On July 15, 2015, the U.S. Department of Labor (“DOL”) issued Administrator’s Interpretation No. 2015-1 to clarify the historically vague and unpredictable classification standards applicable to employees versus independent contractors. This article summarizes the DOL Interpretation. Although not groundbreaking, the DOL attempts to further narrow the permissible use of independent contractors by shifting the regulatory focus from employer “control” to an “economic dependency” analysis of each individual situation.
Why Care About Classifications?
Workers properly classified as “employees” are generally entitled to protections under the Fair Labor Standards Act (“FLSA”) such as minimum wage, overtime, and specific rules for the payment of fixed salaries (also newly revised with more than double the minimum salary proposed for 2016). Misclassification occurs when employers label workers as “independent contractors” rather than “employees” for various reasons, including to avoid federal employment taxes, unemployment taxes and unemployment claims liability, worker’s compensation liability, overtime liability, and potential leave or health care costs mandated by laws only applicable to “employees.”
The Department of Labor’s Wage and Hour Division (“WHD”) brings enforcement actions against employers who wrongfully misclassify workers as independent contractors. In recent years, state governmental agencies have also increased enforcement efforts, for example, through worker’s compensation systems, unemployment tax audits, or state wage and hour divisions.
Our firm has defended multiple employers before both the federal wage and hour division and state wage and hour division, and even state agencies seeking to recover back monies for allegedly misclassified workforces. Imagine being subjected to an audit by multiple different state and federal agencies; these agencies may seek to impose at least one and one half times wage rates for all prior unpaid contractor “overtime” hours worked (for an entire contractor workforce over the past two years), at least an additional 10% of employment taxes for all wages paid plus penalties and interest, in addition to potential $1,000-$2,000 or more fines per employee for failure to provide other mandatory benefits. It is imperative that employers and HR professionals seek legal counsel to help further understand and mitigate risk in this unpredictable area of classification. Without any bright line rules, even under the new Interpretation’s multifactor test, very few situations are absolutely clear without risk. One court and agency could take an entirely different view from another jurisdiction or governmental agency.
Classifications 101:
How to Determine the Difference Between an “Employee” and an “Independent Contractor” Under the new DOL Interpretation
Under the FLSA, to “employ” means to “suffer or permit to work.” This inherently vague definition includes any person acting directly or indirectly in the interest of an employer. According to the DOL Interpretation, this determination now depends upon whether the worker is “economically dependent” on the employer (thus an employee) and subject to the control of the employer, or whether the worker is truly engaged in an independent business for him or herself in a trade or profession (thus a contractor).
It is important to note that the employee’s status label, in and of itself, is not definitive of the type of relationship – one of the most common misconceptions made by business owners. Simply because an employer labels a worker as an “independent contractor,” and pays him or her via IRS Form 1099 (without tax withholding), does NOT mean the employer can legally treat the worker as such under the law. The worker must pass the legal test which varies depending upon each particular statutory scheme or government agency enforcement mechanism (the IRS, DOL, and NC Department of Commerce Employment Security Division, for example, all enforce different tests and rules). In all instances, however, the label and treatment by the employer is of little relevance. Under the new DOL Interpretation, the focus is now instead on the six-part “economic realities” test applied to actual work performed.
The economic realities test is guided by factors that determine the worker’s economic dependence or independence upon/from the employer. It is important to note that most workers are sought to be classified as employees under the FLSA due to the broad scope of the statute and subsequent judicial and regulatory interpretations. The Supreme Court has recognized that broad coverage is essential to accomplish the FLSA’s goals. Furthermore, the obscure multifactor test is suggested to be used “as a gauge, rather than a mechanical formula,” to determine the degree of the worker’s economic independence. Every single employer is different, and employers must be vigilant to obtain a thorough employment law analysis to determine their risk of improper classification.
Factors
The following are factors that help determine whether a worker is an independent contractor or employee under the DOL Interpretation. Remember, this test should be analyzed as a “gauge,” NOT a rigid or mechanical checklist:
- The extent to which the work performed is an integral part of the employer’s business.
