Employers Must Carefully Select Status with Multifactor Test

HIGHLIGHTS:

  • The Department of Labor's (DOL) recent interpretation of independent contractor classification foreshadows challenges to the status of employers' independent contractors.
  • DOL's interpretation concludes that under the broad definitions of the Fair Labor Standards Act (FLSA), most workers are employees.
  • Employers can carefully monitor their independent contractor workforce to help reduce risks, although not completely eliminate them, with each worker's appropriate status.

Administrator David Weil issued an Administrator's Interpretation (Interpretation) on July 15, 2015, on behalf of the United States Department of Labor (DOL) regarding the appropriate classification of workers as independent contractors or employees. The Interpretation has created less certainty over whether a worker is an independent contractor and greater certainty that the DOL, state agencies and the plaintiffs' bar will challenge any independent contractor status.

The Interpretation conclusion made it clear that "most workers are employees under the FLSA's broad definitions," meaning that the DOL will view classification issues with the presumption that a worker is an employee. Employers should govern themselves accordingly.

Economic Realities Test

In the Interpretation, the DOL affirmed the use of the previously used economic realities test. The use of an economic realities test is not new. The administrator's interpretation of the test to determine employee status, however, is another matter. The Interpretation discouraged a bright-line test whereby employers could meet multiple factors to better understand if a worker was truly an independent contractor. Now, employers are on notice not to apply factors of independent contractor status in a "mechanical fashion, but with an understanding that the factors are indicators of the broader concept of economic independence."

Under the Interpretation, the factors are no longer to be "applied as a checklist, but rather the outcome must be determined by a qualitative rather than a quantitative analysis."

Employers Should Pay Attention to Avoid Consequences of Misclassification

Thus, the Interpretation should put employers on notice and for good reason. Misclassification has many adverse effects, including liability for unpaid payroll taxes, unpaid unemployment taxes, unpaid workers' compensation premiums, overtime liability, unpaid 401(k) contributions, unpaid PTO, and potential personal liability for the uncollected state and federal taxes.

Under the economic realities test, employers should review the following factors to determine if an independent contractor is an employee:

  • Is the work performed an integral part of the employer's business? In other words, someone who stocks the shelves of a grocery store is most likely an employee because stocking the shelves is integral to the business. Conversely, an information technology professional who provides periodic penetration tests to monitor the security of the store's computer systems is less likely an employee.
  • Does the worker have an opportunity for profit and loss? Independent contractors will almost always have other costs, such as insurance, rent, cost of materials and other overhead that drives them to be efficient in order to make the business profitable.
  • Is there a significant personal investment that the worker brings to a job? The more the worker provides his or her own tools and supplies, the more likely to be deemed an independent contractor. Be mindful, however, that the DOL reviews personal investment beyond one particular job.
  • Does the work require special skills or initiative? Avoid technical skills and focus on business skills, independent judgment and initiative as it relates to the business.
  • What is the length of the engagement? Simply put, the longer the person performs work for an employer, the more likely the worker is an employee.
  • How much control does the employer have over the job? If the employer merely controlled the output and it was up to the worker how to complete the task, the test points toward the result of independent contractor status. If the employer had many requirements related not only to the result but also for the means to achieve the result, the more likely the worker is an employee.

Given that the DOL has advised not to give any particular weight to each factor, a better name for the economic realities test should be the "Looks Like an Employee, Talks Like an Employee, Walks Like an Employee ... Must be an Employee" Test. Thus, the lens through which an employer now must see its workers to determine their appropriate status is to look at how economically independent the worker is from the employer.

How Employers Can Minimize Risk

Given the change, there are steps that employers can take to minimize the risk of any adverse independent contractor determination. The best way is to have questionable independent contractors work through employee leasing agencies as leased employees. By doing this, employers shift most of the risk to the staffing company, who mostly avoid these issues by making the worker an employee.

At that point, there are fewer liability issues because the worker is now an just another company's employee. In fact, given the rapid movement of businesses, many companies are increasing their contingent workforces. In addition to avoiding independent contractor issues, this allows the employer to rapidly shift its workforce based on the company's changing strategies, while avoiding many of the headaches of reorganizations and reductions in force. Of course, employers cannot completely eliminate all such risks, because many adversarial employment actions will result in a finding that the employer and the staffing agency are "joint employers" for the purposes of liability. This will require a greater partnership between the employer and staffing agency to ensure both are acting in a way that reduces potential liability, or at least allocates risk.

As business models have changed, so have staffing agencies as it relates to finding top talent. Staffing agencies have been able to capitalize on the growing trend of workers who do not want to be tied to a certain employer. The next generation of worker (i.e., millennials) generally desires having the flexibility of when they work and for whom they work. Further, they enjoy the freshness of having different work challenges based on different employer core strategies. Hence, the talent pool – especially for highly skilled workers – many times is industry leading and will lead to the right business staffing solution.

Absent a staffing arrangement, the following are other factors employers should consider when determining whether to treat a worker as an employee or independent contractor:

  • Perform an audit of your company's current workforce and correct any situations that can be treated as suspicious under the economic independence test. Pay special attention to independent contractors who have been in that status for an extended period of time.
  • Ensure that independent contractors have their own business. They should have their own corporation or other business entity, carry their own liability insurance, have a Taxpayer Identification Number, and have their own rented or owned work location.
  • Avoid having independent contractors perform the same work as regular employees. If this is the case, then consider augmenting your workforce through staffing agencies.
  • Avoid rebranding employees into independent contractors. Under most circumstances, this will quickly draw the attention of the DOL or state equivalents.
  • Make sure the employer is managing the result, not the process. If a worker is merely given a goal with complete discretion as to how to achieve the goal, it favors independent contractor status.
  • Check your ERISA plan language to ensure a misclassification issue does not result in the application of benefits if the worker is later determined to be an employee. Under ERISA, a finding that someone is eligible for benefits is solely determined by the plan language. Excluding "independent contractors" in the plan means the misclassified employee is now subject to benefits.

Ultimately, employers are now challenged to take a holistic approach when it considers the employment status of its workers. Careful monitoring of your independent contractor workforce will help reduce risks, although not completely eliminate them, with each worker's appropriate status.