Business and Commercial Law

— State Agency Tests —

State laws vary as to when a worker is considered an employee versus an independent contractor for unemployment compensation, workers’ comp and state tax purposes. Some state agencies use what’s called an economic reality test that focuses on how economically dependent the worker is on the hiring business. In many states, unemployment compensation laws follow what’s called the ABC test, which focuses on:

Whether the worker is operating a business independent of the hiring business.
Where the work is actually performed (onsite at the hiring business or elsewhere).
What control the hiring business has over the worker while the job is being performed.
When You Want to Hire an Independent Contractor

To make sure you’re actually hiring an independent contractor

Find out ahead of time how your state’s unemployment compensation, workers’ comp and state tax agencies determine who is an independent contractor.

Have the prospective worker fill out an “independent contractor form” rather than a job application. This should include information such as the name, address and phone number of the independent business, number of employees, professional and business credentials of the business, names of other businesses the worker’s company does business with and the worker’s business insurance.

Ask the prospective worker to provide you with documenting evidence for business credentials and insurance, such as articles of incorporation and insurance policies.

Get a signed independent contractor contract with the worker, which sets out the specifics of the relationship, including where the work will be performed, how the worker will be paid and the fact that the worker is responsible for paying his or her own federal and state taxes, social security and other expenses. The contract should make it clear that your business owns the work product of the worker for all purposes.

Is a limited partnership any different?

From a tax standpoint, partnerships serve as great investment vehicles. However, investors are oftentimes very leery of investing in a general partnership, as every general partner can be held responsible for 100 percent of the debts and liabilities of the partnership. To address the issue, most states recognize another entity that is called a limited partnership. Generally, a limited partner’s potential exposure is designed to be limited to the extent of that partner’s investment. For example, if a partner invests $10,000 in a business venture organized as a limited partnership, his or her potential liability would be limited to that $10,000 investment rather than allowing creditors to go after the rest of the limited partner’s personal assets.

The tradeoff is that limited partners must take a passive role in the operation of the business in order to maintain such a status. In many regards, a limited partner would be comparable to a shareholder in a corporation.

So what is a limited liability company and how is it different from a limited partnership?

The best way to describe a limited liability company (“LLC”) is as a hybrid between a corporation and a partnership. When properly organized and capitalized, an LLC has the limited liability benefits of a corporation while at the same time having the tax benefits of a partnership. At the same time, an LLC goes a big step beyond a limited partnership by allowing the owners (who are called “members”) be actively involved in the management and control of the entity (as opposed to limited partners in a limited partnership, who must remain passive investors).

The LLC is a creature of statute that, in relative terms, has only come into existence in recent years. Thus, the business world is not entirely familiar with the LLC mode of operation (as evident by the fact that even sophisticated investors will refer inaccurately to an LLC as a “limited liability corporation”). An LLC isn’t a corporation and doesn’t have shareholders, nor does it have to have directors or officers. Instead, the owners are called “members” and one or more “managers” make the day-to-day decisions of the business. You file “Articles of Organization” when forming an LLC. An “operating agreement” governs the affairs of the organization (rather than articles of incorporation and bylaws, as with a corporation).

What are some of the major risks in running a business?