Unless they have been run out of a cabin in the woods with no internet for the last five years, most businesses are starkly aware of the ongoing efforts by state and federal regulators to find and eliminate the misclassification of independent contractors. What started as a concern in the construction industry is now affecting all types of businesses, from health care to high tech. Despite the well-publicized and well-organized battle against misclassification, companies and individuals continue to put themselves at risk by treating people who should more properly be employees as contractors.
If all of the notices and warnings issued by agencies ranging from the state department of labor to the IRS have not made an impression, a cursory read of the US Department of Labor’s recent guidance should bring focus to the issue. On July 15, 2015, the Administrator of the US Department of Labor issued a document entitled 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 lengthy document focused on the so-called Economic Realties Test used to determine whether workers are truly independent. The Administrator summarized the issue by saying, “ The analysis whether the factors are met must focus on whether the worker is economically dependent on the employer or truly in business for him or herself.”
What does that mean? It means your neighbor’s son isn’t an independent contractor when you hand him a paintbrush and ask him to paint your fence for $50.00. It means your company’s retired former CFO is not a “consultant” when he fills in for your new CFO who is on maternity leave for the next six weeks. It means your VP of Sales working out of his home in California is indeed an employee even though he would prefer that you give him a 1099 and not deduct taxes from W-2 wages and is even willing to sign an agreement to that effect.
Is the purpose of this post to tell businesses that they cannot utilize the services of independent contractors without being at grave risk? Not at all. However, the most important take away is that a very careful assessment should be done prior to entering into an independent contractor arrangement. The questions to be asked in conducting the analysis follow:
- Is the work being performed by the individual an integral part of the employer’s business? If so, the worker is likely not independent as he would more likely be economically dependent on the employer’s business.
- Does the worker’s managerial skill affect the worker’s opportunity for profit or loss? If not, it is more difficult to view the individual as being established in her own business.
- How does the worker’s relative investment compare to the employer’s investment? The relative investments of the parties are significant to a determination of whether the worker is engaged in an entrepreneurial endeavor.
- Does the work performed require special skill and initiative? A worker’s business skills, judgment, and initiative, not her technical skills, will aid in determining whether the worker is economically independent on the employer.
- Is the relationship between the worker and the employer permanent or indefinite? Permanency or indefiniteness in the worker’s relationship with the employer suggests that the worker is an employee.
- What is the nature and degree of the employer’s control? The worker must control meaningful aspects of the work performed such that it is possible to view the worker as a person conducting his own business.
The test above is one employed by the US DOL. Each state will also have its own tests, often different ones, for determining whether an individual is an independent contractor for unemployment, worker’s compensation and state wage and hour purposes. Many of those tests, including those used by the New Hampshire, Massachusetts and Maine Departments are even more stringent than the one described above.
Therefore, the first order of business for a company seeking to engage an independent contractor is to review all of the relevant statutes and tests, preferably with counsel. Once convinced that the criteria are met, do the following:
- Have a written contract setting out mutual obligations and expectations;
- Negotiate the fee for service on some basis other than hourly payment for time worked;
- Require the contractor to carry his or her own worker’s compensation and liability insurance;
- Determine whether the contractor is in an independent business, preferably established as an LLC or corporation offering similar services to others; and
- Require the contractor to provide his or her own tools, equipment and assistants.
This issue is likely to remain challenging for businesses, and it is important that careful steps are taken to minimize risk by following the law and documenting all efforts to do so. The US DOL Administrator’s guidance summed it up by saying that “most workers are employees under the FLSA’s broad definitions.” Businesses should heed this warning; if you think your contractors are independent, think again and then think one more time. At least five state and federal agencies are looking to prove you wrong.