The cold winds of February swept in chilly news for employers. On February 1, 2010, the U.S. Department of Labor ("DOL") released its 2011 fiscal year budget in which it sought $25 million for a "Joint Labor-Treasury Misclassification Initiative" to detect, investigate, and prosecute employers who misclassify their workers as independent contractors ("ICs").1  Just two weeks later, the Associated Press reported that the Internal Revenue Service ("IRS") and 37 states had also set their sights on companies that improperly classified workers as ICs.2 

On one hand, government scrutiny of potential IC misclassification is nothing new. The IRS collects employment taxes for employees, not ICs. The DOL promulgates the Fair Labor Standards Act's ("FLSA's") overtime requirements for employees, but not ICs.  Since unemployment benefits and anti-discrimination laws provide recourse for employees, but not ICs, state labor agencies regularly deal with this question.  Courts trying to determine employer liability for the acts of its employees often have to settle a dispute as to whether the employee really was an employee, or just an IC. 

On the other hand, IC misclassification has clearly vaulted up the government's prize target list. Perhaps this is because there are more prizes to target. The recession has left many employers unable to support the costs associated with full-time employees.  As a result, more employers have turned to ICs to the extent they can which, of course, has lowered tax revenue for the government. 

Employers are justifiably concerned with this news since inadvertent misclassification can quickly spiral into a widespread host of problems.  Federal Express has been dealing with the alleged misclassification of its drivers as ICs for over a decade.  What started as class action overtime suits in one part of the country evolved into IRS tax audits and further escalated into investigations by various state labor boards for allegedly "intentional violations" of state labor laws.

Given the government's heightened interest in this area, and the broad scope of governmental concerns involved, prudent employers are reviewing their IC arrangements now so that they will be prepared when the auditors come calling.  To this end, employers must understand that no agency or court has ever presented a specific, bright-line test for determining IC status.  Instead, IC status is determined on a case-by-case basis after weighing various factors, none of which are controlling. 

The DOL presents a comprehensive list of factors that it relies on, which include:3

  1. The extent to which the worker's services are an integral part of the employer's business     (e.g.: Does the worker play an integral role in the business by performing the primary type of work that the employer performs for his customers or clients? Does the worker perform a discrete job that is one part of the business' overall process of production? Does the worker supervise any of the company's employees?);
  2. The permanency of the relationship (e.g.: How long has the worker worked for the same company?);
  3. The amount of the worker's investment in facilities and equipment (e.g.: Is the worker reimbursed for any purchases or materials, supplies, etc.? Does the worker use his or her own tools or equipment?);
  4. The nature and degree of control by the principal (e.g.: Who decides on what hours to be worked? Who is responsible for quality control? Does the worker work for any other company(s)? Who sets the pay rate?);
  5. The worker's opportunities for profit and loss (e.g.: Did the worker make any investments such as insurance or bonding? Can the worker earn a profit by performing the job more efficiently or exercising managerial skill or suffer a loss of capital investment?); and
  6. The level of skill required in performing the job and the amount of initiative, judgment, or foresight in open market competition with others required for the success of the claimed independent enterprise (e.g.: Does the worker perform routine tasks requiring little training? Does the worker advertise independently via yellow pages, business cards, etc.? Does the worker have a separate business site?).

The considerations touted by the IRS are similar, but grouped into three "categories" of factors:4

  1. Behavioral: Does the company control or have the right to control what the worker does and how the worker does his or her job? (type of instructions given degree of instruction, evaluation systems, training)
  2. Financial: Are the business aspects of the worker's job controlled by the payer? (significance of personal investment, unreimbursed expenses, opportunity for profit or loss, whether worker's services are available to the market, method of payment)
  3. Type of Relationship: (written contracts, employee benefits, permanency of the relationship, services provided as key activity of the business)

In a recent case concerning whether a worker was an "independent contractor" for purposes of overtime wages owed under the FLSA, the Fifth Circuit presented the following "non-exhaustive" factors, which mirror those presented by the United States Supreme Court over sixty years ago:5

  1. the degree of control exercised by the alleged employer;
  2. the extent of the relative investments of the worker and the alleged employer;
  3. the degree to which the worker's opportunity for profit or loss is determined by the alleged employer;
  4. the skill and initiative required in performing the job; and
  5. the permanency of the relationship.

