Winding down the business of the U.S. independent contractor

If you haven’t noticed, federal agencies have been churning out regulations faster than you can say “another one?” In recent weeks, we’ve seen final rules from the Equal Employment Opportunity Commission (EEOC) on the Genetic Information Nondiscrimination Act and the Americans with Disabilities Act. Health and Human Services released proposed regulations for Nondiscrimination in Health Programs and Activities — detailing gender expression and gender identity as protected nondiscrimination classes for the first time. The Department of Labor (DOL) released a new fiduciary rule for investment advice, along with a final rule updating overtime pay rules for workers.

And the DOL’s Wage and Hour Division (WHD) has been busy issuing new guidance on the entire independent contractor classification system. Let’s take a closer look at that effort.

WHD’s opposition to the improper classification of workers as independent contractors (generally, “misclassification”) is built upon several notions, including:

  • Misclassification of employees as independent contractors is found in an increasing number of workplaces in the United States, in part reflecting larger restructuring of business organizations.
  • When employers improperly classify employees as independent contractors, the employees may not receive important workplace protections such as the minimum wage, overtime compensation, unemployment insurance, and workers’ compensation.
  • Misclassification also results in lower tax revenues for the government and an uneven playing field for employers who properly classify their workers.
  • Although independent contracting relationships can be advantageous for workers and businesses, some employees may be intentionally misclassified as a means to cut costs and avoid compliance with labor laws.

Guidance forecasts an increase in misclassification enforcement

The WHD — which says it continues to receive numerous complaints from workers alleging misclassification — has brought a slew of successful enforcement actions against employers who misclassify workers. Many states are seeing more complaints, which is why they’ve responded with legislation and coordinated with the WHD and OSHA on misclassification task forces. Indeed, combating misclassification requires a multi-pronged approach — which had led the WHD to enter into memoranda of understanding with many of these states, as well as with the Internal Revenue Service.

When you apply the economic realities test in light of the more expansive definition the Act gives “employ,” you’ll find most workers are employees under the Fair Labor Standards Act.

The Administrator of the DOL also released two significant pieces of guidance under the FLSA.  First, the backstory:

  • In July 2015, the DOL released Administrator’s Interpretation 2015-1, expanding the scope of application of the so-called “suffer or permit to work” standard. This effectively replaced the long-standing business control analysis of worker classification with the economic realities test.
  • This past January, they issued Administrator’s Interpretation 2016-1 which strengthens worker’s rights — reasserting and affirming the FLSA’s authority to apply the recently-expanded “suffer or permit to work” standard to joint employment relationships.

Suffer or permit to work standard: what’s the significance?

The FLSA’s definition of employ as “to suffer or permit to work” and the later-developed “economic realities” test provides a broader scope of employment than the traditional common law control test, (the prevailing testing at the time the FLSA was drafted).

In order to determine 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.  A worker who is economically dependent on an employer is “suffered or permitted to work” by the employer.

When you apply the economic realities test in light of the more expansive definition the Act gives “employ,” you’ll find most workers are employees under the FLSA.

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. Each factor of the economic realities test must be considered in each case, and no one factor (particularly the control factor) determines whether a worker is an employee. Moreover, the factors themselves should not be applied in a mechanical fashion, but with an understanding that they are indicators of the broader concept of economic dependence.

Ultimately, the goal is not simply to tally which factors are met, but to use them as a guide.

Employees and independent contractors: what’s the difference?

An entity “suffers or permits” an individual to work if, as a matter of economic reality, the individual is dependent on the entity. 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. Factors typically include the:

  • Extent to which the work performed is an integral part of the employer’s business;
  • Worker’s opportunity for profit or loss depending on his or her managerial skill;
  • Extent of the relative investments of the employer and the worker;
  • Permanency of the relationship; and
  • Degree of control exercised or retained by the employer, and
  • Whether the work performed requires special skills and initiative.
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 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.

The very broad definition of employment under the FLSA as “suffer or permit to work” and the Act’s intended expansive coverage for workers must be considered when applying the economic realities factors to determine whether a worker is an employee or an independent contractor, particularly when misclassification occurs in industries employing low wage workers.

Next steps for employers

Employers are encouraged to thoughtfully evaluate the classification of their independent contractors, keeping these “best practice” guidelines in mind:

  • Generally, where an individual has been an independent for several years, the classification will fail.
  • To the extent possible, employers using independent contractors should define and maintain strong partitions between contractors and the business, limiting required attendance and encouraging remote supervision.
  • Independent contractors should never be offered fringe benefits and they should not be participating in the employer’s defined contribution plans.
  • Additionally, employers are encouraged to verify and document appropriate business licenses, certificates of insurance, and other forms of self-employment verification for purposes of defending the independent contractor classification.

See me at SHRM

Wednesday, June 22, 11:30 a.m. – 12:45 p.m.
The Not So Independent Contractor: Understanding and Resolving Worker Misclassification Conflicts

Join me also for:
Benefits Boot Camp
Sunday, June 19, 8:00 a.m. – Noon
With Jay Kirschbaum, Practice Leader, National Legal and Research Group

Incentivizing a Health Workplace: Implementing a HIPAA-compliant Health Outcomes Program
Monday, June 20, 10:45 a.m. – Noon

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Jason SheffieldGuest blogger Jason Sheffield, JD, is an Employee Benefits Attorney with Willis Towers Watson’s National Legal & Research Group. He  joined Willis Towers Watson in 2013 as an attorney for the Human Capital Practice’s National Legal & Research Group (NLRG). He supports the national human capital practice by providing assistance and technical expertise to Willis Towers Watson clients located primarily in the western region.

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