Employee or Independent Contractor – What does it all mean?

It seems that at least once a month I get a call from a business owner with questions about whether the business can or should classify someone as either an employee or an independent contractor.  Before I explain the factors that are used to determine the classification I always explain the significance of classifying someone as an employee versus an independent contractor.  If you treat an individual as an employee, the business must withhold the required employment taxes (federal, state, social security and Medicare withholding taxes) and pay any required unemployment or workers compensation insurance premiums.  In addition, if someone is considered an employee, the business would need to include that person when determining if  it is required to provide the mandated Massachusetts health insurance.  Classifying a person as an employee also has possible implications regarding liability for the actions of that person.

In contrast, if someone is classified as an independent contractor, then all that the business owner is required to do is pay the agreed upon price to the person and send them a 1099 form reporting income paid for the prior year.  The independent contract is responsible for paying all the required taxes and obtaining worker’s compensation insurance.   It is easy to see why businesses would prefer to classify individuals as independent contractors.  However, as you have probably guessed, both the Commonwealth of Massachusetts and the federal government prefer that individuals be classified as employees.  The reason is very simple, while the independent contractor is required to pay essentially the same taxes, the reality is that it is much simpler to collect the tax from one business owner versus all the individuals who may work for that business as independent contractors.

Massachusetts General Laws, c. 149 §149B sets forth a 3-prong test to determine when an individual is considered an independent contractor and states in part as follows:

§ 148B. Persons performing service not authorized under this chapter deemed employees; exception

(a) For the purpose of this chapter and chapter 151, an individual performing any service, except as authorized under this chapter, shall be considered to be an employee under those chapters unless:

(1) the individual is free from control and direction in connection with the performance of the service, both under his contract for the performance of service and in fact; and

(2) the service is performed outside the usual course of the business of the employer; and,

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

Under this three prong test, very strict criteria must be satisfied to classify someone as an independent contractor.  The presumption is that someone is an employee unless the exceptions apply.  An example of someone who would “probably” be considered an independent contractor is a bookkeeper who works for many different business.  As long as the business that hires the bookkeeper is not in the bookkeeping business, then the bookkeeper should be classified as an independent contractor (e.g. a lawyer hires a bookkeeper).  However, if the bookkeeper only does work for that one business, then the outcome may be uncertain.  I said the person would “probably” be classified as an independent contractor because the determination is always very fact specific and every case could be different.

What is clear, is that the Commonwealth is taking an aggressive stand in classifying individuals as employees.  If you are treating an individual as an independent contractor you should carefully review all the facts with your attorney to determine if your classification is defensible and to make sure you create and maintain documentation to support your treatment if you are ever audited.   If you don’t have a business attorney, I would welcome the opportunity to meet with you for an initial no cost consultation.

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