Dodging legal pitfalls

How to avoid today’s common legal traps

By Jennifer Lucarelli

Employment law is front and center for many Massachusetts business owners, report area law firms. The perennial concerns of business succession planning and creditors’ rights also rank high.

Employee vs. independent contractor

One area business owners should revisit and review is how they classify their employees, especially if they have independent contractors working for them.

The Massachusetts Independent Contractor Law, revised in 2004, created a new three-prong test that reclassifies many former independent contractors to employees. Aimed primarily at the construction industry, it has affected a wider range of businesses and may be confusing to some business owners.

In the past, a federal, 20-prong test was used to classify employees as independent contractors, and it was not necessary to meet all the requirements. But under the new Massachusetts law, independent contractors must meet all three of the criteria below.

1. The worker is free from control and direction in connection with performance of the services.

2. The services are performed outside of the usual course of business of the enterprise for which the work is being performed

3. The worker is customarily engaged in an independently established trade, occupation, profession or business of the same nature as that involved in the service performed.

Most independent contractors pass 1 and 3, but fail the second test, according to David Officer, director and attorney at Fletcher, Tilton & Whipple in Worcester.

There are a few ways to avoid violating the law. "Employers must meet the minimum wage and overtime standards that are currently in place," says Kimberly Rozak, a partner and chair of the Labor and Employment Law Group at Mirick O’Connell. "And they should make sure to keep fair and accurate payroll accounts."

The law is under review and may be changed. "But it is important to classify employees correctly to avoid penalties," says Officer.

Since Enron and WorldCom became household names in recent years, the federal government has made it a priority to revamp executive compensation so that other employees and the future of the company are protected.

Previously, there was no clear regulatory authority governing the tax treatment of plans for executives who chose to defer receiving pay that they had earned in order to delay paying taxes on that money, says Terrence Briggs, partner at Bowditch & Dewey in Worcester.

The new rules offer both more clarity and more complexity, Briggs says. Furthermore, if employers set up a plan incorrectly, the executives who participate in the plan face harsh punishment if the plan fails to meet the new rules.

"This stuff is so complicated," says Briggs, "that a company would be ill-advised to set up one of these plans without consulting someone expert in the rules. These rules are a trap for the innocent. For example, stock options and severance payments can be subject to these new rules, which is something no one would expect."

In the weeks before Enron declared bankruptcy, more than $51 million in previously deferred compensation was paid out to senior executives who could take the money early if they were willing to lose 10 percent of the deferred amounts-a plan provision known as a "haircut," Briggs says. Under the new law, haircut provisions are explicitly impermissible and new restrictions have been included.

For instance, "key employees" of publicly traded companies cannot get any payment of deferred compensation until six months have elapsed after they terminate employment. Also, if they want to change when or how they are going to get their money, they have to push out the date they begin to receive their payments by five years.

Nonqualified deferred compensation arrangements including top hat plans are common in corporate America. They are used to recruit and retain executives and provide them with benefits not available to the general workforce, says John McMorrow, an employee and benefits attorney for Mirick O’Connell. "These programs must be amended before year-end to meet new restrictions. That’s why employers should be talking to an attorney who is familiar with section 409A of the Internal Revenue Code."

Rosalie Beith, a senior, non-owner attorney who holds the title "of counsel" at Fletcher, Tilton & Whipple in Framingham, says these new rules will affect a lot more arrangements that owners offer employees and executives.

"In the past, executives were able to manipulate when they receive their compensation and avoid penalties," she says. "Now owners need to inventory what plans they offer and get some advice on how to comply with the new regulations."

Another aspect of employee benefits business owners should be aware of is the newly signed Pension Protection Act of 2006.

The recently-enacted Pension Protection Act of 2006 is a broad tax bill that revamps many of the rules relating to qualified pension and retirement plans, says Beith of Fletcher, Tilton & Whipple. The legislation affects defined benefit pension plans as well as defined contribution plans such as 401(k) plans, and any employer who offers one of those plans needs to be aware of the changes.

One key change is that employees can be included by default in a company’s 401(k) plan. "This means more employees will be included in a company’s plan and if they don’t want to be, they will have to affirmatively say they don’t want to be part of the plan," says Briggs of Bowditch & Dewey. "They also changed the rules on how rapidly an employee can vest - they have three years or no longer than six years to vest."

Also, employees are able to invest more if they are over 50 years old and need to catch up. "They can add $5,000 more per year if they meet the criteria," says Briggs.

With 401(k) plans, employees are able to choose their own stocks in their portfolio. "This can be confusing for some employees," says Briggs. "So, now employers can offer investment advice without worrying about liability if an investment goes bad."

Beith says it is important for business owners to realize the complexity and wide range of the new Act. All plan administrators and plan sponsors need to consult their advisors for more detail on legislative changes and for a better understanding of how the changes affect their plans, she adds.

