DOL Issues New Guidance on Classification of Workers as Employees or Independent Contractors

08/24/2015

On July 15, 2015, the Department of Labor (“DOL”) issued an Administrator’s Interpretation (the “Interpretation”) on the application of the Fair Labor Standards Act’s (“FLSA”) “suffer or permit” standard in identifying employees who are misclassified as independent contractors. Although the Interpretation does not announce a new test for determining worker classifications, it reemphasizes the DOL’s belief that most workers are employees under the FLSA.

The misclassification of employees as independent contractors has been on the DOL’s radar for several years and continues to be a focus of enforcement efforts. The DOL is currently working with the Internal Revenue Service and twenty-five states, including California, New York, and Texas, to combat employee misclassification and to ensure that workers get the wages, benefits, and protections to which they are entitled. In fiscal year 2014, DOL misclassification investigations resulted in more than $79 million in back wages for more than 109,000 workers in industries such as the janitorial, temporary help, food service, day care, hospitality, and garment industries. The DOL’s enforcement efforts coupled with the issuance of the Interpretation, on the heels of the DOL’s proposed overtime exemption rules, highlight the DOL’s objective to bring as many workers as possible under the protections of the FLSA.

The DOL’s Guidance on the Economic Realities Factors

In determining whether a worker is an employee or an independent contractor under the FLSA, the DOL and courts use the multi-factor “economic realities” test, which focuses on whether the worker is economically dependent on the employer or truly in business for him or herself. The Interpretation states that a worker who is economically dependent on an employer is “suffered or permitted to work by the employer” in accordance with the FLSA’s definition of “employ” and, thus, an employee under the statute. Conversely, if a worker is in business for him or herself (i.e., economically independent from the employer), then the worker is an independent contractor. The DOL advises that the economic realities factors should be applied in view of the FLSA’s broad definition of employment and intended expansive coverage for workers.

The economic realities test typically includes an analysis of the following factors: (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 skills; (3) 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 nature and degree of control by the employer. The DOL makes clear in the Interpretation, as it has in past guidance, that no single factor is determinative or should be over-emphasized (such as the control factor); rather, the factors should be considered in totality (and not applied as a checklist) to determine whether a worker is economically dependent on the employer. The DOL also reminds us that only the economic realities of the working relationship are determinative – and not the label an employer gives it (such as the existence of an independent contractor agreement or the issuance of a Form 1099).

In analyzing each of the six economic realities factors, the Interpretation relies on case law favorable to the DOL’s position, while virtually ignoring case law in which courts found workers to be independent contractors. The Interpretation also rejects many of the arguments made by employers when defending independent contractor classifications. In particular, the DOL provides the following noteworthy guidance on each factor:

  • The extent to which the work performed is an integral part of the employer’s business. According to the DOL, a true independent contractor’s work is unlikely to be integral to the employer’s business. The DOL also takes an expansive view of what type of work can be integral, noting that work can be integral to a business even if the work is just one component of the business or is performed by many workers. Further, work can be integral even if it is performed away from the employer’s premises, such as at the worker’s home or at a customer site. To illustrate this factor, the DOL gives the example of a construction company that frames homes, stating that carpenters are integral to the company’s business while a software developer hired to create software to assist in business management is not integral to the business.

  • The worker’s opportunity for profit or loss depending on his or her managerial skills. If a worker exercises managerial skills that affect the worker’s opportunity for profit and loss, then this is indicative of an independent contractor according to the DOL. The DOL makes clear that this factor should not focus on the worker’s ability to work more hours or the amount of work available from the employer – as both independent contractors and employees are likely to earn more if they work more and if there is more work available. Rather, a true independent contractor should exercise managerial skills (e.g., make decisions on staffing, advertising, and purchasing; negotiate contracts; decide which jobs to perform; etc.) in a way that affects the worker’s opportunity for both profits and loss beyond the current job.

