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The recent case, Vizcaino v. Microsoft , highlights yet again the significant financial consequences that can flow from a misclassification of workers as independent contractors rather than employees. Not only was Microsoft hit with past due tax liabilities and tax penalties, but the Ninth Circuit Court of Appeals has now ruled that Microsoft is liable for having improperly excluded the affected workers from its § 401(k) plan (which includes a 3% matching contribution) and its employee stock purchase plan (which permits employees to purchase company stock at a discount).

The Facts
Between 1987 and 1990 Microsoft employed “regular employees” and “freelancers.” Although the freelancers were integrated into Microsoft’s workforce, they were not on Microsoft’s centralized payroll system. At the time they were hired they were told that they were not eligible for Company fringe benefits and would be responsible for their own employment and income taxes. As a result of an IRS audit, however, in 1990 the freelancers were reclassified as employees. Microsoft settled with the IRS on the tax issues, but its problems did not end there.

The Ruling
The Court ruled that Microsoft was bound by the language in its plan documents to cover these workers retroactively. Notably, in reaching this conclusion, the Court disregarded the fact that the workers had acknowledged when hired that they were not eligible to participate in the plans.

The stakes have just gone up in misclassification cases. Employers who thought that, at worst they would be subject to retroactive employment taxes and failure to withhold penalties, may now have to add potential retroactive exposure under their company’s health care, retirement and other benefit plans. Employers may be able to limit this added exposure, however, by carefully drafting their plan eligibility provisions, so to exclude certain workers regardless of whether the IRS subsequently classifies them as employees.