A recent recitation from the Texas Supreme Court is essentially the same, with a slightly different emphasis:6

  1. the independent nature of the worker's business;
  2. the worker's obligation to furnish necessary tools, supplies, and material to perform the job;
  3. the worker's right to control the progress of the work, except as to final results;
  4. the time for which the worker is employed; and
  5. the method of payment, whether by time or by the job.

Faced with these multi-factor tests that produce varying conclusions depending on the case-specific facts, it is plainly unwise to assume that a government-sanctioned IC relationship will exist so long as the employer and worker agree in writing to have one.  Indeed, none of the tests give any serious weight to the existence of a written IC agreement; instead, they examine how the parties perform the relationship in actuality, as opposed to how the parties described the relationship in writing.  Employers must therefore be prepared to do more pre-relationship analysis than simply drawing up an agreement. 

Such pre-relationship analysis should consider the expected duration of the need for the services and how integral the services are to the employer's operation. Too long and too much are too likely to require an employment relationship instead of an IC arrangement. The employer must consider the necessity and amount of materials, oversight or training that it intends to provide. If the employer cannot be satisfied with requiring a specific result within a specific timeframe and leaving basically EVERYTHING else up to the worker, perhaps the employer needs an employee instead of an IC. If an employer won't let the worker simultaneously work on projects for other parties, or if the worker requires a regularly-paid and guaranteed compensation regardless of amount or progress of performance, the parties simply may not have a realistic, DOL-approved view of an IC relationship. 

Never assume, however, that a sufficiently-analyzed and cautiously entered-into IC relationship will be blessed in perpetuity by the government. An IC relationship that even the IRS could approve may subsequently evolve into more of an employment relationship due to factors that were previously non-existent.  In Cromwell,7 the Fifth Circuit ultimately found in what it considered to be a close call that cable installers were not independent contractors, even though they controlled the details of their job, utilized more than $60,000 of their own equipment, and technically had the ability to perform similar jobs for other entities during the time that they worked for the employer.  Key to this decision was the fact that the contractors had essentially worked solely for the employer for an 11-month period without working for anyone else and without, in the opinion of the Court, being realistically able to do so.  Employers take note - if your IC relationship has existed continuously for a sufficient amount of time, whether it was originally intended to do so or not, it may be deemed an employment relationship, at least according to the Fifth Circuit. 

It is also important to avoid assuming what has worked before will work again.  These situations are fact-specific, and facts are never exactly the same.  Just because an IC relationship is upheld in the health care industry does not mean that a similar finding would be made if an apparently similar relationship existed in the hospitality industry.  Conversely, an employer in the hospitality industry may actually have a proper IC relationship, but a different employer in that same industry may not due to internal differences between the companies. It is therefore important to conduct a thorough analysis of the proposed IC relationship in each instance before concluding that it can support IC status.  Consultation with legal counsel will help in analyzing and determining the propriety of any future or current IC arrangement. 

Footnotes

1  http://www.dol.gov/dol/budget/2011/bib.htm

2  Associated Press, Dave Gram, 2/12/2010.

3  http://www.dol.gov/elaws/esa/flsa/docs/contractors.asp

4 See www.irs.gov/businesses/small/index.html, answering the question "Independent Contractor (self-employed) or Employee?"

 5  See Cromwell v. Driftwood Electrical Contractors, Inc., 15 Wage & Hour Cas. 2d (BNA) 718 (5th Cir. Oct. 12, 2009); United States v. Silk, 331 U.S. 704 (1947)(examining whether an employer owed Social Security taxes on certain workers).

6  Texas A & M Univ. v. Bishop, 156 S.W.3d 580, 584-85 (Tex. 2005).

7  See Cromwell v. Driftwood Electrical Contractors, Inc., 15 Wage & Hour Cas. 2d (BNA) 718 (5th Cir. Oct. 12, 2009).

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.