Establishing the correct business relationship between massage therapy businesses and the massage therapists who actually perform the work presents important legal and taxation choices for both the business owners and the massage therapists. It involves regulation at the federal, state and, sometimes, local levels, and potential large negative impacts for making the wrong decision.
More often than not, the business owners and massage therapists seeking to ensure compliance with federal and state laws are likely to find that the relevant factors point toward characterizing their relationship as employer-employee, not employer-independent contractor, say CPAs and attorneys who counsel in this area.
Employee vs. Independent Contractor
At a high level, federal and state regulators generally deem there to be an employer-employee relationship if the business owner controls many of the aspects of a massage therapist’s activities.
The IRS has a 33-question form, Form SS-8, that a business owner can submit to the IRS for an official determination of whether a business relationship is between a business and an employee or an independent contractor.
Among the factors that the IRS scrutinizes are behavioral control factors, such as:
- How the worker receives assignments
- Financial control, such as who pays for supplies and materials used by the worker and benefits provided under the relationship
- Relationship control issues, such as whether the arrangement can be readily terminated.
In addition, states are free to make the employer-employee classification even more demanding, and many have their own statutory definitions for certain professions, tests for determining between the two, and/or provide examples online to help guide business owners and workers.
Cynthia Pasciuto, an Arlington, Massachusetts-based attorney and insurance advisor who owns TrueNorth Business Consulting, LLC, and has a practice focused on health and wellness providers, including massage therapists, says almost none of her massage therapy business owner clients can properly classify those who provide massage services for them as independent contractors. “Massage therapy business owners generally provide the hours they want the therapists to work, provide them with materials like tables, sheets, cream and other supplies, and then most of the time they provide the clientele,” says Pasciuto. “Because they are controlling where they work, the hours they work and their tools, that equates to their workers being employees.”
Pasciuto says that in Massachusetts, the scrutiny applied to the distinction is so great that the relationship between business owners and workers can only be highly limited in order to claim an independent contractor status. This would essentially involve an individual subletting space from the business owner, arranging all of their own clients, and providing all of their own equipment and supplies, among other factors, Pasciuto says. At that point, the benefits to both sides of the relationship may become very limited.
Mellinda Abbott, a Lexington, Massachusetts-based CPA at Abbott & Co., says her experience has been the same. And every client of hers that has submitted a Form SS-8 to the IRS has resulted in the relationship being deemed employer-employee rather than employer-independent contractor, she says. “Less than half of one percent of individuals in these industries could be classified as independent contractors under the IRS rules,” Abbott adds.
The Implications of Each Form
There are important considerations for both the business owner and the massage therapist for the classification of their relationship. From the business owner side, classifying individual practitioners as employees means that they must pay half of the workers’ Social Security, federal unemployment and Medicare taxes at the federal level and pay additional charges at the state level, sometimes including unemployment insurance, workers’ compensation and disability insurance.
Business owners are also required to withhold federal income taxes for their employees, unless the employee claims on their IRS Form W-4 that they’re exempt from withholding, notes accountant Robert Decker, president of Tucson, Arizona-based Robert Decker CPA, P.C.
Certain federal and state laws also govern employment practices, such as fair labor codes that require overtime, breaks and minimum wages or prohibit certain types of discrimination.
Generally, engaging in an independent contractor relationship avoids many of these financial expenses for the business owner and shifts them onto the massage therapist, who will also usually want to pay federal and state taxes on a quarterly basis to minimize the risk of underpayment penalties. “The Social Security and Medicare costs alone are $1.53 of every $10 you make, even before state and federal taxes,” Abbott says. “Suddenly, your $15-per-hour rate is down to $12.70 per hour. When they realize this, many independent contractors become upset and say their greater independence was not worth it.”
There are some additional benefits offered from each classification. Independent contractors are free to pursue their own clients and other business relationships, for example, whereas employees may be required to sign non-compete clauses that could hobble their ability to transition from employees to running their own businesses, Pasciuto notes.
A benefit for business owners of the employer-employee relationship and for individual practitioners who are independent contractors is that they can enjoy tax deductions related to their expenses. Such expenses could include mileage to visit clients, tables, oils and lotions, notes Abbott. Employees can also deduct expenses they pay for and for which they are not reimbursed, but are subject to a 2 percent adjusted gross income threshold before deductions are permitted, notes Warren W. Warner, Jr. a partner at St. Helena, California-based accounting firm Blyth Warner & Associates, LLP.
