It’s an “Economic Reality”: Your Independent Contractors May Actually Be Employees

  • The U.S. DOL clarifies how businesses should determine whether workers are independent contractors or employees
  • Classifying as independent contractor or employee is based on “economic realities” of relationship, not “control” of the worker by the employer
  • “Economic Realities” test looks at six broad factors

The federal Department of Labor (“DOL”), the agency charged with enforcing the Fair Labor Standards Act (“FLSA”), recently published an Administrative Interpretation clarifying the test businesses must apply to determine whether workers are properly classified as independent contractors or if they are, in fact, employees. The Interpretation makes clear that “control” of the worker by the employer is not the name of the game. Rather, proper worker classification is determined by the “economic realities” of the relationship.

 

“Economic Realities,” Not “Control”
You may be tempted to say, “Thanks Obama,” for this latest news – but hold that thought. The “economic realities” test is not new. It has been applied by federal courts in assessing FLSA classification since 1961, and the U.S. Supreme Court acknowledged the “economic realities” in 1985. In 2012, the Washington State Supreme Court also jettisoned the “control” test and adopted the “economic realities” test, bringing assessment of independent contractor status under Washington law in line with federal law.

 

What does the “economic realities” test look at? Generally, six broad factors:

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

Yes, one of the factors is “control.” But don’t get too excited. The DOL emphasizes that although “control” is considered part of the economic realities test, “the ‘control’ factor should not be given undue weight.” So it’s there – but don’t focus on it. Also keep in mind that courts can and do consider additional factors depending on the circumstances.

The Interpretation includes an in-depth discussion of each of the six factors with examples. If you are an employment law junkie like me, you can read the full Administrative Interpretation here. For everyone else, here is a summary:

  1. Integral Part of the Employer’s Business

    Courts find this factor particularly compelling. Notably, work can be integral to the employer’s business even if the work is only one component of the business or performed by many other workers. Work can also be integral to the business if it is performed away from the employer’s premises, from the worker’s home, or on the premises of the employer’s customers. Some examples:

    • Work performed by FedEx drivers has been deemed “integral” to the business of delivering packages
    • Work performed by cake decorators is “obviously integral” to the business of selling custom decorated cakes
    • “Picking the pickles” is a necessary and integral part of the pickle business[1]
    • Answering calls at a call center is integral to the call center’s business
    • Carpenters integral to business of construction company that frames residential homes
  2. Worker’s Opportunity for Profit and Loss Depending on Managerial Skill

    The focus of this factor is whether the worker’s managerial skill – that is, the individual’s ability to manage his or her own independent business – affects the individual’s risk of profit or loss, as opposed to the profit or loss of the employer company. As the Interpretation explains, whether the worker is available to work more hours and the amount of work available from the employer is not relevant to this determination. In addition, the possibility or risk of a reduction in wages is not the type of loss contemplated by this factor. (In fact, risk of wage reduction indicates an employment relationship, not an independent contractor one.) Rather, the inquiry examines whether the worker makes decisions that impact the profit or loss of the worker’s independent business. Such decisions may include whether to hire others to perform the work, purchase materials or equipment, advertise, rent space, and accept or reject assignments.

  3. Relative Investment of the Worker Compared to the Employer

    As explained by the DOL, this factor contemplates that in an independent contractor relationship, the worker makes some investment in his or her independent business beyond any specific or particular assignment or job (and therefore takes on some risk of loss). However, don’t think requiring a worker to purchase equipment, tools, attire, or other items required for the job will transform an employee into an independent contractor. Au contraire. This factor looks at the worker’s investment relative to that of the employer. If the worker’s investment is relatively minor, the factor may suggest the worker is economically dependent on the employer and tip this factor in favor of an employment relationship. Some examples:

    • Rig welders’ investment in equipped trucks costing between $35,000 – $40,000 did not indicate an independent contractor relationship when compared to the employer’s investment in the business
    • Cake decorators’ $400 investment in their tools did not indicate independent contractor relationship when compared to employer’s investment in business including rent, advertising, operating expenses, supplies, decorating equipment, and labor
    • Farm workers’ investment in purchasing gloves did not indicate independent contractor relationship compared to employer’s investment in farm equipment, land, seed, fertilizers, and living quarters
  4. Special Skill or Initiative Required by the Work

    Again, this factor focuses on the worker’s business skills, judgment, and initiative, not on technical skills. Notably, even specialized skills do not indicate that the worker is in business for himself or herself, especially if those skills are technical and used to perform the work. As explained by the DOL, the technical skills of cable installers, carpenters, construction workers, and electricians – even assuming these skills are “special” – are not themselves indicative of any independence or business initiative. Only those workers who operate independent businesses, as opposed to being economically dependent on an employer, are independent contractors.

  5. Permanence of Relationship Between Worker and Employer

    Permanence or indefiniteness in the worker’s relationship with the employer tends to indicate that the worker is an employee. However, the absence of permanence or indefiniteness does not automatically suggest an independent contractor relationship either – and courts will closely scrutinize the reason for the lack of permanence. Generally, the longer the relationship and the more exclusive it is, the more this factor will indicated that the worker is an employee.

  6. The Nature and Degree of Employer’s Control

    This factor must be considered with the ultimate goal of the economic realities test in mind: to determine if the worker is economically dependent on the employer or truly an independent business person. To be an independent contractor, the worker must control meaningful aspects of the work and the control must be more than theoretical – the worker must actually exercise it. Independent contractor status is not indicated by a worker’s control of hours worked or an employer’s lack of direct or constant supervision – particularly if the worker works from home or offsite. In addition, quality control measures and regulation of schedules that stem from the “nature of the business” can be sufficient control by the employer business to indicate an employer/employee relationship, rather than one of an independent contractor. Bottom line: the less discretion the worker has in meaningful aspects of the job itself, the more likely the worker is an employee.

 

The Last Word:
The question of whether a worker is properly classified is rarely clear-cut. It is a fact-intensive inquiry that will depend on the specific circumstances of each case. One thing is for certain: Do not assume that a worker is properly classified because the individual has an independent contractor agreement or goes by the term “contractor.” Workers cannot waive their right to be correctly classified under the law, and the cost of misclassification can be significant. Consult with workforce management counsel to conduct an audit and ensure that your workers are correctly classified.

[1]We’ll just set aside that picking “pickles,” whether by the peck or otherwise, is perfectly preposterous. But no doubt picking cucumbers is integral to the pickle-making business. 

 

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