This week the Department of Labor (DOL) issued an Administrator’s Interpretation of the Fair Labor Standards Act’s (FLSA or Act) definition of employment and worker classification–i.e. whether workers are employees entitled to the protections of the FLSA (including overtime pay) or independent contractors not covered by the Act. The DOL did not create a new test for employment classification, instead restating the same six factors of the “economic realities” test from its May 2014 Fact Sheet. However, the Administrator’s Interpretation re-examines each of the six factors and provides specific examples of how the DOL believes the factors should be applied.
Why should you care? It is estimated that nearly one-third of businesses misclassify their workers, subjecting themselves to possible governmental audits and litigation. The new guidance reinforces DOL’s intention to go after employers it believes are misclassifying workers. It also increases awareness of independent contractor/employee classification issues, much to the delight of plaintiff’s attorneys. Of course, worker classification suits and FLSA litigation in general is already on the rise (up nearly 32% from 2009 to 2014). Just last month Federal Express settled a worker misclassification class action for $228 million. Uber is also facing a class action lawsuit after the California Department of Labor found it misclassified a driver as an independent contractor.
FLSA Test For Employee vs. Independent Contractor
The FLSA is the federal law that governs overtime and minimum wage requirements for employees. Independent contractors are not covered by the FLSA. The FLSA’s rather circular definition of an “employee” is “any individual employed by an employer.” The Act’s definition of “employ” is incredibly broad and includes anyone the employer “suffer[s] or permit[s] to work.” This is not the same test used by the IRS to determine whether payroll taxes need to be withheld, or by state agencies to determine eligibility for unemployment or workers compensation benefits. A discussion of the IRS’ 20 factor test can be found in a previous blog post here. While many of the same factors are found in each of these tests, the DOL’s new Administrator’s Interpretation of how the FLSA applies clearly focuses on a bigger picture, the nature of the worker’s business as a whole and not just the job the worker is performing for the alleged employer. According to the DOL, whether the worker is an employee under the FLSA depends on how dependent the worker is on the employer:
The ultimate inquiry under the FLSA is whether the worker is economically dependent on the employer or truly in business for himself or herself. If the worker is economically dependent on the employer, the worker is an employee. If the worker is in business for himself or herself (i.e. economically independent from the employer), then the worker is an independent contractor.
There is no mechanical formula for determining whether someone should be classified as an employee or an independent contractor. The facts must be reviewed on a case-by-case basis depending on the specific facts of the relationship between the worker and the company. To help with this analysis, six factors, called the “economic reality” test have been applied for years. The DOL’s new guidance includes the same six economic reality factors has its 2014 Fact Sheet. While these six factors are not new, there are some changes in how the DOL is interpreting them.
- Is the Work an “Integral Part” of the Employer’s Business? The more closely related the work being performed is to your business, the more likely the person doing that work is an employee. For example, if you own a construction company that frames houses, carpenters are integral to that business and should be classified as employees, but a software developer who creates software to track bids or schedule appointments is not integral and may be an independent contractor (depending on other factors).
- Does the Worker’s “Managerial Skill” Affect the Worker’s Opportunity for Profit or Loss? The focus here is not on whether the worker can work more hours to make more money. Instead it is whether the worker can exercise managerial skills, i.e. purchasing equipment and materials, advertise, manage time tables. In addition, the focus is not limited to the current job, but also looks to whether the worker’s managerial skill will affect their opportunity for profit or loss in the future. If the only way the worker can make more money is to work more hours, then they are more likely to be an employee. However, if the worker can decide how much to charge for a job, whether to hire helpers, whether to advertise, etc., they are using their managerial skills to affect their opportunity to profit or suffer a loss in their business and are more likely to be an independent contractor.
