When Michele Loew opened her yoga studio on Southeast Stark Street in 2007, she recruited the best instructors available and paid them for each student they brought in.

That's how many Portland studios hired their teachers, and how Loew did it for years at the Yoga Space—until state investigators came calling.

It turns out one of her instructors was collecting unemployment after losing her regular job. Oregon Employment Department officials noted that the instructor had disclosed on various forms that she taught classes at Loew's studio.

Before Loew knew it, state officials had swooped in, audited her books and declared that she had been improperly treating instructors like independent contractors when they were actually employees. That meant Loew had to start paying wages, benefits and unemployment insurance—not to mention five years of back payroll taxes the state said she owed.

Loew reached that settlement last year. She says she has been forced to pass some higher costs on to customers, but she can only raise prices so far. She's losing money each month. And she says it's now tougher to afford experienced instructors, many of whom don't want to be employees and instead enjoy being their own bosses.

Loew says she would understand if all yoga studios had to follow the same rules. They don't.

"The bottom line is, it's more expensive to do business," she says. "And it is harder or us to compete with yoga studios that are still using independent contractors."

According to owners of other studios, state officials hit yoga businesses unevenly and haphazardly. Some studios got hammered in a rush of audits by the state, as Loew's did. One owner sold her studio, Yoga Pearl, after an audit.

But many studios have escaped notice entirely, and they continue to operate as they did before. That allows them to keep costs down and attract popular instructors, many of whom enjoy the freedom that comes with working at several studios.

Sweethome Teacup, an instructor who has worked as both an employee and a contractor, says working independently is more in line with the spirit of yoga. "I don't want the business aspect of any studio to interfere in my teaching," she says.

The chill caused by those audits is still felt at many studios, leaving many in the yoga business fearful of speaking out. Owners who continue treating instructors as contractors don't want to draw attention to themselves. And those who have been audited say they don't want reprisals from state officials.

Some studios that use independent contractors continue to believe they're in the right, and that they can pull it off with better results for instructors if they're careful.

"We want people to make a living wage as a yoga teacher," says Todd Williamson, owner of OmBase in Southwest Portland. "But it requires everyone to be in the game in a more aware way, and I think that's what yoga is about."

Nationwide, yoga is a $10 billion-a-year business, with revenue from yoga classes alone exceeding $3.4 billion in 2013, according to the Yoga Alliance, a Virginia-based nonprofit that promotes yoga internationally.

Portlanders are more yoga-crazy than most of their counterparts in the rest of the nation. Forbes magazine in 2013 rated Portland one of the top 10 cities for yoga in the U.S., writing that Portlanders were 23 percent more likely to practice yoga than the typical American.

In some parts of Portland, yoga studios seem to pop up on neighborhood streets as frequently as coffee shops. The studios may share the same scent of burning incense and identical sculptures of Shiva and Ganesh, but beyond the clever names on their windows is a world of difference in the way studios operate.

What's happened to yoga studios isn't unique to the industry. Nail salons, music venues and the taxi industry have also faced scrutiny. Earlier this month, California labor officials in an employment case ruled an Uber driver should be treated as an employee of the ride-sharing giant, a decision that has the potential to bleed into Oregon, where Uber drivers are still considered independent contractors.

Andrea Fogue, a spokeswoman for the Oregon Employment Department, says the agency wants to make sure workers get the protections they're entitled to as employees. She says independent contractors aren't eligible for workers' compensation for injuries on the job and they're not shielded from discrimination and retaliation, as employees are.

Fogue says the state also wants to make sure it's collecting the maximum in unemployment insurance payroll taxes.

Fogue says it's not possible to audit every business in Oregon. Even if the state did, there would be variations in the kinds of business models yoga studios used.

“The legal test for whether someone is an employee, for purposes of the unemployment insurance system, is very dependent on the specific facts,” she says. 

The Employment Department has performed payroll tax audits on about 7,000 business since 2010, but Fogue says the agency doesn't have statistics on the number of yoga studios it has audited in recent years.

Loew, who still runs the Yoga Space, at 2857 SE Stark St., was in the middle of opening a second location, the Yoga Space Northwest, at 210 NW 17th Ave., when the state launched its payroll tax audit of her business. (Disclosure: This reporter has taken classes at the Yoga Space.)

Early on, Loew paid teachers $5 per class for every student who came to their classes—a rate then considered good.

Loew's dispute with the state turned on her relationship with her teachers. Loew argued she simply provided the space, and instructors chose their own times and offered classes they wanted to teach.

But she says state officials claimed she maintained too much control over instructors. The state argued, for example, that Loew controlled when instructors worked (even if the teachers picked the times) in order to build a client base.

In 2014, Loew settled her audit with the state for an undisclosed sum. (Settlement figures aren't public record, and Loew declined to disclose the amount of her penalty.) Now she's paying more for employee benefits, and she's lost experienced teachers who can earn more as independent contractors, she says.

Legal fees alone could have exceeded the cost of the settlement. But Loew remains convinced she did nothing wrong. "If I had deep pockets, I would have fought and won," she says.

Some yoga studios have fought back. Scott Lennartz, owner of Yoga Bhoga in the Central Eastside Industrial District, still uses independent contractors. The state audited the previous owner of Yoga Bhoga, but that owner fought and won her 2008 case in tax court.

"It's a very rare and unusual thing," Lennartz says. "This is the kind of thing people don't want to have to do, because it's scary."

Lennartz pays instructors by the number of students their classes bring in. He says they can earn between $70 and $100 per class.

Yoga studios that have escaped audits are still reeling from the repercussions. One popular studio (the owner didn't want its name used) worried it could be the state's next target, so it switched from treating instructors as contractors to employees in 2012. The additional costs proved too burdensome.

"We made the decision out of fear, without a lot of education on the law," says the owner, who also asked not to be identified. "Financially it just really took a toll on us."

The studio switched back to using independent contractors last year. Now, though, the owner wants to switch yet again, as more yoga teachers see the benefit of being treated as employees and not having to maintain their own business as contractors. She still doesn't know if the arrangement will work out financially for her studio.

Money isn't the primary goal for a lot of owners.

“It’s really the love of yoga that keeps me doing it,” Loew says. “Any sensible business person would close.”