U.S. Department of Labor Issues Guidance On Classification of Independent Contractors

The guidance specifically relates to determining who is an employee under the Fair Labor Standards Act (FLSA).

On July 15, 2015, the U.S. Department of Labor (“DOL”) issued Administrator’s Interpretation 2015-1 (Guidance).

The Guidance specifically relates to the application of the standards for determining who is an employee under the Fair Labor Standards Act (FLSA), and is intended to curtail the misclassification of workers as independent contractors.  According to the Guidance, most workers are employees under the FLSA and are not independent contractors.

The Economic Realities Test

To determine whether a worker is an employee or an independent contractor, the Guidance states that "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 therefore looks to the multi-factor “economic realities” test (the "Test").

The following factors are analyzed under the Test:

  1. the extent to which the work performed is an integral part of the employer’s business;
  2. the workers opportunity for profit or loss depending on his or her managerial skill;
  3. the extent of the relative investments of the employer and the worker;
  4. whether the work performed requires special skills and initiative;
  5. the permanency of the relationship; and
  6. the degree of control exercised or retained by the employer.

The Guidance opines that each factor should be considered in totality to determine whether a worker is economically dependent on the employer.  The Guidance further provides that the application of the economic realities factors must be guided by the overarching principle that the FLSA should be liberally construed to provide broad coverage for workers.  If the Test describes a relationship of economic dependence, the worker is an employee.  In contrast, if the Test describes a relationship of economic independence, the worker is an independent contractor.

Application of the Economic Realities Factors

The Guidance discusses in detail each factor of the Test and uses relevant examples to help employers apply the factors to determine a worker’s employment status. 

1.  Is the work and integral part of the employer’s business?

If the work performed by a worker is integral to the employer’s business, the worker is likely to be economically dependent on the employer, and thus an employee. Work can be integral to employer even if the work is just one component of the business. 

For example, carpenters are integral to a construction company that frames homes because the company is in the business of framing houses.  This factor weights in favor of an employment relationship.  On the other hand, a software developer who performs work for a residential construction company developing programs to help track bids, schedule projects, and maintain inventory, performs work that is beneficial but not integral to the construction company’s business.  Therefore, this factor weighs in favor of an independent contractor relationship.

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

The focus is whether the worker’s managerial skill can affect his or her profit and loss. A worker’s decisions to hire, purchase materials and equipment, advertise, lease space, and manage timetables all likely reflect managerial skills that will affect opportunities for profit or loss.  In contrast, a worker’s mere ability to work more hours or the employer’s ability to provide additional work has nothing to do with the worker’s managerial skill.

The Guidance uses the example of a worker performing work for a cleaning service.  The worker does not schedule assignments, advertise, solicit additional clients, or identify opportunities to reduce costs.  The worker does not exercise managerial skill that affects his profit or loss, which is indicative of an employment relationship.  Conversely, if that same worker advertises his services, negotiates contracts, determines his own work schedule, and/or hires helpers to assist with work - these facts reveal the exercise of managerial skill representative of an independent contractor.

3.  How does the worker’s relative investment compare to the employer’s investment?

This factor centers on the nature and extent of the relative investments of the employer and the worker.  The first step in the analysis is to determine whether the worker has made an investment to support a business beyond any particular job.  The second step of the analysis requires a comparison between the worker’s investments to the employer’s investment. If the worker’s investment is minor to that of the employer, the worker may be economically dependent on the employer and therefore an employee.

For example, a cleaning company provides the worker with insurance, a vehicle, and all equipment and supplies necessary for the work. Additionally, the company invests in advertising and solicitation of clients. Meanwhile, the worker occasionally brings his own cleaning products to the job. The relative investment of the worker is minor in comparison to the significant investment of the company.  These facts are indicative of an employment relationship between the worker and the cleaning company.

On the other hand, if that same worker invests in a vehicle to travel to various worksites, leases space, advertises and markets for services, hires help, and purchases material and equipment, an independent contractor relationship is likely to exist under this factor. 

4.  Whether the work performed requires special skill and initiative?

This factor focuses on the worker’s business skills, judgment, and initiative and not on any specialized or technical skills used to perform the work.

The Guidance provides the following example to help with the analysis. A construction firm uses the services of a highly skilled carpenter. However the carpenter’s skills are not exercised in an independent manner.  The carpenter does not make independent judgments at the jobsite beyond the work he is doing for that job. In essence, the carpenter is simply told what worked to perform and where. In this situation, the carpenter, although highly skilled, does not demonstrate the skill and initiative of an independent contractor.

Conversely, if the construction firm uses the services of a highly skilled carpenter who performs specialized services for multiple customers, actively markets his services, determines when to order materials and the quantity of materials to order, and determines which orders to fill – such facts are indicative of an independent contractor.

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

The lack of a permanent or indefinite relationship between a worker and an employer is suggestive of an independent contractor relationship if it results from the worker’s own independent business initiative.

The Guidance uses an example of the relationship between an editor and a publishing house. The editor works for a publishing house for several years and completes work in accordance with the publishing house’s specifications, using its software, and only editing books provided by the publishing house. This fact pattern demonstrates a more permanent relationship between the editor and the publishing house that is indicative of an employment relationship.

On the other hand, if the editor works intermittently with numerous publishing houses, markets services to different publishing houses, negotiates rates for each editing job, and turns down work from potential publishing houses - these set of facts are indicative of a lack of permanence with a particular publishing house, and suggest the worker is an independent contractor.

6.  What is the nature and degree of the employer’s control?

Most employers mistakenly believe that it is the degree of control over an individual worker that primarily determines a worker’s employment status. However, according to the Guidance, this is only one factor among several factors in the Test that should be analyzed in light of the ultimate determination of whether the worker is economically dependent on the employer. 

To help analyze this factor, the Guidance uses an example of a registered nurse who lists with a nurse registry in order to provide skilled nursing care to clients. The registry then requires the nurse to undergo training presented by the registry, sends the nurse a list of potential clients, and requires the nurse to fill out a form with the registry prior to contacting the clients.  Additionally, the registry sets the wage rates and hours of work and requires the nurse to contact the registry if she will miss any scheduled work.  The degree of control described in this scenario likely demonstrates an employment relationship.

In contrast, another nurse lists with a different registry for the same type of skilled nursing care. The registry sends the nurse a listing of potential clients each week.  The nurse is free to call as many or as few potential clients as she sees fit. Additionally, she is able to directly negotiate her on wage rate and work schedule with the client. The degree of control described in this scenario is minimal and indicative of an independent contractor relationship.

Conclusion

A violation of the FLSA could result in significant damages including back pay of up to three years, liquidated damages equal to 100% of the total back pay awarded, and attorney’s fees.  To avoid legal scrutiny and potential windfall damages, employers should work with experienced employment counsel to audit their classification of independent contractors and correct any potential misclassifications before the government or a court gets involved. 


About the Author

Michael McCain is the lead employment law attorney at Eckberg Lammers. Mike exclusively represents businesses and management in labor, employment, and business law matters. He may be reached at 651-439-2878 or mmccain@eckberglammers.com.

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