- How Does the Worker’s Relative Investment Compare to the Employer’s Investment? This factor looks not only at the amount of the investment, but what the worker is investing in. Investments that support the worker’s business beyond any particular job (i.e. improve the worker’s business capacity, or reduce their cost structure) are more likely to support an independent contractor classification. Simply investing in the tools necessary to do the job is not sufficient to indicate independent contractor status.
- Does the Work Performed Require Special Skill and Initiative? The “skills” the DOL is focusing on in applying this factor are not the technical skills necessary to do the work, but “business skills, judgment and initiative.” Specialized technical skills will not support an independent contractor classification if those skills are not exercised in an independent manner. For example, a carpenter may be highly-skilled technically, but if that carpenter is simply told “what work to perform where,” they are not demonstrating the skill and initiative of an independent contractor. However, if the carpenter provides specialized service to several different construction companies, marketing his services, and determining which orders to fill, he is demonstrating the skill and initiative of an independent contractor.
- Is the Relationship Between the Worker and the Employer Permanent or Indefinite? The longer and more continuous the engagement, the more likely an employee-employer relationship exists. Independent contractors, by contrast typically work on a project basis (when the project is over, the engagement is over) and do not necessarily work repeatedly for an employer. The key to this factor is whether the lack of permanence or indefinite nature of the work is due to the worker’s own business initiative. For example, a worker who intermittently works with multiple businesses, marketing her services, negotiating rates and decides which work to accept and which to turn down is more likely to be an independent contractor.
- What is the Nature and Degree of the Employer’s Control? To be an independent contractor, 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.” The DOL warned that the reasons why the alleged employer exercises control–i.e. because quality control measures or regulation of schedules are “the nature of the business”–is not the question. According to the DOL, if the nature of the business requires a company to exert too much control over workers, “then that company must hire employees, not independent contractors.”
No one factor is determinative. The specific facts related to your business, the worker’s business and the relationship you have with them need to be examined carefully.
The Bottom Line
Worker classification is one of the most difficult and far-reaching employment law compliance issues. Getting it wrong could mean you or your company may have to pay unpaid wages, taxes, penalties and depending on the circumstances could face criminal penalties. The best way to protect yourself and your company is to have an employment attorney to objectively assess each of the relevant factors and determine the appropriate classification.
If the worker can properly be classified as an independent contractor, it is essential that you ask the right questions and get the necessary documents from the contractor to protect the company’s classification. You also need a written Independent Contractor Agreement, specifically drafted for the engagement. The agreement should be drafted by an employment attorney who can include provisions addressing the applicable factors and help protect the independent contractor classification.
If you have contractors who may need to be reclassified as employees, it is important to have legal advice to assist you in making that transition is such a way as to minimize the risks to you and your company.
Given the significant risks businesses face for misclassifying workers, businesses are encouraged to carefully review their relationship with their workers, including any written agreements, policies and procedures used to govern the relationship. Moreover, before businesses enter into an independent contractor relationship, they are encouraged to seek the advice of a tax professional and/or employment attorney. Businesses should also keep detailed notes of how the determination was made and all facts that apply to each factor.
If you have any questions or would like more information about this or any other employment matter, please contact Julie Kinkopf, Esquire at 610-660-7786 or firstname.lastname@example.org. You can also find previous articles written on the proposed overtime changes here, here and here. Additional articles regarding employment matters can be found here. We know this is a confusing area of the law and are here to help protect you and your company from liability.
Julie Kinkopf, Esquire is principal of Kinkopf Law LLC and is an accomplished attorney who has represented employers for over 15 years. Ms. Kinkopf helps businesses develop sound employment practices and provides training to supervisors and employees designed to avoid litigation and government audits. She also represents employers before various governmental agencies as well as in state and federal courts in post-employment litigation, including discrimination, retaliation, pay disputes and non-compete/trade secret matters. More information may be found at www.kinkopflawfirm.com or www.linkedin.com/in/juliekinkopf/
Disclaimer: The contents of this post are for informational purposes only, are not legal advice and do not create and attorney-client relationship.