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It's time to re-examine the classification of independent contractors

July 15, 2015

On July 15, 2015, the U.S. Department of Labor (DOL) articulated a standard that will be used to call into question independent contractor classifications. Specifically, the DOL published Administrator’s Interpretation No. 2015-1 (AI 2015-1), which is the first Administrator’s Interpretation in more than a year. AI 2015-1 broadly defines an employee under the Fair Labor Standards Act (FLSA) and narrowly interprets case law regarding independent contractor status. The DOL announced a “qualitative” application of the “economic realities” test used to classify independent contractors. This test focuses on a worker’s overall “economic dependence,” rather than more traditional concepts of what it means to be an independent contractor. Taking a cue from recent court decisions, including a recent decision from the Sixth Circuit, the DOL cites the historic underpinnings of the FLSA’s definition of “employ” (“to suffer or permit to work”) – arriving at a standard that appears to encompass the broadest array of work relationships yet.

According to the DOL, businesses still must follow the often-used “economic realities” test when classifying employees and independent contractors, but must not do so in a “mechanical” or mathematical way. Instead, the DOL indicates that this is a totality-of-the-circumstances test, where no one factor is determinative. The DOL further opines that the FLSA should be “construed to provide broad coverage for workers.”

As part of this qualitative analysis, the following factors are to be examined in relation to one another, and in view of the FLSA’s purpose, to determine whether a worker is economically dependent or, instead, in business for him or herself:

  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.

While this test may look straightforward at first blush, the 15-page AI 2015-1 suggests that there is no bright-line rule. For instance, the DOL states that, even where a worker spends tens of thousands of dollars on equipment, this still may not support an independent contractor classification, where the company’s capital investment in its overall business is substantially larger than the contractor’s investment in the project at issue. 

Similarly, the type of services being provided can affect the classification if such services could be considered an integral part of the employer’s business. In other words, although performing the same services, one person could be considered an independent contractor while another person could be considered an employee simply based on the business at issue. For instance, according to the DOL, a carpenter may be an independent contractor when working for a software company, but an employee if the same work is performed for a general contractor.

Furthermore, it is hard to know what factor the DOL will find most important in a given case. The subjective nature of the DOL’s analysis provides little practical or objective criteria upon which businesses can rely when classifying an individual as an independent contractor.

While there are few answers from the DOL’s new guidance, some practical takeaways are as follows:

  • The DOL believes most work should be performed by employees. Thus, companies should take great care when classifying individuals as independent contractors.
  • Entering into independent contractor agreements or hiring a business entity (rather than a person) does not necessarily protect you from liability.
  • A careful legal review of the type and scope of work being performed should be completed before classifying an individual as an independent contractor.
  • When entering into agreements with service providers, ensure that you obtain appropriate indemnification to protect against possible wage-and-hour and other claims by the service provider’s workers.      

In summary, if a worker tends to economically depend on a company for whom he or she provides services, the DOL likely would deem that worker an employee – regardless of the amount of control, flexibility and ownership the worker may retain over his or her actual work. Thus, AI 2015-1 arguably restricts the use of independent contractors to very limited situations. 

AI 2015-1 follows a trend in which the use of independent contractors has increasingly come under attack. Although the DOL’s intention was to reduce litigation, there is a real concern that the interpretation actually will result in more DOL investigations and litigation. Companies should be proactive and audit their classifications and use of independent contractors in order to manage the risks associated with costly governmental investigations or audits. For more information or guidance on this issue, please contact one of Honigman’s Labor and Employment attorneys.