On July 15, 2015, the U.S. Department of Labor (“DOL”) issued an important Administrator’s Interpretation discussing the misclassification of employees as independent contractors. Many companies engage independent contractors, rather than employees, to fill temporary and sometimes permanent staffing needs. Such an arrangement is often beneficial for both companies and workers. Companies avoid paying certain taxes applicable to employees and are able to pay their workers by the project, without overtime pay. Workers gain flexibility that might otherwise not be available as an employee. In determining whether a worker is an employee or an independent contractor, companies have often turned to the IRS “right to control” standard. Many companies come to the conclusion that there is little risk in engaging workers as independent contractors so long as the company does not control the manner or method in which the work is performed. The DOL’s latest memorandum is a chilling reminder that this risk analysis is incorrect and that companies can face stiff damages claims and penalties for noncompliance.

Different statutes apply varying tests to determine whether a worker is an employee or independent contractor. While the IRS applies a “right to control” test, many other statutes - such as the FLSA - apply a more employee-favorable standard such as an “economic dependence” or “economic realities” test. In other words, even if the worker is not controlled by the company, a worker may still be an employee if they are in fact economically dependent on the work just like an employee. In its latest guidance, the DOL makes clear that it takes the position that “most workers are employees under the FLSA’s broad definitions.” The DOL’s Administrator’s Interpretation explains that under the FLSA’s very broad definition of employment, to employ means “to suffer or permit to work.” For wage and hour purposes, the DOL explained that it looks to six factors in determining the nature of a working relationship: (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. No one factor is determinative, and instead, “[t]he application of the economic realities factors is guided by the overarching principle that the FLSA should be liberally construed to provide broad coverage for workers.”

The DOL has explained that the misclassification of workers as independent contractors has been increasing. To combat this problem, the DOL has entered into cooperation agreements with the IRS and many states, including California, Colorado, Illinois, Minnesota, Washington, and Wisconsin. These cooperation agreements allow both the DOL and the IRS or states to share information when they determine a misclassification has occurred. Some states have also imposed stricter penalties for misclassification. For example, California recently imposed personal liability on managers who intentionally misclassify workers as contractors not employees. For employers, this means that it is easier to get caught, more difficult to prove contractor status, and with substantially more penalties for misclassification. While the DOL’s Administrator’s Interpretation does not have the force of law, it does set forth the DOL’s general interpretation of the law and the agency’s enforcement position. Companies can expect that the DOL will likely be aggressive in enforcing the FLSA and should consider the following precautions.

Practical tips:

      • While the human resources function clearly “owns” employee issues in corporate America, many companies do not monitor their independent contractor relationships. Companies should make clear which department within the organization is responsible for understanding the law, know which contractors have been engaged, and monitor compliance. Often, the human resources or finance department is put in charge of monitoring compliance.
      • General counsel should question independent contractor classifications as part of their global risk audit, and take appropriate action to ensure that the situation is being monitored.
      • Employers should maintain basic records on the independent contractor determination process, and the facts used to make that determination. For example, they should keep records of business licenses, business cards, contractor tax records, project work plans showing limited engagements, and correspondence from the contractor.
      • Companies should avoid giving contractors rights or access that cut against contractor determination. For example, contractors should not have internal email accounts, should not be given server access, and should not be invited to employee functions.
      • The DOL guidance reminds employers to periodically audit existing contractors to make sure they have not inadvertently slipped from contractors to employees. If an otherwise-valid contractor arrangement becomes economically dependent on the work, then the relationship may convert to an employee entitled to overtime and other benefits. This audit should be conducted with legal counsel in order to obtain confidential advice on the standards and contractor determination.