New DOL Guidance Highlights The Importance of Appropriately Classifying Workers As Employees, Independent Contractors: Broad Definition of "Employment" Means that Most Workers Will Be "Employees" Under the FLSA.
Appropriate classification of workers is an important issue for employers, especially because the penalties for misclassification can be substantial. On July 15, 2015 The U.S. Department of Labor ("DOL") issued Administrator's Interpretation No. 2015-1 to provide guidance on how the DOL applies the definition of "employment" in the Fair Labor Standards Act (FLSA) when identifying whether an employee has been misclassified as an independent contractor. It is important to note that "employment" has been interpreted broadly to provide maximum protection under the FLSA. This means that, in the DOL's words, "most workers are employees," not independent contractors.
The FLSA defines "employment" using the phrase "suffer or permit to work." 29 U.S.C. § 203(g). This standard is important to determining whether a worker is an employee entitled to the protections of the FLSA, or an independent contractor outside the FLSA's scope of protection. The DOL explains that this standard "was specifically designed to ensure as broad of a scope of statutory coverage as possible," and that "[t]he Supreme Court has consistently construed the Act liberally to apply to the furthest reaches consistent with congressional direction...to accomplish the Act's goal." (internal quotations and citations omitted).
It is also important to note that the "label" used by employers and workers is irrelevant. An employee does not become an independent contractor simply because an offer letter or even a contract signed by both parties designates the worker as an "independent contractor." Similarly, issuing a 1099-MISC tax form to a worker instead of a W-2 does not mean that the worker is an independent contractor. Workers are not allowed to waive employee status-even for higher compensation-and the DOL and the federal courts will look at the "economic realities" of the situation, not the label used by either party to describe their relationship.
The courts have developed a multi-factor test to determine whether, based on the "economic realities" of a given worker's situation, that worker is an employee or an independent contractor under the FLSA. The factors generally include:
1. The extent to which the work performed is an integral part of the employer's business;
2. The worker's opportunity for profit or loss depending on his or her managerial skill;
3. The extent of the relative investments of the employer and the worker;
4. Whether the work performed requires special skills and initiative; the permanency of the relationship; and
5. The degree of control exercised or retained by the employer.
The DOL cautions that each factor must be analyzed in relation to one another, and no single factor is conclusive-all factors should be considered together to determine a worker's appropriate classification.
Integral Part. If a worker is performing work that is an integral part of the employer's business, this weighs in favor of designating the worker as an employee. As an example, the DOL notes that a carpenter's work would be an integral part of the business of a construction company that frames residential homes. The same construction company may contract with a software developer to create software that assists the company in managing its business, but that work is not integral to the construction company's business.
Opportunity for Profit or Loss. A worker who is truly an independent contractor in business for himself has the possibility of making a profit or experiencing a loss due to the worker's managerial skill-in other words, the worker's judgment or initiative. The "profit" prong does not simply mean that a worker will be paid additional compensation, as employees are often rewarded for a job well done or working additional hours. The DOL gives the example of a worker providing cleaning services for corporate clients through a cleaning company who advertises, selects, and schedules the worker's client assignments, and the worker has no responsibility for attempting to reduce costs. This worker is not exercising managerial skill that affects his profit or loss. However, if that same worker advertises, negotiates contracts, decides which jobs to take and when to perform work, recruits new clients, or hires new workers, he is exercising managerial skill affecting his profit or loss.
Relative Investment. It is not necessarily true that when a worker invests her own resources into her work, she must be an independent contractor. Instead, courts will look at the relative investment of the worker and the employer. Even when a worker makes a substantial investment, if the employer's investment is far greater, an employment relationship is indicated. Conversely, when the worker's investment is equivalent to that of the employer-for example, a worker who receives referrals from a cleaning company, but purchases a business vehicle, rents her own space to store the vehicle and materials, advertises and markets her services, and regularly purchases and uses her own equipment and supplies-this is more indicative of an independent contractor relationship.
Special skill and initiative. This factor can be tricky, as many employees possess special skills required to perform their work. However the "skill and initiative" involved relate to the worker's business skills, judgment, and initiative, not to his technical skills. A worker demonstrates business skill when he markets his services, decides which jobs to take, and decides how and when to perform each job. A worker does not demonstrate business skills simply because he demonstrates a high degree of technical skill in the actual work performed.
Permanent or Indefinite Relationship. Independent contractors generally work for a finite period of time, or on a per-job basis. Employees are often employed at-will or with the expectation of a continued relationship. Sometimes, a worker may work for a finite period (e.g., seasonal employment), but that alone does not mean that the worker is an independent contractor instead of an employee. The key is whether the lack of permanence or indefiniteness is due to the nature of the industry, or due to the worker's own business initiative. The former is likely going to point to employment, while the latter may point to an independent contractor. A book editor who has worked exclusively for one publishing house for several years, and who does not work with other publishers has the appearance of permanence to the relationship indicative of an employment relationship. On the other hand, if the editor takes jobs from a number of publishing houses, negotiates rates for every job, and turns down work for any reason, this demonstrates a lack of permanence indicative of an independent contractor relationship.
Degree of Control. The DOL cautions that the "control" factor should not be given undue emphasis in the economic realities analysis. To demonstrate the control indicative of an independent contractor, a worker must control "meaningful aspects of the work performed such that it is possible to view the worker as...conducting his or her own business." (citation omitted). With the wide adoption of technology that makes remote work or "telecommuting" available to many workers, it is important not to rely too much on a worker's ability to control the hours during which she works or the fact that she is subject to little direct supervision in determining employment status. The DOL gives the example of a nurse who works with a referral service to be matched with clients. The service has specific procedures regarding training, how to contact clients, wages and hours, and requires notification if the nurse performs work for a client or has to miss scheduled work. In this case, the company's extensive exercise of control indicates an employment relationship. However, if the service simply lists the nurse on a registry and sends the nurse a list of potential clients, with no further requirements regarding whether, when, or how she performs work, this lack of control indicates an independent contractor relationship.
Ultimately, these factors are a guide to making the ultimate determination of whether a worker is economically dependent or independent from the employer. The more economically independent a worker is-in other words, the more he is responsible for managing and controlling his overall business-the more likely he can be appropriately classified as an independent contractor. However, employers must remember that the definition of "employment" is broadly defined to protect the maximum number of workers. For all intents and purposes, most of your workers will be considered "employees" for purposes of the FLSA.
This is intended to be a brief overview of the DOL's new guidance. It is not a comprehensive analysis of all issues relating to employee classification. If you have any questions about whether your workers are appropriately classified, please contact us.
Ahlers & Cooney's Labor & Employment Practice Group
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