In Administrator’s Interpretation No. 2015-1, the Wage and Hour Division of the Department of Labor (DOL) has stated that under the Fair Labor Standards Act (FLSA), most workers are employees, not independent contractors. The DOL also says that misclassification of employees as independent contractors is found in an increasing number of workplaces.
In order to make the determination whether a worker is an employee or an independent contractor under the FLSA, courts use the multi-factorial “economic realities” test, which focuses on whether the worker is economically dependent on the employer or in business for him or herself.
The Administrator’s Interpretation first discusses the pertinent FLSA definitions and the breadth of employment relationships covered by the FLSA. When determining whether a worker is an employee or independent contractor, the application of the economic realities factors should be guided by the FLSA’s statutory directive that the scope of the employment relationship is very broad. The Administrator’s Interpretation then addresses each of the factors, providing citations to case law and examples. 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. 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). The factors are a guide to make this ultimate determination of economic dependence or independence.
The Supreme Court and Circuit Courts of Appeals have developed a multi-factor “economic realities” test to determine whether a worker is an employee or an independent contractor under the FLSA. The factors typically include:
- the extent to which the work performed is an integral part of the employer’s business;
- the worker’s opportunity for profit or loss depending on his or her managerial skill;
- the extent of the relative investments of the employer and the worker;
- whether the work performed requires special skills and initiative;
- the permanency of the relationship; and
- the degree of control exercised or retained by the employer.
In undertaking this analysis, each factor is examined and analyzed in relation to one another, and no single factor is determinative. The “control” factor, for example, should not be given undue weight. The factors should be considered in totality to determine whether a worker is economically dependent on the employer, and thus an employee. The factors should not be applied as a checklist, but rather the outcome must be determined by a qualitative rather than a quantitative analysis. The application of the economic realities factors is guided by the overarching principle that the FLSA should be liberally construed to provide broad coverage for workers, as evidenced by the Act’s defining “employ” as “to suffer or permit to work.” In applying the economic realities factors, courts have described independent contractors 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 employer, regardless of skill level, are employees covered by the FLSA. Moreover, the economic realities of the relationship, and not the label an employer gives it, are determinative. Thus, an agreement between an employer and a worker designating or labeling the worker as an independent contractor is not indicative of the economic realities of the working relationship and is not relevant to the analysis of the worker’s status. Likewise, workers who are classified as independent contractors may receive a Form 1099-MISC from their employers. This form simply indicates that the employer engaged the worker as an independent contractor, not that the worker is actually an independent contractor under the FLSA. The ultimate inquiry under the FLSA is whether the worker is economically dependent on the employer or truly in business for him or herself. 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.
In sum, most workers are employees under the FLSA’s broad definitions. The correct classification of workers as employees or independent contractors has critical implications for the legal protections that workers receive, particularly when misclassification occurs in industries employing low wage workers.
Proper classification of employees takes on even more importance under health care reform. For example, if an employer with 100 employees offers affordable, minimum value health benefits to all those employees, but not to seven people it considers independent contractors and if the government later determines that those seven people are employees, substantial penalties would apply. Starting in 2016, the penalty in this situation would be $154,000 per year. The penalties are not tax deductible, so the impact on the bottom line would be even greater.
In light of this guidance all employers with independent contractors should review how those employees are classified. Some insurance companies will allow employers to offer health insurance to independent contractors. Doing so will protect employers from the large penalties that apply to employers that do not offer minimum essential coverage to at least 90% of all full-time employees (70% in 2015). Offering health insurance will not protect employers from other violations of wage and hour laws, such as paying overtime and reimbursing employees for out-of-pocket expenses.