- If the work performed by a worker is integral to the employer’s business, it is more likely that the worker is economically dependent on the employer – for example, is the worker providing licensed plumbing services to a plumbing company’s customers? Or is the individual providing contract accounting services to the plumbing company? The former would lean towards the integral nature of services provided by the worker and negate independent contractor status.
- According to the Interpretation, work can be “integral” to a business even if the work is just one component of the business, and/or is performed by hundreds or thousands of other workers, and even if the work is performed away from the employer’s premises, at the worker’s home, or on the premises of the employer’s customers.
(B) The worker’s opportunity for profit or loss depending on his or her managerial skill.
- In order to inform the determination of whether the worker is in business for him or herself, this factor should not focus on the worker’s ability to work more hours, but rather on whether the worker exercises managerial skills and whether those skills affect the worker’s opportunity for both profit and loss. For example, is a subcontract hourly plumber’s only ability to make profit essentially fixed by the worker’s sole ability to work more hours, or is the subcontract plumber paid a fixed price and essentially able to make more profit by cutting their own costs, efficiently utilizing their own equipment, and managing their own subcontract labor costs? Regardless of the pay scheme, the former would lean towards the inability to affect profit/loss and negate independent contractor status.
(C) The extent of the relative investments of the employer and the worker.
- According to the DOL Interpretation, employers must look comparatively to the employer versus worker investment to make the independent business analysis. Did the worker provide all of the training, equipment, transportation, insurance, licensing, and materials necessary for the job, or did the employer provide all of these items? The former supports a truly independent business and contractor status.
(D) Whether the work performed requires special skills and initiative.
- A worker’s business skills, judgment, and initiative — not his or her technical skills — will aid in the economic dependency determination. Is a worker merely entering data into a computer (technical skills that can be easily replaced), or is the worker being given raw data, analyzing the data, and using skills and judgment to render a final analyzed end result product to the employer? The former lacks special skills and negates contractor status.
(E) The permanency of the relationship.
- Longer term permanency or indefiniteness in the worker’s relationship with the employer suggests employment status. The key is whether any lack of permanence or indefiniteness is due to “operational characteristics intrinsic to the industry” (for example, employers who routinely hire part-time electrical workers or use staffing agencies) or the worker’s “own business initiative.” For example, an adult babysitter that has provided 30 hours per week of service to one family for multiple years, as the worker’s sole source of income, would support permanency and indefiniteness and thus employee status, while a similar babysitter that only provides occasional, part time project based work to the same family, while also marketing and providing their services to multiple other families over the course of the same time period, would support a lack of permanency and thus support contractor status.
(F) One of the most important factors – the degree of control exercised or retained by the employer.
- The employer’s control should be analyzed in light of the ultimate determination of whether the worker is economically dependent on the employer or truly an independent businessperson. The worker must control meaningful aspects of the work performed – such that it is possible to view the worker as a person conducting his or her own business. One of the most significant changes embodied in the DOL Interpretation is the fact that “control” should not play a complete/oversized role in the analysis of whether a worker is an employee or an independent contractor, although it is an initial indicator and important factor in the overall circumstantial analysis. Does the employer control or direct the detailed manner by which work is performed, or are such details left to the individual? Does the employer only control the acceptable or unacceptable determination of the final end result product or service? For example, imagine a painter: the homeowner doesn’t tell the painter which brush to use, what times to report, what brand of paint to use, or other similar means of work performance, but the homeowner instead simply controls the final acceptability of the end result – indicative of an independent contractor truly in business for himself.
Conclusion
The use of independent contractors can be beneficial to any business model, while unlawful misclassification of such workers can have serious legal and corresponding financial consequences. The legal defense of an administrative agency investigation alone can cost businesses tens of thousands of dollars in legal fees and lost productivity and requires delicacy and an intelligent strategy. It pays to invest and involve employment counsel up front in these types of larger scale workforce classifications. If unsure whether a worker qualifies for “independent contractor” status, employers should consult the above factors as part of the totality of the circumstances surrounding the economic realities test, however, each situation is different and no employer alone can reliably make this determination on their own.
Contact our firm at www.MKNEmploymentLaw.com for more information.
