Employers: Your independent contractors may actually be employees

July 22, 2015

Employment Law BookLast week, the U.S. Department of Labor (DOL) issued a 15-page Administrator’s Interpretation, which provides new guidance for employers on whether a worker is properly classified as an employee or an independent contractor under the Fair Labor Standards Act (FLSA).  The DOL promulgated this guidance in response to increased “[m]isclassification of employees as independent contractors,” which  causes employees to miss out on “important workplace protections such as the minimum wage, overtime compensation, unemployment insurance, and workers’ compensation.”  In addition, the Labor Department cites lost tax revenues for the government because of the practice.

The gist of this new guidance is summed by one of the closing statements of the document: “most workers are employees under the FLSA’s broad definitions.”  This is indicative of the DOL’s view that the definition of “employee” under the FLSA – which only reads as “any individual employed by an employer” – should be read as broadly as possible.  The DOL notes that, under this new guidance, the department may view a working relationship as one of an employer and employee regardless of whatever labels or legal structures are used by the parties in the relationship.

The guidance lays out how to determine whether a worker is an employee or an independent contractor: through the “economic realities” test, which “focuses on whether the worker is economically dependent on the employer or in business for him or herself.”

The guidance then provides the five most common factors of this test, “which are to be considered in totality to determine whether a worker is economically dependent on the employer.”  Furthermore, the DOL states that the “application of the economic realities factors is guided by the overarching principle that the FLSA should be liberally construed to provide broad coverage for workers.”  In other words, the department is effectively saying that, when in doubt, a worker is best classified as an employee.

Below are the “economic realities” factors, along with short explanations:

(A) the extent to which the work performed is an integral part of the employer’s business

This factor analyzes whether and to what extent the work performed by the worker is “integral” to the employer’s business.  For example, carpenters are integral for “a construction company that frames residential homes.”  On the other hand, a software developer that creates software that, “among other things, assists the company in tracking its bids, scheduling projects and crews, and tracking material orders” wouldn’t be considered “integral” to the same company.”

While this is a relatively straightforward analysis for small, specialized companies like the above construction company, it becomes more difficult when analyzing the employment relationships in large corporations with a variety of products and services.  However, given the qualification provided by the guidance about these factors, it’s safe to assume that any ambiguity here will be resolved in favor of classifying a worker as an employee.

(B) the worker’s opportunity for profit or loss depending on his or her managerial skill

This factor looks at whether and to what extent the worker’s managerial skill can affect his or her profit or loss.  These managerial skills may be reflected in “a worker’s decisions to hire others, purchase materials and equipment, advertise, rent space, and manage time tables.”  Conversely, the worker’s ability to work more hours or do one’s job well do not reflect managerial skill, and thus would likely lend to the worker’s classification as an employee.

(C) the extent of the relative investments of the employer and the worker

Under this analysis, the worker’s investment in the work (e.g., through funds spent on materials and training) should not be “relatively minor compared with that of the employer,” which would suggest that “the worker and the employer are not on similar footings and that the worker may be economically dependent on the employer” – and therefore should be classified as an employee under the FLSA.

(D) whether the work performed requires special skills and initiative

This factor looks at whether work requires a “worker’s business skills, judgment, and initiative, not his or her technical skills.”  Citing the 1991 Third Circuit case Martin v. Selker Bros., Inc., the guidance notes that “the use of special skills is not itself indicative of independent contractor status, especially if the workers do not use those skills in any independent way.”

In short, if a worker is simply creating products or services at an employer’s behest and exercising little to no independent judgments beyond the work that he or she is doing for that job, that worker is likely classified as an employee.

(E) the permanency of the relationship

The guidance states here that “permanency or indefiniteness in the worker’s relationship with the employer suggests that the worker is an employee.”  However, the lack of such permanency or indefiniteness “does not automatically suggest an independent contractor relationship.”  Instead, such lack of permanency or indefiniteness is indicative of an independent contractor relationship “if it results from the worker’s own independent business initiative.”

(F) the degree of control exercised or retained by the employer

Under this factor, to be classified as an independent contractor, a 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 guidance states that an employer’s lack of control over workers who work from home or offsite “is not particularly telling” and that an employer need not “look over his workers’ shoulders every day in order to exercise control.”

Instead, a worker is considered an independent contractor if the worker chooses which work to perform, when to perform it, and has some level of control over the ability to set his or her own wage rate and schedule.

Because this new guidance comes with warnings of the Labor Department’s enforcement actions against employers who misclassify workers, it’s important for employers to review their current employment relationships to determine whether their so-called “independent contracts” truly are such, or whether they are “economically dependent on the employer” and thus an employee.