Independent Contractor or Employee?

Changing state standards on independent contractor statuses and tougher fed enforcement will require even greater scrutiny by construction businesses.

When it comes to identifying workers for the purpose of determining tax, insurance, payroll and employee benefit obligations, construction firms have grown used to the confusing stew of state and federal regulations that guide how their workers should be classified.  

Here in Massachusetts, independent contractor laws have been on the books for years.  As one of the more progressive states in the country, Massachusetts has a relatively long history of protecting workers' access to disability, health care and unemployment insurance, and ensuring that adequate funds are deducted from their paychecks to pay for these benefits.

These same laws are also designed to prevent a company from passing off employees as independent contractors in an effort to circumvent its obligations.  When a business hires an independent contractor, it realizes significant savings by avoiding payments on its share of FICA and FUTA, unemployment and workers compensation insurance premiums, employee benefits costs and the added overhead of handling payroll taxes. The cost difference can approach 30 percent per worker.

Lately, in the face of record budget deficits, the federal government has introduced several new initiatives to crack down on companies that misuse this 'contractor' status. 

These initiatives point to a growing consensus in Washington and elsewhere that worker classification standards need to be toughened.  For companies that legitimately rely on independent contractors as a way to react nimbly to marketplace demands - and construction firms top this list - it will require an even greater understanding of the classification standards, and greater diligence when identifying a worker's relationship with the firm.

At the local level, states certainly have an interest in making sure that workers are properly classified - after all, state tax revenues are at stake.  The confusion arises when businesses discover that states have different standards than the IRS for determining worker status, and that the tests used to determine a worker's status for, say, unemployment benefits may be different from those that determine eligibility for workers compensation or overtime.

For example, Massachusetts has a strict independent contractor law that presumes that every worker in a company's employ is an employee.  It then requires businesses to meet a three-part test to overcome that presumption:

  • The individual must be free from control or direction in connection with the performance of the service, both under his contract for the service and in fact; and
  • The service must be performed outside the usual course of the employer's business; and
  • The individual must be customarily engaged in an independently established trade, occupation, profession or business of the same nature as that involved in the service performed.

The law, based on an earlier version used by at least18 other states (known as the ABC test), was enacted in 1990, and then amended in 2004 with input from the state's construction industry trade unions. 

But the amendment had the effect of making the test virtually impossible to meet for companies in other industries that hired workers to provide occasional services that were within the company's usual course of business (home health care workers, delivery couriers, extra accounting and legal assistance, for example).

So earlier this year, legislators were asked to consider an amendment allowing for a somewhat broader interpretation of the law.  The proposal substituted the word "and" at the conclusion of part 2 for the word "or."  

This seemingly minor word change is actually very significant.  By adhering to only two of the test's three parts, businesses would find it somewhat easier (and less expensive) to hire legitimate independent contractors as a supplement their workforce for specific short-term projects, or during especially busy seasons.

Considering the current atmosphere of greater enforcement, construction businesses may want to err on the side of caution by establishing employee relationships, withholding taxes and paying benefits - even for workers hired for short-term projects.

If your firm hires independent contractors, it may be wise to obtain professional tax advice to make sure you are in compliance with the latest regulations.  In the meantime:

  • Familiarize yourself with the latest advisories issued by your state's attorney general's office and other agencies that shed light on the prevailing interpretations of the law. 
  • Know that any written contract between you and the independent contractor must stipulate that the worker is free from your company's direction and control (part one of the three-part test).
  • Confirm that the worker is providing a similar service to other client companies, and is in control of how, and at what hours, that service is performed.
  • Look for indications of a legitimate, ongoing business - bonding, insurance, business stationery, specialized tools to perform the work, truck lettering, etc.

Many states presume that every worker is an employee; it is up to the employer to prove otherwise.  Failure to do so can incur steep penalties, both civil and criminal. 

On the plus side, careful adherence to the classification laws may also provide a measure of protection against legal actions by workers who feel that their rights to minimum wage, overtime, unemployment insurance or workers compensation have been violated.

Bill Rucci is a partner in the Boston area accounting and business advisory firm Rucci, Bardaro & Barrett PC, where he heads the firm's Construction Business Services Group. For a complimentary copy of "Employee vs. Independent Contractor: 10 Tips for Business Owners," contact Mr. Rucci at (781) 321-6065 or [email protected].