On July 15, 2015, the U.S. Department of Labor's Division of Wage and Hour issued guidance aimed at curtailing the misclassification of employees as independent contractors under the Fair Labor Standards Act (FLSA). The sweeping conclusion at the heart of the DOL's guidance is that "most workers are employees under the FLSA's broad definitions."

The 15-page "Administrator's Interpretation," which is the Wage and Hour Division's first guidance on the topic since President Barack Obama took office, emphasizes the broad definition of employment under the FLSA and addresses the application of each of the "economic realities" factors that employers are supposed to consider when determining how to classify a worker. The guidance seeks to clarify that under the FLSA, the definition of employee is broader than what some employers might believe.

The guidance notes that the FLSA's definition of "to suffer or permit to work" is very broad and the economic realities factors should be applied in view of this expansive definition. Specifically, the guidance states that each factor of the economic realities test should be used as a guide to answer the ultimate question of whether the worker is truly an independent business or is economically dependent on the employer. In discussing the factors, the guidance made the following observations:

  1. Is the Work an Integral Part of the Employer's Business? – "If the work performed by a worker is integral to the employer's business, it is more likely that the worker is economically dependent on the employer." The guidance further notes that "[w]ork can be integral to a business even if the work is just one component of the business and/or is performed by hundreds or thousands of other workers."
  2. Does the Worker's Managerial Skill Affect the Worker's Opportunity for Profit or Loss? – "In considering whether a worker has an opportunity for profit or loss, the focus is whether the worker's managerial skill can affect his or her loss. A worker in business for him or herself faces the possibility to not only make a profit, but also to experience a loss."
  3. How Does the Worker's Relative Investment Compare to the Employer's Investment? – "The 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 investment of a true independent contractor might, for example, further the business' capacity to expand, reduce its cost structure, or extend the reach of the independent contractor's market."
  4. Does the Work Performed Require Special Skill and Initiative? – "A worker's business skills, judgment, and initiative, not his or her technical skills, will aid in determining whether the worker is economically independent." The interpretation further states that "[o]nly carpenters, construction workers, electricians, and other workers who operate as independent businesses, as opposed to being economically dependent on their employer, are independent contractors."
  5. Is the Relationship Between the Worker and the Employer Permanent or Indefinite? – "Permanency or indefiniteness in the worker's relationship with the employer suggests that the worker is an employee. … Even if the working relationship lasts weeks or months instead of years, there is likely some permanence or indefiniteness to it as compared to an independent contractor, who typically works one project for an employer and does not necessarily work continuously or repeatedly for an employer."
  6. What Is the Nature and Degree of the Employer's Control? – "As with the other economic realities factors, the employer's control should be analyzed in light of the ultimate determination whether the worker is economically dependent on the employer or truly an independent businessperson."

While no single factor is determinative of whether the relationship is properly classified, the guidance emphasized that the "control" factor should not "play an oversized role in the analysis of whether a worker is an employee or an independent contractor." Ultimately, as mentioned above, the guidance points out that each of the factors should be considered in light of whether the worker is really in business for himself or herself (and thus is an independent contractor) or is economically dependent on the employer (and thus is its employee).

The DOL's "economic reality" test explained by the "Administrator's Interpretation" differs from some other tests that are utilized to determine whether an individual or entity is properly classified as an independent contractor. Under state law, the so-called "right to control" and "ABC" tests are prevalent. The primary factors considered significant when analyzing the right to control include: evidence of control over the worker's terms and conditions of employment, right of termination, furnishing of equipment, and method of payment. Under the ABC test, companies defending their independent contractor classifications in either litigation or government investigations are required to show that an individual providing services:

  1. is free from the company's control in performing the services;
  2. performs work outside the usual course of the company's business or outside the company's place of business; and
  3. is engaged in an independently established business.

In addition to the right to control and the ABC tests, the IRS utilizes a 20-factor test that incorporates the right to control and economic reality test elements and is used for federal tax purposes. The National Labor Relations Board has also adopted a test for independent contractor misclassification and determining whether a worker is an employee who can unionize. Under the NLRB’s test, 11 factors are evaluated to determine whether an individual is, in fact, rendering services as part of an independent business. The 11 factors are similar to the DOL's economic reality test and are as follows:

  1. Extent of control by the employer;
  2. Whether or not the individual is engaged in a distinct occupation or business;
  3. Whether the work is usually done under the direction of the employer or by a specialist without supervision;
  4. Skill required in the occupation;
  5. Whether the employer or individual supplies instrumentalities, tools and place of work;
  6. Length of time for which the individual is employed;
  7. Method of payment;
  8. Whether or not the work is part of the regular business of the employer;
  9. Whether or not the parties believe they are creating an independent contractor relationship;
  10. Whether the principal is or is not in the business; and
  11. Whether the evidence tends to show that the individual is, in fact, rendering services as an independent business.

What This Means for Employers

While the guidance does not change the DOL's policy on how to evaluate whether an employee is properly classified under the FLSA, it reemphasizes the DOL's commitment to its Misclassification Initiative. Employers who utilize independent contractors should consider reexamining the status of their workers as a result of this guidance. Additionally, since the DOL's test differs from tests that may be utilized by state labor departments, taxing authorities and the NLRB, employers should consider the application of all tests relevant in their jurisdiction for the at-issue workers before classifying them as independent contractors.