I routinely field calls from clients about how to classify workers. As a business and entertainment attorney, this issue impacts most of my clients on a regular basis. Recently, one client inquired, “Can my assistant be an independent contractor?” The short answer is NO. Under current law, there are no circumstances under which someone who is an assistant should be classified as an independent contractor. This is very important to know if you are interested in setting up your own contracting company, you can check out this recent article by SGI to learn more.
For the past several years, commencing with the economic downturn, the federal Department of Labor (“DOL“) along with the labor departments of states across the country have been focusing on the problem of misclassification of workers. With this intensified scrutiny on misclassification, the DOL has acknowledged that combatting this serious labor issue requires a multi-prong approach. To that end, the DOL began working with several states as well as the IRS to share information and coordinate enforcement efforts to combat the misclassification of workers as independent contractors.
Signaling that recent efforts would only increase, the DOL issued an interpretation that indicates its enforcement position under the Fair Labor Standards Act of 1938 (“FLSA“). Courts and the DOL use the six-factor “economic realities” test which focuses on whether a worker is economically dependent on an employer (employee) or in business for herself (independent contractor) under the FLSA. None of the six factors in and of itself is controlling; rather, the factors are weighed together to determine whether a worker is economically dependent on the employer, and thus an employee. At the state level, there are different tests to determine if a worker is an employee. This article focuses on the economic realities test under the FLSA.
Why Misclassification Matters
Worker misclassification is a serious issue for many reasons. When employers are allowed to misclassify workers, many important workplace benefits and protections are lost such as minimum wage, overtime compensation, unemployment insurance, and workers compensation. Misclassification also results in lower tax revenues for cities and states, as well as an unfair advantage for employers who mischaracterize employees as independent contractors. These employers often misclassify workers to avoid compliance with critical labor laws and illegally cut costs.
Factors Used to Determine Employees versus for Independent Contractors
These six factors are a guide to make the determination of economic dependence or independence.
- Whether the work performed is an integral part of the employer’s business.
- The worker’s opportunity for profit or loss depending on her managerial skill.
- The worker’s investment in equipment and materials versus that of the employer.
- The special skills and initiative required to perform the work.
- The degree of permanence of the working relationship.
- The degree of control exercised or retained by an employer.
Work Performed is Integral to Employer’s Business
Courts have found this factor to be compelling. If the work performed is integral to an employer’s business, then courts are more likely to find that the worker is economically dependent on the employer, and thus an employee. The Supreme Court in Rutherford held that the workers were employees in part because they were “part of the integrated unit of production”. Rutherford Food Corp. v. McComb, 331 U.S. 722, 729 (1947). On the other hand, the work of a true independent contractor, while important, is not likely to be integral to an employer’s business.
For example, a plumber is likely to be considered an employee if she works for a company that provides plumbing services, as plumbing is integral to that company’s business. If the plumber provides the same services to an IT company, among other clients, her plumbing services are not integral to the business of the IT company.
Worker’s Opportunity for Profit or Loss
For the second factor, courts focus on how a worker’s managerial skills affect his opportunity for a profit or loss. When a worker is in business for himself, his managerial skills will affect the opportunity for profit or loss beyond the current job. Decisions such as hiring others, renting space, or purchasing equipment will impact a worker’s ability to realize a profit or loss beyond his current job. This exercise of managerial skills indicates the worker is an independent contractor. However, employees can be taught these skills, click here to see how, in order to put them to good use for the benefit of the company they work for. This person wouldn’t be seen as an example of an independent contractor as they are still part of a team that combines efforts in order to create profit, rather than someone who can independently control this.
Conversely, a worker’s ability to work more hours or the amount of work available from the employer is not related to the worker’s managerial skills. And, a reduction in earnings is not the same as a loss. A worker whose earnings fluctuate based on the availability of work or her willingness to work more does not indicate a use of managerial skills.
