The use and misuse of independent contractor status has been one of the most talked about issues facing businesses over the past decade. Major newspapers have published exposés, lawmakers have threatened new legislation, and attorneys have authored countless articles attempting to explain the rules. Still, despite all this discussion and debate, the rampant misclassification of employees as independent contractors and a general misunderstanding of the law continues.
In fairness, at least part of the current confusion is due to the fact that the playing field keeps changing. Government agencies (state and federal) are now cracking down on practices previously considered common and acceptable, and businesses are being hit from all angles – unemployment tax claims, IRS audits, wage-hour complaints, etc. In an effort to ramp up their efforts and further combat the misclassification of employees as independent contractors, agencies have tightened up their enforcement positions. The latest and perhaps most extreme example of this comes from the U.S. Department of Labor ("USDOL").
If you have been following along over the years, then you know that there is no single, uniform test accepted by all government agencies to determine who qualifies as an independent contractor.
Historically, the IRS has used a 20-factor test, which more recently was reconfigured into three primary factors:
Financial Control; and,
The Type of Relationship.
The courts have developed a common law test which focuses on the hiring party's right to control the manner and means by which the worker accomplishes the worker's end product.
The USDOL has its own test, the "Economic Realities" test, to determine if the worker is covered under the Fair Labor Standards Act ("FLSA"). Although the USDOL test has always looked at a number of factors, the one most often focused upon was control – more specifically, the nature and degree of control a business (or "principal") has over the worker. Indeed, for years, most legal commentators have agreed that the only constant in determining independent contractor status is whether the business has the right to control the manner and means by which the relevant work is accomplished.
Would it surprise you to learn that the USDOL no longer takes this position? Would it surprise you to hear that the USDOL now says that control over such things as work hours, schedule, and location are not important? If so, then you might want to keep reading.
The USDOL's Position Pre-2014
To understand the USDOL's current position, it is helpful to look back and review some history. In July 2009, the USDOL revised its "Fact Sheet #13," which was published for the express purpose of providing general information concerning the meaning of the "employment relationship" in applying the provisions of the FLSA. The USDOL noted that no single rule or test applied and that it would look at the totality of the situation in determining whether an individual qualified as an independent contractor; however, to aid in this process, the USDOL identified seven factors which it considered significant:
The extent to which the services rendered are an integral part of the principal's business.
The permanency of the relationship between the alleged independent contractor and the principal.
The amount of the alleged independent contractor's own monetary investment in facilities and equipment.
The nature and degree of control by the principal.
The alleged independent contractor's opportunities for profit and loss.
The amount of initiative, judgment, or foresight in open market competition with others required for the success of the alleged independent contractor.
The degree of independent business organization and operation of the alleged independent contractor.
The USDOL's 2014 Revision
The USDOL revised Fact Sheet #13 in May 2014, an action that did not garner much attention at the time. In the new Fact Sheet, which remains in place today, the USDOL expressly states that "most workers are employees" and then proceeds to list six revised factors (note, one less than the original seven) which are to be generally considered when determining whether an employment, rather than independent contractor, relationship exists:
The extent to which the work performed is an integral part of the employer's business.
Whether the workers managerial skills affect the worker's opportunity for profit and loss.
The relative investments in facilities and equipment by the worker and the employer.
The worker's skill and initiative.
The permanency of the worker's relationship with the employer.
The nature and degree of control by the employer.
The revisions appeared to be relatively minor and, at the time, few appreciated the significance of what the USDOL was attempting to do. Of course, the overall order changed from 2009, and the original seventh factor (the degree of the worker's independent business organization and operation) was omitted. At first glance, it appeared that the only other substantive changes were the addition of the words "managerial skill" to the second factor and the reference to "relative" investments in the third factor; however, there were two other subtle changes which foreshadowed things to come: the "control" factor was moved to the end (possibly reflecting its relative importance in the eyes of the USDOL); and all references to "principal" or "business" changed to "employer" (demonstrating, perhaps, the USDOL's classification preference). Looking back, it is now apparent that these "subtle" changes signaled a major shift in the USDOL's enforcement position.
The USDOL's Administrator's Interpretation No. 2015-1
It's fair to say that the USDOL's 2014 revision of Fact Sheet #13 didn't affect the way most businesses analyzed their contractor relationships. The general consensus continued to be that control was the key. So long as the relationship was structured in a manner in which the worker retained control over how and when the work was performed, then most businesses assumed an independent contractor designation was appropriate.
Last year, the USDOL decided it was time to take a more aggressive approach. On July 15, 2015, it issued Administrator's Interpretation No. 2015-1 ("2015 Interpretation"), which addresses: "The Application of the Fair Labor Standards Act's 'Suffer or Permit' Standard in the Identification of Employees Who Are Misclassified as Independent Contractors." The clear purpose of this Interpretation was to accomplish three goals:
Establish that the default rule is that every worker is an employee;
Explain that those "minor" changes to Fact Sheet #13 are, in fact, significant; and,
Clarify once and for all that control is no longer the key.
