The use of independent contractors to supplement a workforce has long been a source of conflict between employers and government agencies. Among other things, employers desire the perceived freedom an independent contractor relationship brings (no need for emotionally laden discipline, layoffs, or firings), the lower investments in recruiting and training, and the significant savings in payroll taxes, overtime, and benefit costs.
On the other hand, the government views independent contractor relationships as giant black holes, sucking tax and unemployment revenues from public coffers and leaving large numbers of workers without retirement funds, paid vacations, health insurance, or workers compensation coverage, denying them legal protections under discrimination, leave, and accommodation laws, and reducing job security without the security of unemployment benefits.
Recently, the battle lines between these two viewpoints have grown more intense. Costly class action claims by disgruntled workers who claim to be misclassified have plagued businesses such as FedEx, Uber, and Lyft. Tax agencies, such as the federal Internal Revenue Service and Wisconsin Department of Revenue, have increased their scrutiny of possible worker misclassifications. Other agencies, such as state workers compensation and unemployment divisions, have expanded their definitions of “employee” and restricted independent contractor exceptions. (For example, in January, 2011, the Wisconsin Unemployment Division greatly expanded unemployment coverage into traditional independent contractor relationships.)
More recently, the U.S. Department of Labor implemented its “Misclassification Initiative,” pursuant to which it has entered into information-sharing agreements with various federal and state agencies. The sharing of information has provided more opportunities for multiple government agencies to crack down on worker misclassifications identified by other agencies and has greatly enhanced the financial and legal exposures to non-compliant employers. (Under the Initiative, Wisconsin signed an information-sharing agreement with the Department of Labor on January 20, 2015.)
In July, 2015, the Department of Labor escalated its attacks on independent contractor classifications by issuing new guidelines which significantly alter the definition of employee under the Fair Labor Standards Act (“FLSA”). The guidelines indicate that employers and courts have been improperly limiting the definition of “employee” and opening the door to excessive misclassification of workers as independent contractors. To address this problem, the Department issued a new list of “factors” which are to be used to analyze whether the worker is an employee. Emphasizing the intent of the new definitions, the Department declared that “most workers are employees under the FLSA.”
New Independent Contractor Factors
Like the former test for independent contractor status, the new test focuses on the “economic realities” of the relationship between the employer and the worker. The guidance identifies six key factors, and indicates that all six are to be analyzed and no one factor should be given undue weight. The six factors are: 1) Is the work performed an integral part of the employer’s business? 2) Do the worker’s managerial skills affect the worker’s opportunity for profit and loss? 3) How does the worker’s relative investment in facilities and equipment compare to that of the employer? 4) Does the work require special skills and initiative? 5) How long is the intended relationship? and 6) What is the nature and degree of control by the employer? The title provided to the worker, and even the existence of a written contract memorializing the intent of the parties to create an independent contractor relationship, will not be determinative of whether or not the worker is an employee.
The guidance provides an explanation of the intent of each of the new factors:
- Whether work performed is an integral part of employer’s business. If the services being performed by the worker are the same type of services performed by the business to the public, it is more likely that the worker is an employee. For example, a carpenter hired by a construction company would be performing a function “integral” to the business, whereas a software developer hired to create bid-tracking software for the construction company would not be doing an “integral” function. Work can be integral even if it is only one part of an employer’s business, if the work is performed offsite (e.g., telework and flexible work schedules), and/or if it is also performed by hundreds of other individuals. Another factor is whether the worker is or would be displacing work performed or previously performed by employees. If so, then it would be an indication of employee status.
- Worker’s managerial skills impacting their opportunity for profit or loss. The new factors analyze what steps the worker must take to create a profit or loss for himself. If the worker must make decisions on whether to hire help, which tools and materials to purchase, how to market and advertise, where to rent space and how to manage time tables, it may indicate an independent business/contractor status. If the ability to earn a profit is primarily tied to the opportunity for additional hours or more work to earn more, or to the quality of work performed, it is not indicative of independent contractor status. The key question is whether managerial skills, not basic work skills, are required in order to make a profit or suffer a loss.
- Relative investments by worker and employer. The new test also analyzes whether the worker has made an investment in their business beyond the particular job and the nature of the investment of the worker in their business. Investing solely in equipment and tools tied to a particular job is insufficient to demonstrate the existence of an independent business, particularly if not significant in comparison with the employer’s investment in the business.
- Specialized skills and initiative. The test distinguishes between a worker’s “technical skills,” which do not necessarily provide evidence of an independent business, and their “business skills, judgment, and initiative,” which may reflect the operation of a separate business, the latter being determinative of independence. For example, a highly skilled carpenter who works for several contractors because of his or her experience and knowledge may not reflect independent contractor status because the skills, though important, are not exercised with independent judgment. On the other hand, a specialized custom handcrafted cabinet maker, who markets his or her services, determines which orders to fill, orders materials and decides how much to order, and makes similar business-related decisions is evidence of a specialized skill or initiative.
- Duration of worker’s relationship. A worker employed for long periods of time, or for a permanent or indefinite duration, is more likely an employee than an independent contractor. Even periods of a few weeks or months may, depending on the type of service, be more reflective of an employment relationship than an independent business. An independent contractor generally does not work continuously for the same employer but takes ad hoc jobs or assignments.
- Nature and degree of control by the employer. The issue of “control” should primarily examine how economically dependent the worker is on the employer. If the worker is primarily reliant on work from the employer, even if work is performed for other businesses, it is an indication of employee status and reflects that the employer has ultimate “control” from the viewpoint of “economic realities.” Less important is who has day-to-day decision making authority over the aspects of the job and how, when, or where it is performed. For example, flexibility over the hours to be worked does not necessarily reflect an independent business, nor does the issue of where the work is performed.
These tests, and the examples of how each test is to be analyzed, represent a significant departure from the former test of employee versus independent contractor status. The new tests greatly expand the definition of “employee” to cover many relationships that were formerly considered independent contractors.
Lessons and Takeaways From the New Guidelines
It is becoming extremely risky to classify workers as independent contractors. With the various inter-governmental information-sharing agreements, the increasing threat of worker class action lawsuits, and the changing legal definitions, the financial costs can be significant for misclassifications. These costs can include past and continuing liability for tax withholdings, past and continuing liability for minimum wage and overtime obligations, past and continuing liability for unemployment contributions, past and continuing liability for medical, retirement and other benefits, and other costs and liabilities. Human Resource professionals should take the following steps to avoid being targeted for worker misclassifications:
- Internal Audit. Conduct an internal audit to identify all workers who are classified as independent contractors, and analyze each of the relationships under the various government tests. Create an internal review system that requires every independent contractor relationship to be audited for legal compliance before the relationship begins.
- Education and Training. Conduct management training to make sure that the upper levels of your business understand the financial and legal risks of misclassifications and the steps needed to minimize such risks.
- Create Checklists for Contractor Relationships. Create a list of items to verify for any worker or group of workers who are retained as independent contractors. These should include evidence of their work for other businesses, evidence of their marketing and advertising efforts, evidence of their business obligations and expenses, and review of factors that may help determine whether the worker operates a true independent business.
- Update Independent Contractor Contracts. All workers providing services as independent contractors should sign a written contract reflecting the terms and conditions of the relationship. Such contracts should be updated to reflect the new rules and help insulate against challenges from government agencies or disgruntled workers.
A copy of the new Department of Labor guidance and other information on independent contractor classifications can be obtainedby contacting our employment law team. We would like to recognize the contributions of Attorney Molly Berkery and law clerk Lauren Maddente to this article.