In response to concerns that an increasing number of employers are misclassifying employees as independent contractors under the FLSA, the Department of Labor Wage and Hour Division issued guidance clarifying the extremely broad definition of “employee” and explaining the factors to be considered in determining a worker’s proper classification.  Basically, every worker is an employee under the DOL’s analysis and truly independent contractors are the rare exception.    The DOL emphasized that clarifying this distinction is important because employees who are misclassified as independent contractors do not receive “important workplace protections” such as minimum wage and overtime compensation, unemployment insurance, and workers’ compensation, and misclassification also results in lower tax revenues for the government and an uneven playing field for employers who properly abide by classification rules.

The FLSA defines “employ” broadly as including “to suffer or permit to work.”  This definition was specifically designed to ensure as broad of a scope of statutory coverage as possible and it is intended to cover more workers as employees than the common law control test–which was specifically rejected by Congress when it drafted the FLSA, despite being the prevalent inquiry at that time.  In order to make the determination whether an entity “suffers or permits” an individual to work–and, therefore, whether the individual is  an employee or an independent contractor under the FLSA–courts use the multi-factor “economic realities” test, which focuses on whether the worker is economically dependent on the employer or truly in business for himself.   This inquiry should be guided by the FLSA’s statutory directive that the scope of the employment relationship is very broad and the DOL’s expansive belief that “most workers are employees under the FLSA.”  Ultimately, the goal is not simply a mechanical application to tally which factors are met, but to make a big-picture determination whether the worker is economically dependent on the employer (thus, an employee) or really in business for himself (thus, an independent contractor)–unlike the common law control test, which analyzes whether a worker is an employee based only on the employer’s control over the worker and not the broader economic realities of the working relationship.

The “economic realities” test typically includes six factors, but no single factor is determinative and the factors should be considered in totality.  In applying these factors, independent contractors are described as those workers with economic independence who are operating a business of their own.  On the other hand, workers who are economically dependent on the business of others to find employment, regardless of skill level, are employees covered by the FLSA.  The overarching economic realities of the worker’s relationship with the employer control, rather than any technical concepts or labels used to characterize that relationship.  For example, an agreement between a worker and an employer designating the worker as an independent contractor or the fact that the worker receives a Form 1099 are irrelevant to analysis of the worker’s status.  The following “economic realities” factors “are aids [and] tools to be used to gauge the de gree of dependence of alleged employees on the business with which they are connected; it is dependence that indicates employee status” and each factor “must be applied with that ultimate notion in mind.”

1) Is the work an integral part of the employer’s business?

If the worker is truly an independent contractor, his work is unlikely to be integral to the employer’s business.  Work can be integral to a business even if it is just one component of the business or if it is performed by hundreds or thousands of other employees.  Addressing increasingly common workplace developments like telecommuting and flexible schedules, the DOL noted that work can be integral even if it is performed away from the employer’s premises, at the worker’s home, or on location of the employer’s customers.

2) Does the worker’s managerial skill affect the worker’s opportunity for profit or loss?

A worker who is truly an independent contractor has the ability to not only make a profit, but also to experience an actual loss (not limited to merely reduced wages).  The focus is not only if there is an opportunity for profit or loss, but whether the worker has the ability to make decisions and use his managerial skill and initiative to affect such opportunity for profit and loss beyond the current job.  A worker’s decisions to hire others, purchase materials and equipment, advertise, rent space, and manage time tables may reflect managerial skills that will lead to additional business from other parties or reduce the opportunity for future work.  The worker’s ability to work more hours and the amount of work available from the employer have nothing to do with the worker’s managerial skill, judgment, and initiative and do nothing to separate employees from independent contractors.

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–that supports a business beyond any particular job in order to be classified an independent contractor.  But even if the worker makes such an investment, it should not be considered in isolation; it is the relative investments of the worker and the employer that matter.  The worker’s investment must be significant in nature and magnitude compared to the employer’s investment in its overall business to indicate that the worker may be an independent contractor.  Investing in tools and equipment is not necessarily a business investment or a capital expenditure that satisfies this requirement.

4) Does the work performed require special skill and initiative?

The worker’s business skills, judgment, and initiative and not necessarily his technical skills will determine whether he is an independent contractor or an employee.  Even specialized skills such as cable splicers, carpenters, construction workers, and electricians are not indicative of any business initiative, and only those skilled workers who operate as independent businesses–as opposed to being economically dependent on their employer–are independent contractors.  For example, an electrician who works for a construction company and does not make any independent judgments at the job site beyond the work that he is doing for that particular job, does not determine the sequence of work, does not order additional materials, and does not think about bidding the next job is not an independent contractor–he is merely told what work to perform and where.  Although that worker is highly-skilled technically, he is different fr om the carpenter who builds made-to-order custom handcrafted cabinets and markets his services, determines when to order materials and the quantity of materials to order, and determines which orders to fill, thereby demonstrating the skill and initiative of an independent contractor.

5) Is the relationship between the worker and the employer permanent or indefinite?

Permanency or indefiniteness in the worker’s relationship with the employer (such as the typical employment at-will) 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 the same employer.  However, lack of permanence or indefiniteness in the worker’s relationship with the employer does not automatically indicate that he is an independent contractor; the reason the relationship is not permanent or indefinite must be considered.  The key inquiry is whether the lack of permanence or indefiniteness is due to “operational characteristics intrinsic to the industry” (such as employers who hire part-time or seasonal workers or use staffing agencies) or the worker’s ” own business initiative.”  A worker’s lack of permanent or indefinite relationship with an employer is only indicative of independent contractor status if it results from the worker’s own business initiative.

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.  An employer’s control is but one of the factors to be considered, and it “should not play an oversized role” or be the sole determining factor.  To be classified as an independent contractor, the worker must control meaningful aspects of the work performed such that it is possible to view the worker as truly conducting his own business.  The worker’s control over meaningful aspects of the work must be more than theoretical–the worker must actually exercise it.  In light of the rise in telecommuting, working from home or offsite, and flexible work schedules, the fact that a worker is subject to little direct supervision and can control the hours when he works is largely insignificant to proper classification in these situations; “[a]n employer does not need to look over his workers’ shoulders every day in order to exercise control.”

Further, the economic realities test requires examination of the nature and degree of the alleged employer’s control, not why the employer exercised such control.  Some employers claim that they assert control over aspects of the workers’ jobs due to the nature of their business, quality control measures, regulatory requirements, or the desire to ensure that their customers are satisfied; however, control exercised over a worker–for one or all of these reasons or any other reasons–still indicates that a worker is an employee, not an independent contractor.  “Business needs cannot immunize employers from the FLSA’s requirements.  If the nature of a business requires a company to exert control over workers to [a significant] extent,…then that company must hire employees, not independent contractors.”

By Rebecca D. Stanglein, rstanglein@dsda.com