Misclassification of Employees as Independent Contractors
january 12, 2016
On July 15, 2015, the United States Department of Labor issued Administrator's Interpretation No. 2015-1 focusing on the classification, or in its eyes, the misclassification of workers as independent contractors rather than employees. The primary purpose for this interpretation was to lend guidance to employers when determining whether a worker is an employee or an independent contractor. The Department of Labor's interpretation of a worker's status as an employee is broad and the clear message is that most workers are employees, not independent contractors. This is an important issue for both the government and employers as whether a worker is an employee or an independent contractor may have significant tax implications.
Interpretation No. 2015-1 identified the "economic realities" test as the prevailing means for determining of how to classify a worker. The economic realities test is a multi-factor test that focuses on whether the worker is economically dependent on an employer or is in business for him or herself. According to the Administrator, the economic realities test should be construed so that the scope of employment is very broad. The factors comprising the economic realities test are: (1) the extent to which the work performed is an integral part of the employer's business; (2) the worker's 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. All factors should be considered in each instance and no one factor is determinative.
The first factor, whether the work performed is an integral part of the employer's business, is considered to be one of the primary factors in all misclassification cases because it encompasses the Federal Labor Standards Act's "suffer or permit" standard. If the work performed is an integral part of the employer's business, it is more likely that the worker is economically dependent on the employer. The Department of Labor offers examples in the Interpretation and in this instance, the example contrasts a carpenter employed by a construction firm—an integral part of the construction firm's business—and a software company the same construction firm contracts with to assist in bids, schedule projects and crews, and track material orders, which is not an integral part of the construction firm's business.
The second factor looks to whether a worker's managerial skill can impact the worker's profit and loss. A worker's decision to hire others, purchase materials and equipment, advertise and rent space, among other tasks, may reflect the worker's managerial skills that impact the opportunity for profit or loss beyond the current job. On the other hand, a worker's ability to work more hours and the amount of work available from the employer has little correlation to the worker's managerial skills.
Third, the relative investment of the worker and the employer examines whether the worker's investment supports the business beyond the particular job. Importantly, no matter the size of the worker's investment, it must be considered relative to the employer's. An example cited in the Interpretation discusses a worker providing cleaning services for a cleaning company who receives a 1099-MISC from the company, signed a contract stating he or she was an independent contractor and relied on the employer for a vehicle, equipment and supplies compared to a worker providing cleaning services who receives referrals, sometimes works for a local cleaning company and invests in his or her own vehicle, advertises services and hires help for larger jobs as well as bringing his or her own supplies. In the first example, the worker's investment is minimal compared to the employer's as the worker essentially provides only labor; that worker is likely an employee.
Next, a worker's business skills, judgment and initiative are considered to determine whether the work performed requires special skills and initiative. Importantly, the worker's technical skills are not considered. This means that jobs such as cable installers, construction workers, carpenters and electricians, while requiring specialized skills, are not alone indicative of whether the worker is an independent contractor. Of course, those workers with specialized skills who operate their own independent businesses are generally considered independent contractors.
A determination of whether the relationship between a worker and an employer is permanent or indefinite is another factor to be considered. Independent contractors typically work one job for an employer and not always continuously or repeatedly. However, the reason for the lack of permanence should be carefully reviewed. If the lack of permanence is due to the intrinsic nature of the business, such as with seasonal employees, that worker may still be an employee. Contrastingly, if the worker's independence is due to his or her own initiative, this suggests the worker may be an independent contractor.
Finally, the degree of control exercised by the employer must be considered. To be classified as an employee, the worker must control some meaningful aspects of the work and the worker must actually exercise that control. The Administrator cautions that this should not play an oversized role in the determination of whether a worker is an employee or an independent contractor. The Administrator notes that control, exercised by the employer for any reason, is indicative that a worker is an employee.
The Administrator's Interpretation reflects the Department of Labor's increasing trend toward classifying workers as employees. Indeed, it suggests that most workers are employees. It is important to keep the economic realities test in mind when trying to make the determination as to how to classify a worker and equally important to remember that this Interpretation reflects only the Administrator's view and is not the law.
If you have questions about whether a worker should be classified as an employee or an independent contractor, the best advice is to contact your attorney. Classification of a worker can be a difficult issue and misclassification of a worker could have negative consequences in the future.