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Independent Contractors vs. Employees: Proper Classification

Worker Classification: Independent Contractor versus Employee

Whether an individual worker is an independent contractor or employee has an impact on the legal consequeces to the company engaging the services of that individual.  Proper categorization of a worker as an independent contractor or employee is vital to satisfying certain regulatory liabilities, including proper withholding and remittance of tax.  Similarly, proper documentation of an independent contractor relationship is important to establish limitations of liability, and ownership of work products, especially intellectual property.

General Liability

Pursuant to Maryland courts the determination of whether a worker is an independent contractor or employee rests on several basic findings.  The factors that must be considered include: (1) who has the right to control the work; (2) who has the right to select the worker that will perform the duty; (3) how wages are paid; (4) whether the work is part of the employer’s regular business; and (6) the intention of the parties when entering into the relationship.  Rubin v. Weissman, 59 Md App. 392 (1984); L.M.T. Steel Products v. Peirson, 47 Md.App. 633, 635 (1981).   

“If that right of control is present, the relationship is necessarily one of employment, because it negates the independence or autonomy presumed to exist with an independent contractor." L.M.T. Steel v. Pierson, 47 Md. App. at 635.  “The decisive test in determining whether the relation of master and servant exists is whether the employer has the right to control and direct the servant in the performance of his work and in the manner in which the work is to be done.  It is not the manner in which the alleged master actually exercised his authority to control and direct the action of the servant which controls, but it is his right to do so that is important."  Id.

If a company controls the relationship between the customer and its workers it will most likely be liable for the actions of its workers because the workers will be declared employees.  A company must relinquish some control of the relationship if it wants to create an independent contractor relationship.  The final determination of whether a worker is an independent contractor is fact driven, on a case by case basis.   

Maryland Unemployment Taxes

When determining whether a company must pay unemployment tax as required by Maryland law, there must be a finding as to whether the worker is an independent contractor or an employee.  Maryland Code Annotated, Labor and Employment, Section 8-205 sets forth the circumstances in which an individual is considered an independent contractor and therefore not covered by unemployment taxes.  To be declared an independent contractor the individual (1) must be free from control and direction over his work both in fact and pursuant to the contract between the employer and contractor; (2) must be customarily engaged in independent business or contracting; and (3) the work must be outside the usual course of business of the person for whom the work is performed.   MD Code, Labor and Employment, Section 8-205.  Code of Maryland Regulations (“COMAR”) 09.32.01.18 sets forth a list of factors that are to be used to determine if a worker fulfills these requirements. 

The following factors are used to determine whether the person has been free from the employing unit's control or direction: (1) whether the employing unit requires the person to comply with detailed instructions about when, where, and how the person is to work;  (2) whether the employing unit trains the person to perform the service in a particular manner or using a particular method determined by the employing unit; (3) whether the employing unit establishes set hours of work for the person performing the services; (4) whether the employing unit establishes a schedule or routine for the person performing the service; and (5) whether the employing unit has the ability to terminate the person for failure to obey the employing unit's specific instructions on how the service is to be performed.

Factors used to determine whether the person performing the service is customarily engaged in an independently established business include whether the person: (1) maintains a business listing in the telephone directory; (2) has his or her own place of business; (3) has a financial investment in a related business and can incur a loss in the performance of the service; (4) has his or her own equipment needed to perform the service; (5) determines the price of the service to be performed; (6) employs others to perform the service; (7) carries his or her own liability or workers' compensation insurance, or both; (8) performs the service for more than one unrelated employer at the same time; (9) sets his or her own hours; and (10) is paid by the job.

The following are factors used to determine if the service is outside the usual course of business of the employing unit: (1) whether the person performs the work off the employing unit's premises; (2) whether the person performs work that is not integrated into the employing unit's operation; (3) whether the service performed is related to the employing unit's business.

