common law em- ployee. If such reviews reveal potential problems, the employer needs to take immediate and substantive action to change the relationship enough to address the problems.

Second, employers should be careful to classify all workers accurately. This will more likely avoid (1) taxes and penalties from the IRS for misdassifying workers and (2) lawsuits by nontraditional workers who believe they should be getting benefits more in line with regular, full-time employees (as in Vizcaino). Boes and Ransom (1998) recommend that the company (1) test itself on the 20-factor IRS test to determine whether a worker is an employee or independent contractor, (2) review the determination procedure in the IRS training manual, (3) seek relief under IRS Section 530 if found to misclassify employees, and (4) develop written agreements between such workers and the employer for clarification purposes. As Boes and Ransom also discuss, an employer can file Form SS-8 with the IRS for its ruling on whether a worker is an employee or independent contractor. If the employer does not like the IRS determination, it can appeal to the IRS’s National Office or contest the IRS determination in court.

Third, employers should develop proper procedures to prevent problems, or if en- countered, to minimize their deleterious impact. Companies should institute policies to limit temporary help workers from working more than a certain period of time (Jefferson, 1999). Subsequent to settling the permatemps’ lawsuit, Microsoft instituted a policy of not

172 Kondrasuk, Reed, and Jurinski

employing a temp for more than 1 year without a break (Lawrence & Robinson, 2001). Additionally, employers should rethink participation in their pension and other benefit plans. Because Microsoft’s plans specifically included all common law employees, once the temporary workers were deemed to be common law employees, they were automati- cally entitled to participation (assuming they met the other requirements for participation). Microsoft might have avoided this result had it written its plans differently. However, em- ployers should keep abreast of any future legislation that could constrain their ability to define participation eligibility based on employment labels rather than objective eligibility criteria. Timmerman (2000) suggests that client employers should require their temporary help agency providers to cover their temp workers with the requisite employee benefits. Flynn (1999) recommends making sure managers treat regular full-time employees dis- tinctly different from nontraditional workers.

Should employers now shy away from temp agencies? Even in the light of Vizcaino, businesses should not necessarily avoid hiring any temporary employees. There are still many legitimate and practical reasons for including these workers in a business’s workforce. Temp agencies can still provide a useful and cost-reducing service for an employer, but both the agency and the worksite client employer should be mindful of Vizcaino and similar cases when using temporary workers. The courts seem increasingly wary of the incidents of businesses abusing their ability to hire temporary workers and thus avoid the greater direct and indirect costs associated with regular full-time employees. Make sure the temp agency exercises sufficient control over the employee so that the worksite employer can reduce its control over these same workers. And, as Flynn also points out, businesses should only use the contingent workers on a project-by-project basis, rather than keep those workers on indefinitely. If the business wants to continue using that worker, the business could consider hiring the worker as a regular employee or rehire that worker after a sufficient period of time has elapsed between the previous employment (Flynn, 1999).


So, currently we face much confusion over the appropriate terms to use for people who work for others for pay and how to define those people in legal terms. Additionally, legal and regulatory changes are occurring in what types of workers are hired and how they are used. Employers must make changes in how they hire/categorize/use workers or the government and/or dissatisfied nontraditional employees’ lawsuits will penalize them. Employers should also consider the ethical constraints present when they treat nontradi- tional employees virtually identically to their traditional employees save the perks of the job, including participation in employee benefit plans. In the employee benefits area at least, the entitlement of nontraditional employees to be treated the same as their com- mon law employee counterparts when there is little distinction in the terms and conditions of their employment seems to be a growing attitude, in the courts, the government, and among the contingent workforce. Both client employers and temporary staffing services will need to monitor themselves carefully in classifying and using workers or suffer penal- ties. For the temporary staffing services, the ultimate penalty could be dissolution of their industry.

The Dangers of Misclassifying “Employees” 173


Thanks to students who assisted in this project: Travis Andrews, Brynn Black, Daniel Morgan, Edward Moriarity, Scott Petersen, Martin J. Jones, and Wang Hua.


Allen, S., & Chandrasheker, A. (2000). Outsourcing services: The contract is just the beginning. Business Horizons, March-April, 25-34.

American Management Association (1999). HR Focus, 76(12), 7-8. Boes, R., & Ransom, G. M. (1998). Worker employment classification. Journal of Compensation and Benefits,

75(4), 11-17. Burrey v. Pacific Gas & Electric, 159 F.3d 388 (9th Cir. 1988). Congressional Record, 146 Cong. Rec. S7841 (statement of Sen. Kennedy, 2000). Employee Benefits Eligibility Fairness Act of 2000, S.2946, 106th Cong. (2000a). Employee Benefits Eligibility Faimess Act of 2000, H.R. 4962, 106th Cong. (2000b). Flynn, G. (1999). Temp staffing carries legal risk. Workforce, 78(9), 56-62. Houseman, S. (1997). Temporary, Part-Time, and Contract Employment in the United States: A report on the

W. E. Upjohn Institute’s Employer Survey on Flexible Staffing Policies. Kalamazoo, MI: W. E. Upjohn Institute For Employment Research. Nov., 1996, revised lune, 1997.

lefferson, G. (1999). New policy chums Lilly’s temp staff, Indianapolis Business Journal, Nov. 15, 1. Kundu, K. (2000). Temporary workers—No Longer growing. Fmployment Trends, (Accessed on Feb. 2) 1 htm 1 – 3 . Lawrence, L., & Robinson, K.-S. (2001). Microsoft ‘Permatemp’ settlement seen as warning to employers.

HRNews, 20(2), 8. Nationwide Mutual Insurance Co. vs. Darden, 503 U.S. 318, 323-324 (1992). Pianko, H. (2000). Microsoft and its legacy—Employers confront “Contingent” worker benefit issues. (Accessed

in August) Rev. Rul. 87-41, 1987-1 CB. 296 (1987). Staff (2000). Temps and the law, Industry Week, May 15,72. Staff (1999). Maximize the human retum on temp staff investments. Worttforce, 78(\ 1), 58-60. Timmerman, L. (2000). Scrambling over who pays temps benefits. The Seattle Times, May 24, p. E2. United States General Accounting Office (2000). Contingent Workers. Washington, DC: U.S. Govemment,

GAO/HEHS-00-76 Contingent Workers, June 2000, 1-57. Vizcaino v. Microsoft Corp., 97 F3d 187 (9th Cir. 1995); Vizcaino v. Microsoft Corp., 120 F3d 1006 (9th Cir.

1997); Vizcaino v. Microsoft Corp., 173 F.3d 713 (9th Cir. 1999) (referred to respectively as Vizcaino I, II, and III).

Wotfv. Coca-Cola Co., 200 F3d 1337 (11th Cir. 2000).

Comments are closed.