Keeping Tabs on Independent Contractors

Is your organization classifying its independent contractors correctly?

The misclassification of independent contractors as employees continues to remain at the forefront of the enforcement agendas for both the Internal Revenue Service (IRS) and the Department of Labor (DOL). In addition, as of this writing, 37 states have entered into formal memoranda of understanding with the DOL to jointly pursue worker misclassification. Many employers, both small and large, continue to struggle with how to properly classify their workers. The potential costs to an employer who misclassifies an employee as an independent contractor can be significant. For example, if an employer issues Form-1099 to a worker considered to be an independent contractor who is later determined to be an employee by the DOL, the employer may be required to pay back-wages, liquidated damages and attorney’s fees. He may also be liable to the IRS and Social Security Administration for unpaid taxes and other penalties.       

In July 2015, Administrator David Weil of the DOL’s Wage and Hour Division published “Administrator’s Interpretation No. 2015-1 to give employers further guidance on how to determine who is and is not properly classified as an independent contractor under the Fair Labor Standards Act (FLSA). The opinion analyzes independent contractors in a manner giving much more weight to whether they are “economically dependent” on the employer. FLSA uses a couple of different standards to analyze whether a worker should be classified as an independent contractor or employee. Traditionally, FLSA has examined to what extent a worker is in the “employ” of an employer; “employ” is defined as “to suffer or permit to work.” FLSA also uses the more modern, court developed “economic realities” test. The “economic realities” test analyzes the underlying economic realities between workers and employers, rather than general contractual labels between the two.

In recent years, the DOL has interpreted the “to suffer or permit to work” standard and “economic realities” test more broadly, resulting in more workers being classified as employees under FLSA. In its guidance to employers, the Administrator’s Interpretation uses the six factors of the “economic realities” test to determine proper worker classification, but with an emphasis on to what extent the worker is economically dependent on the employer.  These six factors are:

  1. Is the work an integral part of the employer’s business?
  2. Does the worker’s managerial skill affect the worker’s opportunity for profit or loss?
  3. How does the worker’s relative investment compare to the employer’s investment?
  4. Does the work performed require special skill and initiative?
  5. Is the relationship between the worker and the employer permanent or indefinite?
  6. What is the nature and degree of the employer’s control?

The ultimate inquiry, according to the opinion, is whether the “worker remains economically dependent on the employer” or “[is] truly in business for him or herself.” See U.S. DOL. WGH. Adm. Op. No. 2015-1, p. 5. This also includes (in Footnote 2) an examination of those workers who are mislabeled as “owners”, “partners”, or “members of a limited liability company”, as opposed to employees. The Administrator’s Interpretation again stresses that these labels will be ignored in determining whether the workers are, in fact, FLSA-covered employees.

Though the Administrator’s Interpretation does not carry the force of law as a regulation would, the economic realities test described in that Interpretation is already used by federal circuit courts—with some variation between the circuits—to analyze FLSA worker misclassification cases. Employers are thus advised to review all their workers currently classified as independent contractors. For example, for those independent contractors who receive a substantial amount of money each year from an employer, the employer should verify that those independent contractors are: (1) paid through an incorporated business or corporate entity; (2) possess liability insurance; and (3) have a valid taxpayer identification number. In addition, employers are advised to examine if their independent contractors are hired to do the same or similar work as their employees, especially if those independent contractors are doing the same work as their employees for a year or more.  

To avoid DOL audits and the potential costs associated with worker misclassification, employers are advised to review all workers’ terms of employment to ensure they are properly classified. If you are unsure of how to classify your organization’s workers, please do not hesitate to contact our firm.  

This article is provided for general information and is not intended to serve as legal advice for a specific situation. The attorneys of Bea & VandenBerk are experienced in representing organizations in employment matters. If you are in need of specific advice or legal representation, please do not hesitate to contact us.

©2016 Bea & VandenBerk