Is Incorporating Necessary for Freelancers?

If you’re striking out on your own as a freelancer, you may be wondering if it is necessary for you to incorporate or form a LLC for your freelancer activities?

One of the main benefits of incorporation or LLC formation is the limited liability shield for the owner’s personal assets. However, limited liability does not extend to torts committed by you, so if you are negligent in performing your work, or if you get into a car accident while driving to a work-related matter, you are still personally liable even with a corporation or LLC. But limited liability can protect from other business liabilities, such as leases, loans, other debts, employment matters, etc. (assuming that such liabilities are not based on a theory of negligence). Of course, that protection is lost again if you personally guarantee liabilities like loans or leases.

Incorporating can also provide some tax benefits. It is possible for a freelancer to incorporate and then elect to be taxed as a S-corporation. That way, the freelancer can pay himself or herself both in salary and distributions — while salary may be subject to self-employment tax, distributions are not. However, you must take care not to pay yourself too much with distributions as opposed to salary, as the IRS looks out for business owners who pay themselves primarily with distributions in order to avoid paying self-employment taxes.

Finally, incorporating or forming a LLC can also make it slightly more likely to get hired. Companies are becoming increasingly wary of hiring independent contractors, as the IRS and federal and state departments of labor are beginning to crack down on misclassifications of employees as independent contractors. However, the fact that a freelancer has his or her own corporate entity that he or she performs their work through for multiple employers weighs in favor of an independent contractor classification.

Massachusetts Finds Workers to Be Independent Contractors and Reaffirms State Test

Some consider Massachusetts to have the highest standards for classifying workers as independent contractors, rather than as employees by default. However, the Supreme Judicial Court recently ruled that taxi drivers in Boston were properly classified as contractors. In its ruling, the SJC reaffirmed the state law qualification test for independent contractors, known as the “ABC test”.

Under the ABC test, a worker is presumed to be an employee, and can only be classified as an independent contractor if all three of the following factors can be shown:

1) The worker is free from control and direction in the performance of her/his services (both under the terms of the contract for services as well as in actual practice).

2) The services performed are outside the usual course of business for the entity receiving the services.

3) The worker is customarily engaged in independently providing services of the same nature.

The court ruled that taxi drivers were not employees of the taxi garages, since the drivers provided no services to the garages, nor were they employees of the medallion owner companies or the dispatch companies, since the dispatch companies provided services to the medallion owners, who then leased their medallions to drivers (with the condition that drivers use the medallion owner’s dispatch company), and the leases were based on a flat fee (rather than fares received) that mean that the drivers were not engaged in the usual course of the medallion owner’s business.

Massachusetts’ ABC test contains three of the more prominent factors of the IRS and Department of Labor tests for independent contractors. However, the difference is that while each factor could separately and independently support a determination that a worker is an independent contractor, the ABC requires that all three factors are met. 

The SJC’s ruling serves as a reminder of the difficulties for a company to properly classify its workers as independent contractors. 

Further reading:

Employee or Contractor? Questions an Employer Should Ask Themselves Before Classifying

There have been numerous articles covering the distinction between classifying workers as employee or independent contractors. And although many companies prefer to classify workers as contractors due to the lower costs, these many articles have also covered the risks of improperly classifying workers, including having to shell out for back pay, interest, and/or tax penalties. What some company founders may not realize is that there are different tests for classifying workers as employees or contractors, depending on which agency you’re dealing with. For example, wage-hour law violations are dealt with by the Department of Labor, whereas improper classification for employment tax purposes are policed by the Internal Revenue Service; both agencies have different tests, as though both tests share many common factors, both also have factors unique to each. In addition, each state may have differences in their tests; state revenue agencies may share a test with their state’s department of labor, or each agency may have different tests as well. If a company founder is looking to do an analysis of how a potential worker should be classified, there are a number of questions that should be asked. – What is the intent of the parties? — Although government agencies focus more on the economic reality of the relationship rather than what the parties call it, the intent of the parties can be used to help push a close analysis one way or the other – Does the worker have an independent business or perform this type of work for other entities? — A worker that has their own business through which they perform the work contemplated for other companies is a classic image of an independent contractor. For example, your startup hires a graphic designer who has her/his own graphic design firm or practice through which they do design work for other companies. A contractor would have their own equipment, office, and/or employees. – Is there a risk of profit or loss for the worker depending on how the project turns out? — A worker who is responsible for covering their own costs for working on the project, and could incur a loss if their costs were to spiral out of control, is indicative of a contractor. – Who controls how the work is completed? — If the employing company can direct how the worker performs the work, including setting hours when the worker is to work, requiring the worker to come into the company’s place of business when not necessary to complete the project, and micromanaging the steps or processes employed to complete the work, that looks like an employer-employee relationship. – How is the worker paid? — Contractors typically invoice for work performed and are given 1099s; contractors are also typically hired on a per-project basis.

