On July 15, 2015, the US Department of Labor, Wage and Hour Division, issued Administrator’s Interpretation No. 2015-1, reminding us that one of their central focuses is limiting the ability of employers to classify workers as independent contractors instead of employees under the Fair Labor Standards Act (FLSA). This means that they have decided to dedicate an increasing amount of time, money, and other resources 1) to educate employees about independent contractor misclassification with intention to increase worker misclassification claims, and 2) to investigate and prosecute employers who they conclude have improperly misclassified employees. Moreover, they have enlisted the help of 22 state labor offices to support their crusade. Employers more than ever must be aware of the risks of classifying workers as independent contractors and the potential cost of doing so incorrectly. If you are an employer who has classified workers as independent contractors, you have reason to be concerned.
One of the most frustrating parts for employers in determining whether they have properly classified a worker as an independent contractor is the fact that there is not a set of bright line rules on which they may base their decision. Instead, the US Department of Labor and courts rely on a six factor balancing test that is subject to opinion and bias. In its memo, the US Department of Labor confirmed its bias my reiterating its position that the Fair Labor Standards Act should be interpreted so that as many workers are classified as employees as possible. Even when an employer has acted in good faith when classifying workers as independent contractors, the US Department of Labor and courts may have a different opinion and may pursue and enforce legal action against the employer.
6 factor economic realities test
The test used by the US Department of Labor and courts to determine if a worker is an independent contractor or an employee under the Fair Labor Standards Act is called the “economic realities test.” This economic realities test consists of six (6) factors that are all weighed against each other to determine if an employer properly classified a worker as an independent contractor. This means that even if some of the factors lean in the employer’s favor, the decision maker can determine that the factors that lean in the employers favor are outweighed by those that don’t and determine that the employer has misclassified its independent contractors. The six (6) factors relied on by the US Department of Labor and the courts are:
- the extent to which the work performed by the worker is an integral part of the employer’s business;
- the worker’s opportunity for profit or loss depending on his or her managerial skill;
- the extent of the relative investments of the employer and the worker;
- whether the work performed by the worker requires special skills and initiative;
- the permanency of the relationship between the employer and worker; and
- the degree of control exercised or retained by the employer over the worker.
Below is a brief discussion of each of the six factors listed above:
Work is an integral part of the business
The more integral the work performed by an individual is to the operation of an employer’s business, the more likely it is the worker will be found to be an employee. For example, the work of an individual on an assembly line installing a part on a product sold by the employer is more integral to the employer’s business than the work performed by an individual mowing the lawn of the employer’s offices. Thus, the assembly line worker is more likely to be found to be an employee than the individual mowing the lawn.
Opportunity for profit or loss based on managerial skill
The greater the opportunity a worker has for making or losing money due to their own managerial skills, the more likely it is that the worker will be found to an independent contractor. For example, a worker who has independent authority to hire additional employees, to enter into other business agreements, and to make decisions about the sales and marketing of their services is more likely to be found to be an independent contractor than a worker that must receive authority from his or her employer to engage in such activities. Special focus is frequently paid to whether the worker personally and directly suffers economically if a managerial decision results in a loss.
The relative investment of the employer and worker
The greater the investment by a worker in the tools, equipment, and other resources need to complete a job compared to the investment of the employer, the more likely it is that the worker will be found to be an independent contractor. For example, a carpenter who buys expensive saws and other power equipment to build a new home is more likely to be found to be an independent contractor than a carpenter who is only required to purchase relatively inexpensive hand tools.
Skill and initiative
The greater the skill needed by a worker to complete a job, the more likely it is he or she will be found to be an independent contractor. Thus, a journeyman electrician is more likely to be a found to be an independent contractor than an entry level janitor.
Permanency of the work
The more permanent a working relationship is between a worker and an employer, the more likely it is that that worker will be found to be an employee. For example, a worker who works for an employer for an indefinite period of time is more likely to be found to be an employee than a worker who is hired for a short period of time or to complete a specific job.
Nature and degree of control
The more control a worker has over his or her terms and conditions of employment, the more likely it is that they are an independent contractor. Thus, a worker who can determine his or her work hours, break times, rate of pay, work location, and other similar working conditions is more likely to be found to be an independent contractor than a worker who has such working conditions set and enforced by his or her employer.
As noted above, the US Department of Labor and courts will not rely on any one factor of the economic realities test to determine if a worker is an employee or an independent contractor under the Fair Labor Standards Act. Instead they will take all factors into consideration, weighing those that favor independent contractor status against those that favor employee status, to reach a conclusion. Unfortunately, it is in this weighing process where opinion and bias may affect the outcome of the analysis.
Some practices often used by workers and employers to help clarify the existence of an independent contractor relationship are generally considered to be irrelevant in the independent contractor/employee analysis. Two such irrelevant practices that are particularly noteworthy include:
- having workers sign contracts agreeing they are independent contractors, and
- having the workers obtain a business licenses with a state or other local government entity
Such practices are considered to be irrelevant because they may occur in spite of fact that an independent contractor relationship does not actually exist under the economic realities test. What it means in real terms is that the US Department of Labor and courts do not care what the intention of either the employer or the worker are regarding their independent contractor/employee relationship. It also means that an employee who willfully and knowingly enters into a working relationship with an employer with the understanding that he or she was an independent contractor may still pursue a misclassification claim against the employer and recover any damages owed if successful.
More than just the FLSA
In addition to potential liability under the Fair Labor Standards Act, employers may have to defend their decision to classify a worker as an independent contractor under state wage and hour laws, state and federal tax laws, the Employee Retirement Income Security Act (ERISA), the National Labor Relations Act, and many other employment-related laws. Moreover, many of these laws and the entities that enforce them use tests other than the economic realities test to determine whether a worker has been improperly classified (these test will be covered in future blog posts).
Employers who are found to have misclassified a worker as an independent contractor under the Fair Labor Standards Act may be required to pay the worker for any overtime worked, any unpaid wages if the effective wage rate for the worker was less than the minimum wage while working as an independent contractor, and other related damages. If a court determines an employer willfully attempted to avoid its minimum and overtime obligations by classifying workers as independent contractors, it order the employer to pay fines of up to $10,000 per violation. Additional, penalties and fines may be assessed if the employer is found to have misclassified workers under other state and federal laws. On top of all these potential fines and penalties is the cost of hiring a lawyer to help defend your company against the claims.
As the US Department of Labor renews its campaign against independent contractors, with the help of 22 state labor offices, employers must be careful when classifying workers as independent contractors. Understanding the six-factor economic realities test relied on by the US Department of Labor and courts in Fair Labor Standards Act claims will go a long way in helping you make the right classification decision. If at any time you are unsure about you classification decision, I would recommend that you contact an HR consultant or employment law attorney who can provide the guidance and support you need.