There is a presumption that all employment is considered covered employment and therefore a company is required to pay unemployment taxes. The burden is on the company to demonstrate an exemption from covered employment. Blue Bird Cab Co. v. Maryland Dep't of Employment Sec., 251 Md. 458, 464 (1968); Department of Employment Sec. v. Charlie's Barber Shop, 230 Md. 470, 475 (1963); and Warren v. Board of Appeals, 226 Md. 1, 16-17 (1961). See also COMAR 09, § 32.01.18A.           

Maryland Worker’s Compensation           

Pursuant to Maryland Code Annotated, Labor & Employment, Section 9-402, every employer must maintain workers’ compensation insurance for all covered employees.  The Workers’ Compensation Act is not applicable to an independent contractor who contracts to work for another party according to the contractor’s own means and methods, and is free from control of the other related to the performance of the work.  Marine v. Service Trucking Co., 225 Md. 315 (1961).  In order to determine whether a person is an independent contractor or an employee under the Workers’ Compensation Act, a court must take the following factors into consideration: (1) the selection and engagement of the worker; (2) the payment of wages; (3) the right to terminate the relationship; (4) the power to control the worker's conduct; and (5) whether the work is part of the regular business of the employer.  Johnson v. Helicopter & Airplane Services Corp.,389 F. Supp. 509 (1974); Keitz v. National Paving and Contracting Co., 214 Md. 479, 491 (1957); Williams Construction Co. v. Bohlen, 189 Md. 576, 580-581 (1948)

These factors are very similar to those used by the courts to determine whether a worker is an employee or independent contractor for the purposes of paying unemployment insurance taxes. 

Federal Employment Taxes (FICA & FUTA)

Under federal, law a company has a possible safe haven from paying employment taxes for these same workers that under Maryland law would be considered independent contractors.  Every employer must pay its share of FICA (social security) taxes and FUTA (unemployment insurance) taxes. 26 U.S.C. § 3111; 26 U.S.C. § 3306(b).   An employer whose workers are independent contractors shall not be liable for payment of these employment taxes.  See Section § 530 of the Revenue Act of 1978;   Hospital Resource Personnel, Inc. v. United States, 68 F.3d 421 (11th Cir.1995).   

The IRS Code gives employers a “safe haven” and exemption from paying federal employment taxes in certain situations. 26 U.S.C.A. § 3401 note citing § 530 of the Internal Revenue Code.   This sections states that a taxpayer shall have a reasonable basis for not treating an individual as an employee if such treatment was in reasonable reliance upon judicial precedent or a long-standing recognized practice of a significant segment of the industry in which the individual was engaged.   Pub.L. 104-188, Title I, § 1122(a), Aug 20, 1996, 100 Stat. 1766.

The court in Options for Senior America Corp. v. U.S., 11 F. Supp.2d 666  (D. Md. 1998), found that a residential service agency's use of a survey that it had conducted to determine that the treatment of non-skilled home aides for the elderly as independent contractors was an industry practice was proper and thus the agency was entitled to rely on the "safe haven" provision of the Internal Revenue Code and was, therefore not liable for the payment of employment taxes. The court found that the sole issue before it was whether or not the agency reasonably relied on its survey information. The employer conducted a survey of the Metropolitan D.C. area, Baltimore, Maryland and Richmond, Virginia. The results in all locations were similar, finding that about 80% of the employers classified these aides as independent contractors. Upon review of the survey, the court determined that as a matter of law this percentage is a "significant segment" of the industry, in compliance with the § 530(a)(2)(C) requirement that a significant segment of the population follow an industry practice in order to prove that the agency had a reasonable basis for not treating its aides as employees. Therefore, the agency was not liable for employment taxes. 

As for the federal tax liability, a company may have a safe haven under the federal law but the best way to determine this is to file a Form SS-8 with the IRS.  Upon the filing of an SS-8 form the IRS will make a determination as to whether a company’s workers must be treated as employees, and therefore, taxes must be paid, or treated as independent contractors.

Finally, all owners, are liable for unpaid employment taxes and penalties associated therewith.  Therefore, it is imperative that a company properly categories, pay and remit taxes pursuant to the law. 

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