  • The relative investments of the employer and the worker. The DOL emphasizes that the relevant inquiry is not the nature or size of the worker’s investment, but rather how the worker’s investment compares to the employer’s investment in its overall business – and not simply the employer’s investment in the particular job performed by the worker. The DOL specifically states that “the worker’s investment must be significant in nature and magnitude relative to the employer’s investment in its overall business to indicate that the worker is an independent contractor.” In light of this position, the DOL posits that investing in tools and equipment is not necessarily a business investment that indicates that the worker is an independent contractor. To illustrate this factor, the DOL gives the example of a worker providing cleaning services who occasionally brings her own cleaning supplies to certain jobs versus a worker who invests in a work-use only vehicle, rents her own space to store the vehicle and materials, advertises her services, hires a helper for larger jobs, purchases material and equipment not on a job-specific basis, and brings her own equipment and cleaning supplies to each worksite; the DOL states that the first worker’s investment is indicative of an employment relationship while the latter worker’s investments may be indicative of an independent contractor relationship.

  • Whether the work performed requires special skills and initiative. The DOL’s focus for this factor is on the worker’s business skills, judgment, and initiative, and not his or her technical skills. The DOL makes clear that the fact that a worker has specialized skills does not mean that the worker is in business for him or herself, as providing skilled labor is not the same as operating as an independent business. The DOL uses as an example a highly skilled carpenter who makes custom cabinets for multiple construction companies and who markets his services, determines when to order materials and the quantity to order, and determines which orders to fill as someone who may be demonstrating the skill and initiative of an independent contractor.

  • The permanency of the relationship. Permanency or indefiniteness in a worker’s relationship with an employer suggests that the worker is an employee. The DOL notes that an independent contractor “typically works one project for an employer and does not necessarily work continuously or repeatedly for an employer.” The DOL also states, however, that a lack of permanence or indefiniteness does not automatically suggest an independent contractor relationship; rather, the key is whether the lack of permanence or indefiniteness is due to operational characteristics of the employer or the worker’s own independent business initiative.

  • The nature and degree of control by the employer. The DOL states that a true independent contractor must actually control meaningful aspects of the work performed to the point that the worker can be viewed as conducting his or her own business. The DOL also notes that an employer’s lack of control over workers who work from home or offsite as well as workers’ control over their hours worked are not indicative of independent contractor status. Further, the DOL makes clear that the employer’s reason for exercising control – e.g., because of the nature of its business, regulatory requirements, or customer demands – does not matter, as control exercised over a worker indicates that the worker is an employee. Finally, the DOL emphasizes that the control factor should not be overemphasized by employers. Even if there is a lack of control, if the worker is economically dependent on the employer, the DOL will deem the worker an employee.

Advice to Employers

The Interpretation sends a clear message to employers that the DOL will continue to crack down on worker misclassifications, which the DOL considers a significant problem in an increasing number of workplaces across the country. The Interpretation further emphasizes to employers that the DOL will find that most workers should be classified as employees and that the DOL will continue to find misclassification in many cases. Therefore, employers that utilize independent contractors should be cognizant of the potential for a DOL audit, whether randomly selected or based on an actual complaint. This “new” guidance from the DOL provides employers that utilize an independent contractor workforce an opportunity to re-evaluate their classifications and to correct any potential problems going forward. While the Interpretation illustrates how the DOL and its investigators will apply the economic realities factors, employers also should consider the controlling case law from relevant jurisdictions when making classification decisions. Employers should consult employment counsel regarding the process for conducting an internal misclassification audit and the necessary considerations when analyzing a worker’s employment status.

For more information, please contact one of the Haynes and Boone lawyers listed below:

Tamara Devitt
949.202.3060
tamara.devitt@haynesboone.com

Felicity A. Fowler
713.547.2072
felicity.fowler@haynesboone.com

Jason Habinsky
212.918.8995
jason.habinsky@haynesboone.com

Laura O'Donnell
210.978.7421
laura.odonnell@haynesboone.com

Dean J. Schaner
713.547.2044
dean.schaner@haynesboone.com

Meghaan McElroy Madriz
713.547.2082
meghaan.madriz@haynesboone.com

Adam Sencenbaugh
512.867.8489
adam.sencenbaugh@haynesboone.com

 

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