January 18, 2019, Vol. 6
by Marc Campsen

Did You Just Hire An Employee Or An Independent Contractor? And Why It Matters.

Employers often classify workers as “independent contractors” instead of employees.  Generally, this is done to avoid employer-side taxes including Social Security, Medicare, unemployment insurance and workers’ compensation in addition to the burden of withholding employee income tax.  Moreover, independent contractors are exempt from federal and Maryland wage laws for minimum wage and overtime.  The consequences of misclassification, however, are severe and include liability for failure to pay taxes as well as step penalties under wage laws up to three times the amount of the unpaid wages.  Unfortunately, employers often fall into the trap of taking the short-sighted approach of classifying workers as independent contractors to save money in the near-term but fail to understand this approach may lead to significant monetary penalties down the road that far eclipse any immediate savings. Fortunately, there are several tests under federal and Maryland law offering guidance in determining whether an individual is classified as an independent contractor or employee.

Generally, under federal wage laws relating to wage payment, minimum wage and overtime, courts consider the “economic realities” of the relationship between the employer and the individual. The “economic realities” test evaluates whether the individual is economically dependent on the business to which the individual is rendering services or whether the individual is in business for himself/herself.  This test requires analysis of six factors: (1) the degree of control that the employer has over the manner in which the individual performs the work; (2) the individual’s opportunities for profit or loss dependent on managerial skill; (3) the individual’s investment in equipment or material, or employment of other workers; (4) the degree of skill required for the work; (5) the permanence of the working relationship; and (6) the degree to which the services rendered are an integral part of the employer’s business.  No single factor is determinative and courts look at the totality of the relationship under the six factors on a case-by-case basis.  Under analogous Maryland wage laws, courts consider a very similar set of factors evaluating whether: (1) the employer actually exercised or had the right to exercise control over the performance of the individual’s work; (2) the individual’s service is outside all the usual course of business of the employer; (3) the individual is customarily engaged in an independently established trade, occupation, profession, or business; (4) the employer or the employee supplies the instrumentalities, tools, and location for the work to be performed; (5) the individual receives wages directly from the employer or from a third party; and (6) the individual held an ownership interest in the business such that the individual had the ability and discretion to affect the general policies and procedures of the business.

For workers’ compensation under Maryland law, courts apply a five factor test known as the “right to control test,” which differs slightly from the wage law tests identified above.  Courts evaluate: (1) the power to select and hire the individual; (2) the payment of wages; (3) the power to discharge; (4) the power to control the individual’s conduct; and (5) whether the work is part of the regular business of the employer.  The fourth factor – power to control the individual’s conduct – is regarded as the most important factor. Essentially, whomever is exercising control over the individual’s performance of the work and the manner in which the work is to be performed is considered the employer.  In the independent contractor–employee context, “control” can be demonstrated in a number of ways including whether the employer supervised and directed the individual’s actions and rate of work, and the amount and type of rules and regulations imposed upon the individual, particularly if those rules and regulations are substantially the same for regular employees.

Notably, for tax liability under federal law, the IRS uses a detailed questionnaire on a form called SS-8.  This form lays-out tens of questions to evaluate the relationship between the employer and individual and is conceptually similar to the “right to control” test.

Finally, for unemployment insurance and work place fraud, Maryland imposes a statutory test known as the “ABC” test evaluating whether the individual: (1) is free from direction and control over performance of the work; (2) is customarily engaged in an independent business or occupation of the same nature as that involved in the work performed; and (3) works outside the employer’s usual course of business or performs the work outside the employer’s place of business.

In sum, employers face a gauntlet of factual and legal issues when determining whether to classify an individual as an independent contractor or an employee and misclassification can lead to liability under both federal and state law.  The good news for employers is that notwithstanding the differing tests discussed here, in most scenarios, the ultimate determination under each test as to whether an individual is an independent contractor or employee will be the same.  Employers, therefore, need to consider very carefully the overlapping factors in each test to accurately classify workers.

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About The Author:

Marc A. Campsen is an attorney at Wright, Constable & Skeen, LLP, where he focuses his practice primarily on litigating employment and business law matters. He is recognized as a Maryland Super Lawyer.

DISCLAIMER: The materials available on this blog are for informational purposes only and not for the purpose of providing legal advice. You should contact your attorney to obtain advice with respect to your particular issue or problem.

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