Worker’s Investment in Equipment and Materials
To support a worker being considered an independent contractor, courts analyze the nature and extent of the worker’s investment in equipment and materials relative to that of the employer. In order for a worker to be an independent contractor, the worker’s investment in equipment and materials must be able to support a business beyond a particular job, such as investments that impact the business’ capacity to expand or reduce costs. Courts also compare the worker’s investment to that of the employer. If the worker’s investment is relatively minor, that suggests they are not on equal footing and that the worker is an employee who is economically dependent on the employer.
Worker’s Special Skills and Initiative
When analyzing a worker’s special skills and initiative, courts take into consideration if they are used in an independent way such as demonstrating business-like initiative. A worker who uses her special business skills, judgment and initiative, as opposed to solely relying on her technical skills, will be considered economically independent, and not an employee.
For example, the plumber who provides her specialized skills for various clients may demonstrate the skill and initiative of an independent contractor if she markets her services, determines when to hire assistants and decides which jobs to take.
Permanence of Working Relationship
A relationship that is permanent or indefinite suggests the worker is an employee. However, courts have noted that a lack of permanence or indefiniteness does not automatically suggest an independent contractor relationship. Rather, courts look to whether the lack of permanence or indefiniteness is due to operational characteristics intrinsic to the industry (like seasonal or temporary workers) or as result of the worker’s own business initiative. When a worker’s independent business initiative establishes the permanence (or lack thereof) of the business relationship, this suggests the worker is an independent contractor.
Degree of Control
The final factor of the economic realities test is the degree of control. To be considered an independent contractor, the worker must control meaningful aspects of the work such that it is possible to view him as conducting his own business. The control must be more than theoretical; the worker must actually exercise that degree of control. Courts have found that it is not what the worker could do that counts, but rather what the worker actually does that is relevant for this factor.
Courts have noted that a worker’s ability to control her hours or be subject to little supervision is not indicative of independent contractor status. Furthermore, courts are not swayed by companies that claim the nature of their businesses dictate the amount of control exerted over workers (such as the hours worked, prices charged or the tasks they carry out). If the nature of the business requires employers to exert significant control over workers, this suggest workers are employees. The nature and degree of control is but one factor to determine the ultimate question of whether the worker is economically dependent on the employer.
So, Can I Classify My Assistant As An Independent Contractor?
After reviewing these factors in light of the original question, the answer is clear. An assistant simply does not possess the requisite independence that courts require to be considered anything other than an employee. Courts describe independent contractors as workers with economic independence who use their business skills and initiative to invest in and operate their own business. Thus, someone who is an assistant cannot be, and should not be, classified as an independent contractor. To avoid significant future liability, when you hire an assistant (or any other worker who is not sufficiently independent), this person should be classified as an employee.
Steps to Take to Avoid Misclassifying Workers
Employers are looking for many ways to cut costs related to retaining workers, including hiring independent contractors. At the same time, federal agencies and many states are reviewing these decisions to ensure compliance with labor laws.
To avoid misclassifying workers, we recommend taking the following steps:
- Audit your use of independent contractors and keep in mind that the DOL, IRS and several states are cracking down on employers who improperly classify workers. When an employer classifies a worker as an independent contractor as part of a cost-savings strategy, this is usually a very good sign that the worker is misclassified and is actually an employee.
- Analyze your hires using not only the FLSA’s economic realities test, but also the right of control test under the Internal Revenue Code and any test developed by your state labor board.
- Have an attorney review and update your independent contractor agreements to ensure that they address the factors used by courts and federal agencies in determining employee status. Keep in mind that simply having someone sign an independent contractor agreement is not dispositive of a worker’s status. Courts will review the relationship in light of the six factors.
- If worker is determined to be an employee, do not change that classification. A worker who is an employee cannot waive employee status in lieu of being classified as an independent contractor.
- Do not attempt to circumvent an employee designation by labeling a worker as something else, such as an owner, partner, or member of a limited liability company. In these cases, the six-factor economic realities test is still applied.
For more information on how to properly classify your workers, please do not hesitate to contact us.