The all-time best The Far Side cartoon (based on an unscientific survey, sample size of me) is the one with two deer standing in the forest, one with a red circular target imprinted on its chest. The other deer says, “Bummer of a birthmark, Hal.”

Poor Hal. Blessed with the ability to walk upright, but cursed by that darned target.

In an Administrator’s Interpretation issued July 15, the Wage and Hour Division (WHD) of the Department of Labor (DOL) placed a similar target on every company that uses independent contractors. If this describes your company, consider yourself to be Hal. You may be blessed with the ability to avoid paying withholding tax, providing workers compensation coverage, and offering employee benefits; but there’s also that darned target.

The Administrator’s Interpretation focuses on the (allegedly) rampant misclassification of workers as independent contractors, rather than employees. The expansive definition of “to employ” under the Fair Labor Standards Act (FLSA) is broader than the common law definition of who is an employee. The FLSA defines employ as “to suffer or permit to work,” an awkward definition written in 1938 that sweeps in many workers who do not fit within the typical notion of employment.

The memo warns that “most workers are employees under the FLSA’s broad definitions.”   The memo also warns companies that the DOL is going deer hunting. The introductory section reports that the DOL “continues to bring successful enforcement actions against employers who misclassify workers.”

According to the memo, independent contractors are individuals with economic independence, operating a business of their own. On the other hand, workers who are economically dependent on the company, regardless of skill level, are employees under the FLSA’s “very broad definitions.”

The memo details the “economic realities” test that courts and the WHD apply when evaluating whether a worker is an employee covered by the FLSA. If a worker is covered by the FLSA, all minimum wage and overtime rules apply, unless the worker is exempt. The standards for who is exempt are also about to change, further heightening the risk for companies deemed to have misclassified their workers.

Factors typically considered in determining whether an independent contractor is really an employee under the FLSA include:

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

The risks of worker misclassification extend far beyond a potential government investigation or enforcement action. Collective actions alleging FLSA violations are being filed with increased frequency, and companies’ exposure in these lawsuits can be significant.

The Internal Revenue Service is active in this arena as well, seeking to hold companies liable for failing to pay employment taxes on workers who have been incorrectly treated as contractors. State taxing authorities and state departments of labor are increasing their enforcement efforts as well. Failure to provide workers’ compensation coverage can be another source of liability for companies who misclassify workers as contractors.

State laws defining who is an employee provide further grounds for litigation. The consequences of worker misclassification can be substantial, and seven figure liability is not uncommon.

Further complicating the analysis, the tests for determining who is an employee vary from law to law, and from state to state. An independent contractor relationship can be deemed proper under one set of standards, but improper under another.

The July 15th Administrator’s Interpretation focuses solely on the FLSA. It does not claim to set any new rules or heightened standards for evaluating contractor relationships under the FLSA. Rather, it purports to rely on established law. It cites to definitions in the statute and rulings by various courts.

The Administrator’s Interpretation should serve as a stern warning to companies that the government is actively focused on this issue. (The plaintiffs’ bar is too!)

Companies who use independent contractors should be proactive and take steps to evaluate whether these relationships can withstand the various legal tests that determine who is an employee. Steps can usually be taken to strengthen the independent contractor nature of a relationship, while still preserving the business needs of the company. Wipe away the target before the hunters arrive.

Companies that fail to act may soon find themselves in the crosshairs of the DOL, the IRS, or a state agency, or on the wrong end of a class action lawsuit.