Regarding the first goal, the USDOL points out that the FLSA's definition of "employ" includes "to suffer or permit to work," which USDOL says "was specifically designed to ensure as broad of a scope of statutory coverage as possible." Thus, according to the 2015 Interpretation, "[w]hen determining whether a worker is an employee or independent contractor, 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." Further, the 2015 Interpretation states: "[A]pplying the economic realities test in view of the expansive definition of 'employ' under the Act, most workers are employees under the FLSA [emphasis added]." In other words, the USDOL will presume that all workers are employees unless and until it is proven otherwise.
Moving on to the second goal, the 2015 Interpretation offers a detailed discussion of each of the six factors listed in Fact Sheet #13. For many, this discussion significantly alters the traditional independent contractor analysis. In particular, the second, third, and sixth factors have changed considerably. Each of these factors is addressed below.
USDOL FACTOR #2: WHETHER THE WORKER’S MANAGERIAL SKILLS AFFECT THE WORKER'S OPPORTUNITY FOR PROFIT AND LOSS.
All businesses have an opportunity to make a profit or a loss. Employees, on the other hand, are guaranteed certain wage protections and, therefore, don't have the same upside or downside as a business. Accepting this premise, it has been understood for years that a worker's ability to make a profit or suffer a loss was a relevant factor in establishing independent contractor status.
So, what changed? According to the USDOL's 2015 Interpretation, "[t]his factor should not focus . . . just on whether there is opportunity for profit or loss, but rather on whether the worker has the ability to make decisions and use his or her managerial skill and initiative to affect opportunity for profit or loss [emphasis added]." In analyzing this factor, the 2015 Interpretation states says that the USDOL will not be persuaded by the fact that a worker can affect profitability in a particular job by working more hours or being more efficient. Instead, the USDOL wants to see that the worker has made business decisions that affect the opportunity for profit or loss beyond the worker's current job. This would include decisions to hire or fire other workers, purchase materials, advertise, rent space, etc.
USDOL FACTOR #3: THE RELATIVE INVESTMENTS IN FACILITIES AND EQUIPMENT BY THE WORKER AND THE EMPLOYER.
All businesses require some level of financial investment. In that regard, it has always been understood that in order to qualify as an independent contractor a worker should have some "skin in the game." Thus, independent contractors may be expected to bring their own tools, purchase their own insurance, and cover their own overhead. Employees, on the other hand, are not required to make personal investments and benefit from the fact that the employer has made these investments.
So, what changed? The 2015 Interpretation states that "investing in tools and equipment is not necessarily a business investment or a capital expenditure that indicates that the worker is an independent contractor." Instead, the USDOL wants to see the type of investments that will support a business beyond a particular job. For instance, the USDOL likely will be persuaded by the fact that a worker invests in advertising, markets the worker's services to other customers, and takes steps to establish a long-term business venture (e.g., rent office space).
As if that's not bad enough, there's more. According to the 2015 Interpretation, even if the type of investment is considered a true business investment, "the worker's investment must be significant in nature and magnitude relative to the employer's investment in its overall business to indicate that the worker is an independent businessperson." If the worker's investment is minor compared with that of the business, that apparently will suggest to the USDOL that the worker is economically dependent on the business and, thus, employed by it. This frightening step begs the question of whether a large business (with significant overhead) could ever retain an individual worker without establishing an employment relationship.
USDOL FACTOR #6: THE NATURE AND DEGREE OF CONTROL BY THE EMPLOYER.
This final factor also brings us to the USDOL's third and final goal in publishing the 2015 Interpretation: Clarifying once and for all that "control" is no longer the key. Indeed, in the 2015 Interpretation, the USDOL goes out of its way on at least three separate occasions to downplay the role of control. The 2015 Interpretation states:
"All of the factors must be considered in each case, and no one factor (particularly the control factor) is determinative of whether a worker is an employee."
"[E]ach factor is examined and analyzed in relation to one another, and no single factor is determinative. The 'control' factor, for example, should not be given undue weight."
"Finally, the 'control' factor should not play an oversized role in the analysis of whether a worker is an employee or an independent contractor. All possibly relevant factors should be considered, and cases must not be evaluated based on the control factor alone."
[All emphases have been added]
In light of the above, it's fair to ask what role, if any, "control" plays in the USDOL's current analysis. Traditionally, many businesses focused on scheduling issues, such as hours and work location. According to the USDOL, these issues are not persuasive, if even relevant. It notes in the 2015 Interpretation that flexibility in scheduling is common in today's modern workforce; thus, it "is not indicative of independent contractor status." Instead, the 2015 Interpretation states that the "worker must control meaningful aspects of the work performed such that it is possible to view the worker as a person conducting his or her own business [emphasis added]."
The USDOL does not offer much help in determining what would be considered "meaningful." Ultimately, it appears the "control" factor is now a one-way street in the independent contractor analysis. If the USDOL finds that a business retains any control over a worker, then it apparently will take the position that the worker must be an employee. In that limited context, "control" remains a very important factor.
For years, government agencies and employers alike have said that misclassification of independent contractors results in an uneven playing field for employers who properly classify their workers. By issuing the 2015 Administrator's Interpretation, the USDOL has done its best to level the playing field. Indeed, it has clearly stated its position that "most workers are employees under the FLSA's broad definitions."
A default rule has been established, and the USDOL has stacked the deck in its favor. As such, now more than ever, business owners must closely scrutinize their contractor relationships.