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September 1, 2015

DOL Says Most Independent Contractors Are Employees

In recent years, the U.S. Department of Labor, the Internal Revenue Service and their state agency counterparts, have been cracking down on independent contractor misclassification – that is, classifying workers as independent contractors rather than employees.

Employers sometimes elect to classify certain workers as contractors because contractors are believed to be cheaper than employees while giving the employer more flexibility.  Contractors are not entitled to benefits, such as health insurance and 401(K), and the employer is not liable for paying state and federal employment taxes, unemployment insurance and workers’ compensation for contractors.

The line between an independent contractor and an employee has traditionally been blurry.  There are a multitude of legal standards that courts use and no one factor is dispositive.  As part of its continuing efforts to target misclassification of employees, the U.S. Department of Labor has issued guidance on the proper classification of employees and independent contractors.  The guidance makes clear that the agency will view most workers as employees.

The DOL directs employers to focus on the broad definition of “employ” under the Fair Labor Standards Act (FLSA) and the “economic realities” test.  Under this test, employers should determine whether the worker is “economically dependent” on the purported employer (and thus its employee), or is really in business for him or herself (and thus is an independent contractor).


The “Economic Realities” Test

The guidance summarizes the six-factor “economic realities” test:

1.  Is the Work an Integral Part of the Employer’s Business?

If the worker performs the type of work that is core to the employer’s business, this weighs in favor of finding an employee relationship.  On the other hand, if the worker provides a service to the employer’s business, this factor weighs in favor of an independent contractor relationship.

2.  Does the Worker’s Managerial Skill Affect the Worker’s Opportunity for Profit or Loss?

An independent contractor typically has the opportunity for profit or loss of capital investment based on managing the project.

3.  How Does the Worker’s Relative Investment Compare to the Employer’s Investment?

Independent contractors usually supply their own materials, pay for many, if not all, of their own expenses, and are not typically trained by the company.  Even if a worker has made an investment (in tools, supplies, etc.) that investment must be significant when compared to the investment of the purported employer.

4.  Does the Work Performed Require Special Skill and Initiative?

The worker who provides only specialized skill is more likely an employee while the worker who provides specialized skill, offers services to a number of customers, markets his or her services, and makes decisions about materials is more likely an independent contractor.

5.  Is the Relationship between the Worker and the Employer Permanent or Indefinite?

Independent contractors are usually hired to perform a discrete project during a set period of time with a starting and ending date.

6.  What is the Nature and Degree of the Employer’s Control?

Independent contractors usually have a formal, written agreement in place describing the independent contractor relationship, setting the price or fee for the final product and the terms of the project.  And unlike most employees, contractors are not usually terminable “at will” and are not subject to company policies and procedures, or other terms and conditions of employment.  Importantly, the guidance notes that flexible work arrangements are common forms of employment and the fact that an individual works from home or controls the hours of work is not indicative of independent contractor status.

According to the DOL, each factor must be examined and analyzed in relationship with the others and in light of the overall focus on economic dependence and providing “broad coverage” for workers.  Additionally, no single factor should be deemed determinative—in particular, according to the guidance, the “control” factor should not be given “undue weight.”


Penalties, Taxes, and Back Wages, Oh My!

Employers found to be misclassifying employees as independent contractors face severe penalties and damages.  The DOL is empowered to award back pay and liquidated damages, and to assess civil money penalties of up to $10,000 for instances of minimum wage and overtime violations; a second conviction may result in imprisonment.

In addition, the DOL may fine employers who repeatedly violate the requirements up to $1,100 per violation.  Under California law, any person or employer found to have willfully misclassified workers as independent contractors is subject to civil penalties of between $5,000 and $25,000 for each violation.

Employers who are determined to have misclassified employees as independent contractors may be liable for unpaid minimum wage, unpaid overtime compensation, meal and rest break violations, and related wage and hour penalties.  In addition, there may be liability for failure to provide health and other benefits, denied medical leave, state and federal taxes, unemployment insurance and claims, and workers’ compensation insurance and claims.


What Employers Should Do Now

While the new guidance does not have the force of law, it will be applied by the DOL and may be given deference by courts.  Courts will also likely apply the DOL’s guidance when assessing whether employees are improperly classified.  Accordingly, employers should take this opportunity to review non-employee classifications in light of the guidance.