The Consequences of Getting It Wrong
For business owners who have misclassified their workers, the trouble can begin after the individual practitioner leaves and files a state unemployment claim or a claim for other state benefits. In such cases, the state regulatory body will seek to determine what type of relationship was in effect.
If an employer misclassified the relationship, they generally will have to pay the back contributions owed toward the various employer taxes, plus associated penalties and interest. Some states, such as California through its 2012 California Independent Contractor Law, have enacted state legislation imposing heftier fines for willful misclassification of employees.
The IRS penalties for misclassifying workers or unintentionally failing to withhold federal income tax include a penalty of 1.5 percent of the wages paid. The penalty is doubled to 3 percent if the employer did not file a Form 1099-MISC for the worker with the IRS. The penalty for unintentionally failing to withhold the employee’s share of Social Security and Medicare taxes is 20 percent of the employee’s share of the tax, or 40 percent if the employer did not file a Form 1099-MISC for the worker with the IRS.
It is worth noting that in filing a claim for back benefits, there is some risk to the misclassified massage therapist, too, as it potentially can open up their business relationships and practices to scrutiny, such as whether they had properly reported their income to federal and state regulators and followed applicable professional practice requirements.
Consequences for either the business owner or the massage therapist of misclassification could also include the loss of one’s business license and difficulty in getting a new one in states that require licensure.
Some states are cracking down on misclassification, reducing the space for massage therapy businesses to argue ambiguity in the form of classification. In 2008, California labor inspectors conducted a sweep of 108 spas and salons and found that many massage therapists who were working as independent contractors were actually employees, leading to fines for many spa owners. According to Richard Rybicki, a principal at Rybicki & Associates, P.C., Sonoma, California, while no similar crackdowns have since occurred, aggressive California state tax auditing related to that issue continues.
Individual practitioners who think that they have been misclassified as independent contractors should first try to resolve it with their employer, says Michael Singer, managing partner of San Diego-based law firm Cohelan, Khory and Singer, that has represented workers in class action lawsuits based upon employer misclassifications of the workers as independent contractors. “They should speak to their employers about a reclassification to employee status,” Singer says. “They would then be entitled to overtime benefits, minimum wage for time spent between appointments when they are required to remain on premises and/or perform other duties, and reimbursement of business-related expenses.”
Fighting the Good Fight
For business owners and individual practitioners who do wish to try to establish an employer-independent contractor relationship, Pasciuto says that it can be helpful to draft a contract establishing what the relationship is and that both contractual parties understand the independent contractor truly will be independent and will not be receiving the benefits to which they would be entitled if they were employees.
“If a business owner wants to say they are independent contractors, the best thing you can do is sublet, if you own the property or your lease allows that. That way they are building their own client base and doing their own marketing and it means you are really hands off,” Pasciuto says. “But then you have to make sure the relationship doesn’t get blurred and they start acting like an employee, such as if they start making calls for you or provide other services like doing your bookkeeping or staffing the desk. If they are an independent contractor, you can’t tell them to do those things. They and you have stepped over the line.”
There are also sometimes routes to reduce the costs of classifying individual practitioners as employees, such as paying them on a project rather than hourly basis, notes Rybicki. However, in 2016, California state legislation will take effect that will reduce the advantages of doing so by requiring employers paying on a per assignment “piece” rate to also pay for rest periods and other non-productive time, Rybicki adds.
What To Do If You Are Audited
Richard Rybicki, a principal at Sonoma, California-based law firm Rybicki & Associates, P.C., who counsels numerous business owners with massage therapy practices, offers the following advice to address the risk of negative repercussions from a massage therapy business owner or practitioner audit:
Don't be defensive about worker classification. If you can, show that the business considered classification in advance. Realize that under federal and state law, the business owner bears the burden to demonstrate that the individual practitioner is an independent contractor rather than an employee.
Be cooperative when an auditor or investigator walks on site, but be aware they cannot require you to allow them to review all the books or non-public areas at your place of business immediately.
Ask the auditor to make an appointment to view the records and contact counsel.
Prepare for an audit and be as compliant as you can be. “Clients who can show they thought about how to classify workers and figured out in advance how to be compliant are more likely to come out ahead in an audit,” says Rybicki. “There is a lot of flexibility in the auditor’s use of classification factors. If you can show that you thought about it in advance and were trying to do the right thing, you stand a much better chance of coming out ahead.”
Make sure that your efforts are tailored to the legal requirements of the state where you are located.