Employees or Independent Contractors?

When a person is hired by your company to perform services, he or she must be classified as an employee or an independent contractor. Treating a worker as a contractor carries real risks, as an employer can be liable for back taxes, wages, benefits, and other liability for improper contractor classification. The determination of whether someone providing services to your business is an employee or an independent contractor is quite complex. Both federal and state laws apply, and the laws are not necessarily the same. In fact, there are circumstances where a person could be an independent contractor for federal tax law purposes, but an employee for state law purposes.

Federal Determination

At the federal level, the Internal Revenue Service has historically applied a 20-factor test to determine whether an employer has a “right to control” the person in question, but more recently has condensed the analysis into three categories: behavioral control, financial control, and the type of relationship of the parties. The federal Department of Labor has developed a different standard for federal wage and hour purposes.  The IRS test and other federal standards, however, do not control for state law purposes.

State Determination

States have their own methods for determining whether a person qualifies as an employee or independent contractor. The Massachusetts Independent Contractor Law is more stringent than federal law. This Massachusetts law applies a three-prong test known as the “ABC test,” where one of the prongs requires that the service performed cannot be of the usual course of the company’s business. The Massachusetts law creates a presumption that a person hired to perform services is an employee unless a company can prove otherwise by satisfying all three prongs of the ABC test. The California Supreme Court recently adopted the “ABC test.”

Hiring contract workers through staffing agencies should not result in violations under the Massachusetts Independent Contractor Law or similar state laws so long as the staffing agency itself complies with the applicable state employment laws. When using staffing agency firms, be sure you require evidence of compliance and indemnification of your business by the staffing company for any liabilities for failure to comply. Form staffing agency contracts often contain provisions favorable to the staffing company, so be sure to have an attorney review such contracts. 

Consequences of Improper Classification

Improper classifications of persons as independent contractors rather than employees can have serious consequences, including penalties and possible violations under federal and state employment and tax laws, such as wage payment laws (vacation pay, pay stubs, timely wage payment requirements), minimum wage laws, overtime laws, laws governing social security and unemployment insurance, and laws governing tax withholding, each of which carry their own civil and often criminal penalties.

Contractor misclassification cases have been a particular focus of legal action in recent years. Due to the complex nature of the analysis and the risk of exposure to significant criminal and civil liability and penalties, you are urged to tread carefully when classifying workers as independent contractors.