Why it matters

In its continuing fight against the misclassification of employees as independent contractors, the Department of Labor (DOL) released new guidance, issuing Administrator's Interpretation 2015-1 to set forth its take on the "economic realities" test. The guidance explores the six factors in the test (including whether the work performed by the worker is an integral part of the employer's business and whether the worker is retained on a permanent or indefinite basis), emphasizing that the main focus of the inquiry should center on whether the worker is "economically dependent on the employer or truly in business for him or herself." The combination of the broad definition of "employ" found in the Fair Labor Standards Act (FLSA) combined with the totality of the circumstances considered in the test means that most workers are employees, the DOL said. The expansive reading of what constitutes an employee will likely generate an increase not only in DOL oversight but worker lawsuits as well.

Detailed discussion

Citing a continuing increase in the misclassification of employees as independent contractors and "numerous complaints from workers alleging misclassification," the Department of Labor's (DOL) Wage and Hour Division released new guidance on "The Application of the Fair Labor Standards Act's 'Suffer or Permit' Standard in the Identification of Employees Who Are Misclassified as Independent Contractors."

Misclassification has been a major focus for the DOL, which has also created partnerships to advance its efforts. In addition to memoranda of understanding with states including Alabama, Florida, and Wisconsin, the DOL announced last year grants of more than $10 million to 19 states—including California and New York—to "enhance states' ability to detect incidents of worker misclassification."

The Fair Labor Standards Act (FLSA) broadly defines "employ" as including "to suffer or permit to work," and courts commonly use a multifactor "economic realities" test when making the determination of whether a worker is an employee or an independent contractor. The result of the application of the test in view of the expansive definition of "employ" found in the FLSA: "most workers are employees," the DOL said.

To help employers reach such a determination, Administrator's Interpretation 2015-1 provides examples and explanations for each of the six factors found in the economic realities test.

"All of the factors must be considered in each case, and no one factor (particularly the control factor) is determinative of whether a worker is an employee," the DOL wrote. "Moreover, the factors themselves should not be applied in a mechanical fashion, but with an understanding that the factors are indicators of the broader concept of economic dependence. Ultimately, the goal is not simply to tally which factors are met, but to determine whether the worker is economically dependent on the employer (and thus its employee) or is really in business for him or herself (and thus its independent contractor)."

Other notes from the guidance: the "control" factor should not be given undue weight in the economic realities test analysis; the labels placed on a relationship between an employer and a worker—independent contractors, owner, partner, or member of a limited liability company, for example—are not indicative of the nature of the working relationship; and even tax filings (such as receipt of a Form 1099-MISC) do not dictate the type of worker.

"The ultimate inquiry under the FLSA is whether the worker is economically dependent on the employer or truly in business for him or herself," the DOL emphasized. "If the worker is economically dependent on the employer, then the worker is an employee. If the worker is in business for him or herself (i.e., economically independent from the employer), then the worker is an independent contractor."

With that background, the DOL turned to the six factors.

First, the parties should ask: "Is the work an integral part of the employer's business?" If the answer is "yes," it is more likely that the worker is economically dependent upon the employer, the agency explained. "A true independent contractor's work, on the other hand, is unlikely to be integral to the employer's business."

Work can be integral to a business even if the work is just one component of the business or is performed by hundreds of thousands of other workers (answering calls at a call center, for example), and work can be integral to the employer's business even if it is performed away from the employer's premises—a reflection of telework and flexible work schedules in today's economy, the DOL said.

Considering the second factor—whether the worker's managerial skill affects the worker's opportunity for profit or loss—the DOL said a worker in business for himself or herself faces the possibility not only to make a profit, but also to experience a loss. "[T]his factor should not focus on the worker's ability to work more hours, but rather on whether the worker exercises managerial skills and whether those skills affect the worker's opportunity for both profit and loss."

For example, a worker that provides cleaning services for corporate clients is not an independent contractor where he performs assignments only as determined by a cleaning company, doesn't schedule his own jobs or advertise his service, and agrees to work additional hours to earn more, because his managerial skill does not impact his profit or loss. On the other hand, a worker providing the same services who negotiates her contracts, decides what jobs to perform and when, and recruits new clients would be indicative of an independent contractor.

How does the worker's relative investment compare to the employer's investment? In the third factor, "[t]he worker should make some investment (and therefore undertake at least some risk for a loss) in order for there to be an indication that he or she is an independent business," the guidance said. "The investment of a true independent contractor might, for example, further the business's capacity to expand, reduce its cost structure, or extend the reach of the independent contractor's market."

Investing in tools and equipment is not necessarily a capital expenditure indicating the worker is an independent contractor, the DOL said, as it must be considered relative to the employer and "significant in nature and magnitude relative to the employer's investment in its overall business." Even a specially equipped truck in the range of $35,000 to $40,000 would not necessarily satisfy the standard.

A worker's business skills, judgment, and initiative—not his technical skills—will aid in determining whether the worker is economically independent, the DOL explained in factor four. Special skills are not enough to turn a worker into an independent contractor.

A highly skilled carpenter providing carpentry services to a construction firm who does not exercise her skills in an independent manner (such as the sequence of the work, ordering of materials, or bidding the next job) is simply providing skilled labor and is not demonstrating the skill and initiative of an independent contractor. Alternatively, a highly skilled carpenter who markets his own services, determines when and how many materials to order, and determines which jobs to take demonstrates the attributes of an independent contractor.

In factor five, the DOL considered whether the relationship between the worker and the employer is permanent or indefinite. The longer the length of time, the more it suggests the worker is an employee. "After all, a worker who is truly in business for him or herself will eschew a permanent or indefinite relationship with an employer and the dependence that comes with such permanence or indefiniteness," the guidance stated.

A lack of permanence does not automatically indicate an independent contractor relationship, however. "The key is whether the lack of permanence or indefiniteness is due to 'operational characteristics intrinsic to the industry' … or the worker's 'own business initiative,' " the DOL said. The difference was demonstrated in the example of an editor who worked for the same publishing house for several years in accordance with the house's editing specifications (indicative of an employment relationship) as opposed to an editor who worked intermittently with fifteen different publishing houses over several years, turning down jobs and negotiating rates for each job (indicative of an independent contractor).

Finally, the nature and degree of the employer's control should be considered in light of the ultimate determination whether the worker is economically dependent on the employer or truly an independent businessperson. The guidance emphasized that the "control" factor should not play an oversized role in the overall economic realities test, with the location of workers (at home or in the office) and the hours worked "not particularly telling" in light of technological advances and enhanced monitoring mechanisms.

"In sum, most workers are employees under the FLSA's broad definitions," the DOL said. "The very broad definition of employment under the FLSA as 'to suffer or permit to work' and the Act's intended expansive coverage for workers must be considered when applying the economic realities factors to determine whether a worker is an employee or an independent contractor. The factors should not be analyzed mechanically or in a vacuum, and no single factor, including control, should be over-emphasized. Instead, each factor should be considered in light of the ultimate determination of whether the worker is really in business for him or herself (and thus is an independent contractor) or is economically dependent on the employer (and thus its employee). The factors should be used as guides to answer that ultimate question of economic dependence."

To read Administrator's Interpretation No. 2015-1, click here.