It's Time (It's Really Time!) to Evaluate Independent-Contractor Classifications
Does your business or organization use independent contractors? Do you report any payments using Form 1099? Does your business have "owners," "partners," or "members of a limited liability company" who receive payments as distributions in those roles but not compensation as employees? If so, your business or organization might want to re-evaluate (or evaluate) those relationships in light of new guidance issued by the U.S. Department of Labor's Wage and Hour Division (US DOL WHD).
On Wednesday, July 15, 2015, the WHD provided an "Administrator's Interpretation" about employers' classification of workers as independent contractors. This guidance document by David Weil, the Administrator of the WHD (the highest-ranking person in the division) explains why the WHD takes the position that "most workers are employees" under the laws that the WHD enforces. These laws include the federal Fair Labor Standards Act (FLSA), the federal minimum wage and overtime law; the Migrant and Seasonal Agricultural Worker Protection Act (MSPA), the federal law regarding payment for many or most agricultural workers; and the federal Family and Medical Leave Act (FMLA), the federal law that provides job-protected unpaid leave for workers to address their own or their family members' health conditions.
The FLSA does not define the term employee. However, the WHD Administrator defines "employ" to mean "to suffer or permit to work," and thus a person suffering or permitting a person to work is an employer. The WHD and courts interpreting the FLSA have applied an "economic realities" test to determine whether a particular worker is "employed" and therefore covered under the FLSA, or is instead an independent contractor to whom the FLSA does not apply. The "economics realities" test is intended to determine whether a worker is economically dependent on the employer (and therefore an employee) or whether a worker is in business for himself or herself (and therefore an independent contractor, and not an employee). The test involves several factors to be considered and weighed in each case, in a non-mechanical, non-formulaic way, in an effort to answer the ultimate question of whether a worker is economically dependent on the employer. The WHD discussed the factors that it does consider to be important:
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 and 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 WHD's interpretation suggests that the control factor, which has over time been given less and less weight, might now be given so little weight that a worker could be deemed an employee even if the employer exercises almost no control over the worker. And the WHD noted, as it has historically done, that an independent-contractor label that an employer gives a worker or the existence of a contract between an employer and a worker that designates or describes the worker as an independent contractor is irrelevant to this analysis, and not even considered as a factor.
The WHD's explanation of these factors is here:
The WHD looks to continue its focus on workers who have been classified as independent contractors and increase its enforcement efforts on this area. Businesses should remember that the WHD shares information with the IRS and with state enforcement agencies in a number of states, including Washington and Oregon, about businesses that it determines are incorrectly classifying workers as independent contractors. Given the WHD's apparent increased emphasis on this area and these information-sharing agreements, employers should be prepared for a greater possibility of audits by the WHD or state agencies. The financial risk of misclassification is substantial: the employer may be required to pay back income tax withholdings and payroll taxes with interest and penalties, or may be required to pay workers additional compensation above minimum wage or for overtime, along with penalties and possible attorney fees.
Any business or nonprofit organization that engages any person as an independent contractor should consider evaluating those relationships against this guidance document and assessing whether any independent-contractor relationships should be characterized as employment relationships. In addition, businesses and organizations with independent contractors should take care to ensure that the independent-contractor agreements document as thoroughly as possible the reasons why those relationships are consistent with the WHD's interpretation. Your Schwabe employment lawyers can help you navigate this tricky area.
- Jean Ohman BackOf Counsel
- Thomas TriplettRetired Senior Counsel