Are Non-Competes Going the Way of the Dodo?

Even as non-compete agreements become more and more common, the tide of legislative opinion may be turning against non-competes. The Michigan legislature recently introduced a bill into committee that would render many non-compete agreements void — exceptions would exist for non-competes in conjunction with the sale of a business or the goodwill of a business. This largely tracks the famous California policy with regard to non-compete agreements in prohibiting them in all but a limited set of circumstances usually related to sale and acquisition of business interests. Non-compete reform has also been on the agenda in Massachusetts for several years now. A bill that would limit the duration of a presumptively enforceable non-compete agreement (and would render agreement exceeding that limit presumptively unenforceable) was introduced in the previous state legislative session but did not pass. Former Governor Deval Patrick was in favor of non-compete reform, and it remains to be seen what kind of reform legislation Gov. Baker would support or if he would support non-compete reform at all. Even though only a couple of states currently decline to enforce non-competes or consider them void, if a state with as heavy a big-business presence as Michigan were to adopt a California-type policy toward non-compete agreements, it could motivate other states to do the same. Arguments against non-competes include the fact that most states generally enforce non-competes in order to protect the intellectual property, trade secrets, and/or goodwill of the employer, protections that could be accomplished through confidentiality and non-solicitation/no-hire agreements that do not prevent a worker from seeking employment elsewhere in the industry. As an attorney I advise it as good practice to have startups bind the co-founders and key employees to post-employment restrictive covenants such as non-disclosure, non-solicitation, no-hire, and even non-compete agreements. Of course, if there is a legislative sea change with regard to non-competes, it remains to be seen what would happen to non-competes already in effect. Having the full slate of post-employment restrictive covenants will still serve to protect a company’s IP and goodwill from misappropriation and theft. But legislatures and courts will have to decide whether existing non-competes would be grandfathered in, so that companies receive the benefits they bargained for, or whether public policy has so shifted such that even existing non-compete agreements could no longer be enforced.

Do I Have to Pay Workers When We’re Closed for Weather?

Startups and small businesses in the Greater Boston area have been repeatedly faced this winter with the prospect of closing down and/or asking their employees not to come into work. However, founders and managers may not be sure of whether they have to pay their employees when the company closes for winter storms. Employees who are paid on a salary basis and are exempt from overtime requirements generally must be paid their full salary for the pay period regardless of whether the company closes for snow or employees are asked not to come into the office, unless the employee misses the entire pay period. Otherwise, employers risk jeopardizing the employee’s overtime-exempt status by failing to pay the minimum weekly salary necessary to qualify. However, employers can charge salaried employees who choose not to come in due to weather (if the company remains open) their vacation and PTO time for days missed; if the employee does not have enough accrued time, they must be paid their normal salary. Of course, if a company wants to charge salaried employees vacation and PTO time for missing work for snow, it’s best to have that policy from the outset, rather than springing it on employees when the situation arises. Hourly employees generally need only be paid for the hours they actually work. However, many northeastern states require that employers report some minimum number of hours (varying by state) if an hourly employee actually reports for work, even if the workplace is closed or operating at a limited capacity. Northeastern states have a number of labor and wage laws related to weather-related closures, so companies located in those states must be mindful of not only federal regulations but the state’s specific requirements (as northeastern states are far more mindful of the snow!) Employers must be mindful of employers (particularly hourly employees) who decide to telecommute in the event of severe winter weather. Generally speaking, work performed remotely must be compensated at the employee’s normal wage or salary, even if the employer does not request that the employee work remotely. So companies must decide, if they close due to snow, whether employees will be permitted to work remotely (and thus be entitled to pay).