In 1993, the Family Medical Leave Act (FMLA) was created to help employees balance work and personal life. As a result, companies with 50 or more employees are required to post a notice explaining the FMLA’s provisions and provide information concerning the procedures for filing a complaint for a violation of the FMLA. An employer can get a copy of the required notice from local offices of the Wage and Hour Division.

The FMLA allows employees who qualify to take up to 12 weeks of unpaid leave during a 12-month period for the following reasons: the birth and care of a child; the placement and care of a child for adoption or foster care; to care for an immediate family member, spouse, parent or child with a serious health condition; or to care for the employee’s own serious health condition.

It is important for employers to have a clear policy setting forth the eligibility criteria for requesting leave under the FMLA, says Robert Kilroy, of counsel, a senior, non-owner attorney, for Mirick O’Connell of Worcester.

Kilroy recommends that employers adopt a rolling, 12-month backward-looking window period when determining eligibility for FMLA leave. By doing so, employers will not run the risk of an employee taking 12 weeks of FMLA leave during the last 3 months of a calendar year and then becoming eligible for an additional 12 weeks as of January 1st. Kilroy further recommends that business owners consider requiring medical certification for leave based on a serious health condition.

"If an employee has a serious health condition or is caring for a family member, they are also able to take the time intermittently when medically necessary," says Nisha Cocchiarella, attorney and associate for Fletcher, Tilton & Whipple of Worcester. For instance, if an employee is undergoing chemotherapy and needs a few hours or just one day a week off, then the employer has to comply and the 12 weeks can span a longer period of time.

The Americans with Disabilities Act is another place where employers may be confused on how and when they need to comply with the laws. The act says that qualified individuals with a disability cannot be discriminated against based on a physical or mental impairment that substantially limits one or more major life activities.

The ADA defines these terms, but there is also a great deal of litigation describing and defining what these terms mean in the context of particular situations, which can make it difficult for employers to know which employees are and are not covered, Cocchiarella says.

Businesses with 15 or more employees are required to comply with the ADA. During the hiring process, employers may want to identify the essential functions of a particular job and create a job description so that there is a clear understanding of what is expected by the employer, she adds.

In recent years, tax incentives have also been offered to help small business owners make accommodations for their employees.

"The laws are ever-changing, and it is important for a business owner to be aware if there is a change and understand how it affects the company," she says.

Renee Hackett, a partner at Bowditch & Dewey in Worcester, says that it is also important that an employer understand that an employee can request an accommodation, but it cannot cause an "undue burden."

"The best way to comply with the law and not unreasonably burden your business is to engage the employee in a dialogue and try to come up with a reasonable plan," she says. "Also, an employer should be careful to act consistently with all employees to avoid claims of retaliation and discrimination."

Some business owners, who fail to plan for the future of their business after their death, may be causing more problems for their family and employees and it may cost them substantial amounts of state and federal estate taxes.

"Owners must ask themselves one question: do you want to try to leave the company to your children or do you want to sell it?" says Andy O’Donnell, chair of the Trust and Estates Department at Mirick O’Connell of Worcester. "If they are looking to retire and they used extra retirement income, they may want to sell it. But if they leave it to their children, there can be some complications."

By leaving the company equally to all children, the business owner may jeopardize the future of the company because it is not clear who is in control, O’Donnell says. "If John Jr. wants to run the company, but the owner leaves the company equally to his three children, the other two children may be able to sell the company because they have control of the stock."

As a result, O’Donnell says there are a variety of ways to create non-voting and voting shares, which would allow the three children to each have an equal amount of the company, but would ensure that control of the business is in the child who is running the business.

Another option O’Donnell suggests is for John Jr. to take out a life insurance policy on his father (the business owner). "This way, when Dad dies, John Jr. can buy all the stock in the company for $1 million and pay it to his siblings," he says. "That way the children who don’t want the company, but want the cash, have that option."

Studies show that one out of four businesses survives past one generation, says Dennis Gorman, attorney and director at Fletcher, Tilton & Whipple of Worcester. "After that, the numbers dwindle and more businesses fail as the generations go on," he says.

In an attempt to protect the business owner’s personal assets, more and more companies are becoming or changing to Limited Liability Companies (LLC).

If the owner is a member of an LLC, then creditors cannot reach members for liability issues, Gorman says. "For instance, if someone falls while on a property and it is owned by a real estate LLC, then the person cannot sue the owner personally. They would sue the LLC," he explains.

This means that the person suing can only go after the LLC for damages, and cannot go after the owner’s personal assets, Gorman says.

"This also works well if you own business real estate outside of your business," says O’Donnell of Mirick O’Connell. "If an owner owns his business’s real estate through an LLC, he can sell the company, but then still rent the property to someone else."

O’Donnell notes that this is a good way for business owners to plan for their retirement. Creating an LLC can also allow for the most flexibility as well as insulating a business owner’s personal assets, he says.

But an LLC may not be for every company. "If a person already has a lot of property and casualty insurance, they may not see the point," he says. "But it is important to look into an LLC, so you can know your options."

Jennifer Lucarelli is a contributing writer to the Worcester Business Journal.