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[Author: Bob Evnen, Woods & Aitken LLP, 2015 | Keywords: Human Resources, Contractor, Wages]

The federal and state governments are cracking down on independent contractor arrangements when the government thinks the independent contractors are really employees.

What the government is getting at: Who is an employee?

Most workers who perform services for businesses are treated as employees of the business. Income and payroll taxes are withheld from their paychecks. The business pays its share of Social Security and Medicare payments for these workers. At the end of the year, the business sends them W-2 forms reporting their gross employment income and withholdings. These workers are employees who are covered by the Fair Labor Standards Act (FLSA), which is the minimum wage and overtime law enforced by the Wage and Hour Division (WHD) of the U.S. Department of Labor.

Many businesses also make independent contractor arrangements with individuals who perform services for the business. These individuals are not treated as employees. Payroll payments are not made to them; they are paid as vendors instead. No income or payroll taxes are withheld. At the end of the year, they are sent a Form 1099 which reports the payments made to them by the business. The FLSA doesn’t apply to these independent contractors because they are not employees.

One example of workers often treated as independent contractors are individuals who provide evening custodial services for businesses. Another example is individuals who independently contract with companies to provide bookkeeping services. Are these individuals properly treated as independent contractors? Or should they be put on the payroll as employees?

Over the past few years the WHD has increased its attention about who is considered an employee (and thus subject to their enforcement control) and who is considered an independent contractor (and thus not subject to WHD’s enforcement control). The WHD has teamed up with the Internal Revenue Service as part of WHD’s “Misclassification Initiative” to address this issue in the workplace. We have observed this increase in attention by the WHD in minimum wage and overtime investigations where clients have requested our assistance.

This increased scrutiny of independent contractor arrangements is focused on individual workers rather than businesses with multiple employees who perform the work. (Of course, federal labor agencies have other ways of trying to tie employers together for the purpose of wage and hour liability. I will address this subject in a future article.)

How the WHD looks at independent contractor status

Recently, the WHD issued an “Administrator’s Interpretation” memo that discussed the enforcement approach of the WHD on this issue. One of the most noticeable aspects of the memo is the very clear emphasis on the idea that the definition of “employee” is very broad.

The memo discusses a multi-factor “economic realities” test (discussed below), but then goes on to say: “[T]he 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.”

This point is repeated over and over again in the memo. What this probably means as a practical matter is that the WHD will assume that any individual worker is an employee unless it is convincingly demonstrated otherwise. Any doubts are likely to be resolved by treating the worker as an employee, not an independent contractor.

Factors considered when determining whether a worker is an employee or an independent contractor.

The “economic realities” test mentioned above has to do with whether the worker is “economically dependent on the employer or in business for him or herself.” That’s the ultimate question. To answer that question, these are the typical “economic reality” factors considered: “(A) the extent to which the work performed is an integral part of the employer’s business; (B) the worker’s opportunity for profit or loss depending on his or her managerial skill; (C) the extent of the relative investments of the employer and the worker; (D) whether the work performed requires special skills and initiative; (E) the permanency of the relationship; and (F) the degree of control exercised or retained by the employer.”

There is much discussion in the memo about each of these factors and how they will be evaluated. There is no particular “weighting” of these factors. Each situation stands on its own. The factors will be considered and weighed in light of the overall consideration, which is whether the individual has his or her own business or is instead economically dependent upon the employer.

Since this has become an enforcement priority for the WHD and they are working with the Internal Revenue Service on this project, this would be a very good time to review and consider the status of any individual worker who is being treated as an independent contractor.

For additional information, contact the Human Resources Helpline at 855.277.5575.