DOL Issues Guidance on Employee vs. Independent Contractor Classification

Determining whether a worker is an employee or an independent contractor can be a confusing (and, if done incorrectly, costly) endeavor. Though some employers may knowingly misclassify workers to reduce costs and avoid the burden of certain employment laws, it is equally—if not more—likely that the fact-specific multipart classification tests used for this purpose have simply confused well-meaning employers into getting it wrong. In an effort to provide some clarity and guidance on employee classification, U.S. Department of Labor (DOL) Administrator David Weil recently issued an Administrator’s Interpretation that sheds additional light on the existing tests. The primary takeaway from this document: Most workers are employees under the Fair Labor Standards Act (FLSA). Why does misclassification matter? When workers are misclassified, it creates two significant areas of concern to state and federal governments. First, the workers may not be receiving—and the employer may not be bearing the cost and responsibility of providing—appropriate protections granted by state and federal laws. These protections, which are typically limited to “employees,” include not only wage entitlements such as overtime and minimum wage but also benefits such as unemployment and workers’ compensation. Second, misclassification has tax implications because employers aren’t required to pay or withhold taxes for independent contractors. A 2009 study conducted by the U.S. Treasury inspector general for tax administration revealed that misclassification costs $15 billion each year in unpaid FICA and unemployment insurance taxes alone. That doesn’t include the additional $54 billion in losses created by underreporting of federal employment taxes, nor does it account for similar lost state tax revenues. Because of the tremendous financial losses that occur because of misclassification—and the unfair advantage noncompliant employers have over their rule-abiding counterparts—the IRS, the DOL, and state governments have become particularly active, even working collaboratively in recent years to combat employee misclassification. To supplement these efforts, Administrator Weil opted to issue additional guidance to assist employers and further curtail misclassification. FLSA’s ‘economic realities’ test The interpretive guidance, which was released on July 15, 2015, doesn’t change the current standards for employee classification. The DOL will continue to use the well-established six-part “economic realities” test for determining employee versus independent contractor status under the FLSA. The test considers the following factors in the employment relationship:
  1. Whether the work is an integral part of the employer’s business;
  2. Whether the worker’s managerial skill affects her opportunity for profit or loss;
  3. How the worker’s relative investment compares to the employer’s investment;
  4. Whether the work performed requires special skill and initiative;
  5. Whether the relationship between the worker and the employer is permanent or indefinite; and
  6. The nature and degree of the employer’s control.
Classification in light of interpretation The Administrator’s Interpretation provides valuable insight on how the DOL approaches the elements of the economic realities test when determining whether a worker is an employee or an independent contractor. First, the DOL begins with the presumption that every worker is an employee. The burden of proof to establish that a worker is actually an independent contractor then lies with the employer. With that in mind, you should also operate under the presumption that every worker is an employee unless and until sufficient evidence can be shown to justify that a worker is an independent contractor. You should also note that, as is the case with exempt and nonexempt status under the FLSA, labels and job titles aren’t persuasive. Simply referring to an employee as an independent contractor, partner, owner, or member won’t factor into the test of economic realities—that is, how the actual day-to-day work and responsibilities are carried out. Finally, the interpretive guidance clarifies that no single factor of the economic realities test is dispositive. In particular, employers tend to rely too strongly on the last factor—the amount of control exerted over the employee—without considering all relevant factors and the other elements of the test. Instead, while considering each of the six individual factors, you should also consider the broader overall purpose of the six-factor test, which is to determine whether the worker is economically dependent on independent business. When this test is appropriately applied, most workers are dependent on the employer and, as a result, are employees under the FLSA. Specifically, Weil notes, “The goal is not simply to tally which factors are met, but to determine whether the worker is economically dependent on the employer (and thus its employee) or is really in business for him or herself (and thus its independent contractor).” The factors are simply a guide to make this ultimate determination. Bottom line Through this guidance, the DOL is making an important effort to ensure that employers are well-informed of their obligations. Thus, as is typically the case, an employer’s ignorance of the law won’t be a defense to misclassification, regardless of good faith and well-meaning intent. The Administrator’s Interpretation provides specific examples and relevant case law for each part of the six-factor test. You are encouraged to review these factors and, as necessary, reconsider, reclassify, or amend existing relationships with independent contractors.  We hope this information is valuable to you. If you have any questions, please do not hesitate to contact Holman HR.