Be Careful How You Classify: DOL Issues Guidance on Misclassification of Independent Contractors

The guidance, titled Administrator’s Interpretation No. 2015-1: The Application of the Fair Labor Standards Act’s “Suffer or Permit” Standard in the Identification of Employees Who are Misclassified as Independent Contractors (the Guidance) states that misclassification of employees as independent contractors has been found in an increasing number of workplaces. The Guidance comes in response to what the DOL described as “numerous complaints from workers alleging misclassification.”

Under the DOL’s jurisdiction, whether a worker is an employee or an independent contractor is governed by the Fair Labor Standards Act (FLSA) and judge-made legal doctrine. The FLSA defines employ as “to suffer or permit to work.”  Courts later adopted the “economic-realties” test, which focuses on whether the worker is economically dependent on the employer or in business for him or herself.  The Guidance states that when determining whether a worker is an employee or an independent contractor, “the application of the economic realities factors should be guided by the FLSA’s statutory directive that the scope of the employment relationship is very broad.”

The economic-realities factors 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; (5) the permanency of the relationship; and (6) the degree of control exercised or retained by the employer. No one factor controls and the factors should be considered in totality to determine whether a worker is economically dependent upon the employer and thus considered an employee.

The Guidance then discusses in detail each of the six economic realities factors. For the first factor, the Guidance states that an employee is integral to the employer’s business if the service provided is central to the business that the employer runs – such as carpenters to a construction company that frames residential homes. As to factor two – whether the worker’s managerial skill affects the opportunity for a profit or loss – the Guidance focuses on whether the worker exercises managerial skills at the work place and whether those particular skills will affect the worker’s opportunity to make or lose money. For factor three, the focus is on whether the investment of tools or supplies by the worker goes beyond that one particular job and is part of a business investment as a whole. Factor four focuses on whether the worker is hired to provide a specialized skill for a particular job as opposed to simply providing labor to the employer over a period of time. Factor five focuses on the duration of the employment and how permanent it is. Time alone is not the only factor, but how consistently a worker performs work for the employer is the key criteria. Finally, factor six focuses on how much control an employer has over the worker and whether the worker can control meaningful aspects of the work such that it is possible to view the worker as a person conducting his or her own business.

The Guidance concludes that based on the economic realities test and the FLSA’s definition that “most workers are employees under the FLSA[.]” The very broad definition of employment and the fairly strict factors of the economic realities test make this conclusion virtually inevitable. In closing, the Guidance states that “the correct classification of workers as employees or independent contractors has critical implications for the legal protections that workers receive, particularly when misclassification occurs in industries employing low wage workers.”

The Guidance is a good summary for all employers who engage or are considering engaging workers who are treated as independent contractors. Other federal and state agencies, such as the IRS and state unemployment offices, have similar but slightly different tests for distinguishing between employees and independent contractors.  Misclassification of an employee can lead to significant liability for back taxes, penalties, interest, back pay and benefits, and other damages. Thus, employers should audit their classification of workers to make sure they are managing these risks appropriately.