Q. What is the standard for determining whether an individual is an independent contractor under Pennsylvania’s unemployment compensation law?

A. Following a recent decision from the Pennsylvania Supreme Court, businesses now face a tougher standard under the state’s unemployment compensation law for demonstrating that a worker is an independent contractor and not an employee. In A Special Touch v. Commonwealth of PA, the Court held that, to claim the exemption from tax liability for a self-employed worker, the employer must show that the individual in question is involved in an independent trade or business “in actuality,” rather than “having the mere ability to be so involved.”

Under Pennsylvania’s unemployment compensation statute, workers are presumed to be employees unless the employer can demonstrate otherwise. The law defines employment as “services performed by an individual for wages,” although the employer may seek an exemption from tax liability by classifying a worker as an independent contractor, provided two conditions are met. First, the employer must show that the worker “has been and will continue to be free from control or direction” in performing the contracted-for work. Second—and specifically at issue in A Special Touch—the worker must be “customarily engaged in an independently established trade, occupation, profession, or business.”

The Special Touch case arose when a nail salon disputed the results of an audit by the state’s Office of Unemployment Compensation Tax Services, which indicated that the business owed more than Ten Thousand Dollars of unpaid taxes and interest for misclassified workers. The agency argued that the salon had misclassified half of its workers, specifically, that two nail technicians and three other individuals who performed a variety of tasks were employees rather than independent contractors.

In a split decision, the Commonwealth Court reversed the agency’s determination, finding that all ten of the workers under scrutiny met the standard for independent contractors under the relevant provision of the state’s unemployment compensation law. In essence, the Commonwealth Court appeared to endorse the potential for the workers to provide services elsewhere as sufficient to meet the standard even if they were not actually doing so. As the court explained, the workers “were able to work for more than one entity, were not limited by the nature of their work for Salon, or hours, to a single employer; and were not dependent upon Salon’s existence for ongoing work.”

On appeal, the Supreme Court rejected the Commonwealth’s Court’s reasoning. Turning to the dictionary for the meaning of the phrase “customarily engaged in an independent business,” the Court decided that “customarily engaged” implied something more than the mere potential for workers to provide services elsewhere. As the Court explained, “customarily engaged” for the purposes of the unemployment statute “requires that an individual actually be involved, as opposed to merely having the ability to be involved, in an independently established trade, occupation, profession, or business.”

The Court was careful to note, however, that this standard does not require that the individual actually perform services “for third parties during a given time period.” In other words, the determination of what constitutes “customarily engaged” does not rely on “the extent to which an individual actually performs…services” for third parties, or when. While “actually” performing services is a factor to consider, the statute may “encompass more activity than actually performing services for others, so long as it is demonstrated that the individual is in some way actually involved in an independently established trade or business.” The Court noted other ways an individual could be considered “actively holding himself out to perform services for another,” such as the use of business cards or advertising.

As a result of A Special Touch, the burden is now higher for claiming the independent contractor exemption under the state’s unemployment compensation law. When reviewing these independent contractor relationships, companies should ensure that those workers classified as independent contractors are “actively holding themselves out to perform services” for other businesses, regardless of whether they actually performing such work.

An agency determination that a worker has been misclassified can result in penalties and back taxes under Pennsylvania’s unemployment compensation law. As such, businesses are advised to review their independent contractor relationships as soon as feasible, and if needed, to consult legal counsel for guidance in light of the Court’s decision in A Special Touch.