Government and Human Resources

Employee or contractor? How to avoid misclassification

Economic realities test is an important determining factor.

August 7, 2015
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The misclassification of employees as independent contractors is on the rise, according to the Wage and Hour Division of the U.S. Department of Labor.

“When employers misclassify their employees as independent contractors, often to cut their own costs, those workers are denied the protections of basic labor standards such as minimum wage and overtime, in addition to necessary safety and health protections,” the division said in a written statement.

In July, the Wage and Hour Division issued a memo it hopes will help clarify for employers exactly who is eligible for independent contractor status and who should be considered an employee.

“The department is saying, ‘Here is how we distinguish between employees and independent contractors under the Fair Labor Standards Act,’” said John Lichtenberg, attorney with Rhoades McKee.

He noted it is the interpretation of the law, not the law itself, that has changed.

“It tells us how this Department of Labor is viewing things, and when and where it is likely to seek enforcement actions against an employer,” he said. “The guidance doesn’t plow new ground; it just takes an aggressive view of prior court rulings.”

The memo refers to what is called the “economic realities test” for determining whether someone is an employee or an independent contractor.

The economic realities test is used to determine if the worker is economically dependent on the employer, and therefore an employee, or in business for him or herself, and therefore an independent contractor.

The test asks a series of questions to determine a worker’s status:

  • Is the work an integral part of the employer’s business?
  • Does the worker’s managerial skill affect the worker’s opportunity for profit or loss?
  • How does the worker’s relative investment compare to the employer’s investment?
  • Does the work performed require special skill and initiative?
  • Is the relationship between the worker and the employer permanent or indefinite?
  • What is the nature and degree of the employer’s control?

Under the broad definitions of the Fair Labor Standards Act “most workers are employees,” according to the Wage and Hour Division.

The division will look at the totality of the circumstances to make its determination of whether a worker has been misclassified or not.

“For employers who want to avoid a fight, they need to review all of their independent contractor arrangements with a critical eye,” Lichtenberg said. “Any individual that you have identified as an independent contractor, start with the presumption that the person is not, and then work backwards — that is what the department is really saying.”

The Wage and Hour Division’s interpretation of who should be classified as an employee will have an impact on how other agencies classify workers, as well.

“If you, as an employer, are obliged to say someone is an employee under the Department of Labor, then chances are they’ll get treated as an employee for tax purposes and ERISA (Employee Retirement Income Security Act), as well, among other things,” Lichtenberg said.

“So this is really a wedge in the door for a whole range of benefits, not just minimum wage and overtime.”

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