On July 15, 2015, the United States Department of Labor (DOL) issued an Administrator's Interpretation setting out the DOL's views on when a worker is an "independent contractor", and therefore excluded from the protections of the Fair Labor Standards Act (FLSA) that apply to employees. According to the DOL, "most workers are employees under the FLSA's broad definitions." Although the DOL paid lip service to the traditional multifactor test courts have used to determine who is a contractor, it made clear that what matters is "whether the worker is economically dependent on the employer (and thus its employee) or is really in business for him or herself (and thus its independent contractor)." Because most employers work with contractors who don't fit this definition, under the DOL's framework these employers may be violating the FLSA, and therefore an inviting target for a DOL investigation and employee lawsuits. While an Administrator's Interpretation is not binding on the courts, it is likely that most courts will defer to the DOL's view.

The DOL's Administrator's Interpretation is one more in a series of events highlighting the potential exposure faced by companies that use independent contractors. Two recent cases have drawn wide attention: a California case decided last month, which concluded that Uber drivers are employees for California wage-and-hour purposes, and Federal Express' $228 million settlement with its California drivers, following the company's loss in federal court last year over whether its drivers are independent contractors under California law. These cases make clear the potentially enormous financial consequences an employer faces if it misclassifies its workers. Even the mere filing of lawsuits can potentially devastate a company, as just this week, Homejoy, a home cleaning start-up that mostly engages "contractors" to do the work, announced it was shutting down due to a spate of lawsuits by workers who claimed the company misclassified them.

A worker's status as an employee versus an independent contractor has consequences not only for federal and state wage-and-hour purposes such as eligibility for overtime, but also for payroll taxes and wage withholding, and application of the Affordable Care Act's employer mandate requirements, as well as unemployment insurance and workers' compensation.

One of the complexities of determining whether a worker is an employee or an independent contractor is that the wage-and-hour tests for employee status are much broader than the payroll tax and Affordable Care Act tests, with differences under state law as well. For example, a worker can be an employee under federal wage-and-hour law but a contractor under state law, and a contractor under federal tax law but an employee for workers' compensation purposes. The practical reality, of course, is that a business cannot treat a worker as an employee for one purpose and an independent contractor for another without considerable administrative burdens.

Given the increased scrutiny by the government and the increase in litigation by workers, companies that treat workers as independent contractors should review that classification to make sure it is accurate and defensible.

Common Mistakes.

  • "By entering into a written agreement, a worker and a business can agree and declare the worker is an independent contractor."

    Wrong: If the terms of such an agreement make clear that the worker is not under the control of the business in performing services for the business, that may help to show that the worker is an independent contractor, but the various government agencies and the courts long ago concluded that such agreements are by no means conclusive.
  • "People who work part time, or on an temporary basis, can be treated as independent contractors because they aren't full-time employees."

    Wrong: Although part-time or temporary status may indicate a worker is an independent contractor, that worker can just as easily be a part-time or temporary employee.

What to do?

  • Get ahead of the issue: Businesses that use independent contractors should assess whether the workers really are independent contractors. In addition, they should review their benefit plans to be sure that eligibility is limited to individuals who the business treats as employees under the common law test for federal payroll tax purposes (or a similar formulation), rather than simply stating that "employees are eligible to participate" in the plan. This minimizes the exposure to benefit claims that could occur if a court or a government agency requires the employer to reclassify independent contractors as employees.
  • Make sure that compensation paid to independent contractors is timely reported to the IRS on a Form 1099-MISC. Failure to do so makes settlement of worker classification disputes with the IRS considerably more difficult.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.