Independent Contractor or Employee? Proper Classification of Workers is Critical

March 2, 2010

Robert owns a delivery business in rural New Hampshire.  He is having difficulty meeting his expenses and plans to lay off several employees who perform services for him and to replace them with independent contractors who will work on demand.  The contractors will use their own vehicles, pay their own expenses and  manage their own work schedules.  What does Robert need to be concerned about as he enters into relationships with these workers?
In a soft economy employers look for ways to reduce overhead.  Payroll costs include not only an employee’s wages, but also income tax and Medicare, unemployment tax and fringe benefits.  When companies reduce workforces to trim the bottom line, they may look for alternatives to fill the gap.  Companies may enter into consulting or independent contractor relationships, but a horse by any other name may still be a horse.

A variety of state and federal agencies have jurisdiction over the classification of employees or independent contractors.  The Department of Employment Security (“NHES”), Department of Labor (“NHDOL”) and Internal Revenue Service (“IRS”) are all keeping a watchful eye on the situation and taking action which can result in significant liability for business which make the wrong determination.  Each has its own test for determining whether one is an employee. Any one of these agencies is empowered to conduct an audit of a company’s business records and payroll records to determine whether violations have occurred.  Robert needs to be very careful to make sure his workers meet the requisite tests before signing them on as contractors.

The NHDOL monitors employers’ compliance with the state’s minimum wage, overtime, safety, and worker’s compensation laws.  Under RSA 275:4 one must meet all of the following criteria to be an independent contractor:

  • Possess a federal employer identification number or social security number, or have agreed in writing to carry out the responsibilities imposed on employers;
  • Have control and discretion over the means and manner of performance of the work, in that the result of the work, rather than the means or manner by which the work is performed, is the primary element bargained for by the employer;
  • Have control over the time when the work is performed. However, this does not prohibit the employer and worker from agreeing on a completion schedule, range of work hours, and maximum number of work hours to be provided by the person;
  • Hire and pay his or her own assistants and supervises the details of the assistants’ work;
  • Hold himself or herself out to be in business for himself or herself;
  • Have continuing or recurring business liabilities or obligations;
  • The success or failure of the business depends on the relationship of   business receipts to expenditures;
  • Receive compensation for work or services performed and remuneration is not determined unilaterally by the hiring party;
  • Be responsible for the main expenses related to the service.  However, this does not prohibit the employer or worker from providing the supplies or materials necessary to perform the work;
  • Be responsible for satisfactory completion of work and  be held contractually responsible for failure to complete it;
  • Supply the principal tools and instrumentalities used, but the employer may furnish certain unique tools or instrumentalities needed to perform the work;
  • The worker is not required to work exclusively for the employer.

The Department of Employment Security (“NHES”) is responsible to collect unemployment taxes from the state’s employers and to determine whether individuals are entitled to collect benefits under the state’s unemployment law, RSA 282-A.  NHES has its own test for purposes of the unemployment statute, RSA 282-A:9, III (a), (b) and (c), known as the “ABC Test.”

 The ABC test provides that services performed by an individual for wages are subject to unemployment coverage unless:

  • The individual has been and will continue to be free from control or direction over the performance of the services;
  • The service is either outside the usual course of business for which such  service is performed or is performed outside of all the places of business of the enterprise for which such service is performed; and
  • The individual is customarily engaged in an independently established    trade, occupation, profession or business.

In essence, this test imposes a rebuttable presumption that all workers are employees.  The employer bears the burden to establish each part of the ABC or the individual will be considered an employee. 

To help avoid the risk of misclassifying a worker, Robert would be wise to consider the following:

  1. Be fully familiar with the different tests employed by the applicable state and federal agencies.
  2. Enter into written independent contractor agreements which show that the relationship meets the criteria set forth under state and federal laws.
  3. Make certain that all contractors are operating their own businesses and have federal tax ID numbers.
  4. Negotiate a fixed fee for payment for services, rather than paying by the hour or some other way similar to wages.
  5. Have the independent contractor use his or her own tools, equipment and other resources to complete the work.
  6. Use a Form 1099 (not a W 2) to report income to the person.
  7. Classify similarly situated people in the same manner; avoid classifying two people performing the same or similar tasks differently.

Employers such as Robert who attempt to replace laid off workers with independent contractors must structure these arrangements carefully. Failing to adhere to these principles can result in significant liability to a company for injured workers not covered by worker’s compensation, unpaid wages and overtime, and unpaid payroll and unemployment taxes.  Each of the enforcing authorities, the NHDOL, DES and IRS all have significant power to bring actions against employers to collect back taxes and wages, to make the worker whole and to impose fines and penalties.  The savings enjoyed by cutting corners may in the long run end up costing the employer far more than he or she could have dreamed.  
Charla Bizios Stevens is a Director and Shareholder in the Employment Law Practice Group at the law firm of McLane, Graf, Raulerson & Middleton, P.A.  Charla can be reached at 603-628-1363 or The McLane Law Firm is the largest law firm in the State of New Hampshire, with offices in Concord, Manchester, Portsmouth and Woburn, Massachusetts.