Employers: Are Your Workers Misclassified?

By: Shelbie J. Luna, Drewry Simmons Vornehm, LLP

There’s no shortage of recent legal headlines of cases claiming worker misclassification.  We have seen FedEx, Uber, Lyft and Lowe’s, to name a few, all hit with worker misclassification.  Often, employers do not even know how to identify under the Fair Labor Standards Act (“FLSA”), which of their workers are employees and which of their workers are not.  Misclassification refers to a worker who is an employee under the law, but is incorrectly classified as something other than an employee (usually an independent contractor).  So what happens when a worker is misclassified?  What are the penalties?  What are the risks?

Most of us have heard the phrase, “we 1099 our employee”; however, what this really means is that these workers are being classified as independent contractors, are not provided workers’ comp, minimum wage, overtime, unemployment, and their wages are not subject to employment withholdings.  The Department of Labor Wage and Hour Division issued a guidance last year noting that it is the DOL’s position that most workers are employees and NOT independent contractors, but rather are employees under the law.  The DOL uses a 6 factor test under the FLSA for determining which workers are employees and which are independent contractors.  Can you tell the difference?  The DOL’s factsheet at https://www.dol.gov/whd/regs/compliance/whdfs13.htm provides the following:

1)      The extent to which the work performed is an integral part of the employer’s business. If the work performed by a worker is integral to the employer’s business, it is more likely that the worker is economically dependent on the employer and less likely that the worker is in business for himself or herself. For example, work is integral to the employer’s business if it is a part of its production process or if it is a service that the employer is in business to provide.

2)      Whether the worker’s managerial skills affect his or her opportunity for profit and loss. Managerial skill may be indicated by the hiring and supervision of workers, or by investment in equipment. Analysis of this factor should focus on whether the worker exercises managerial skills and, if so, whether those skills affect that worker’s opportunity for both profit and loss.

3)      The relative investments in facilities and equipment by the worker and the employer. The worker must make some investment compared to the employer’s investment (and bear some risk for a loss) in order for there to be an indication that he/she is an independent contractor in business for himself or herself. A worker’s investment in tools and equipment to perform the work does not necessarily indicate independent contractor status, because such tools and equipment may simply be required to perform the work for the employer. If a worker’s business investment compares favorably enough to the employer’s that they appear to be sharing risk of loss, this factor indicates that the worker may be an independent contractor.

4)      The worker’s skill and initiative. Both employees and independent contractors may be skilled workers. To indicate possible independent contractor status, the worker’s skills should demonstrate that he or she exercises independent business judgment. Further, the fact that a worker is in open market competition with others would suggest independent contractor status. For example, specialized skills possessed by carpenters, construction workers, and electricians are not themselves indicative of independent contractor status; rather, it is whether these workers take initiative to operate as independent businesses, as opposed to being economically dependent, that suggests independent contractor status.

5)      The permanency of the worker’s relationship with the employer. Permanency or indefiniteness in the worker’s relationship with the employer suggests that the worker is an employee, as opposed to an independent contractor. However, a worker’s lack of a permanent relationship with the employer does not necessarily suggest independent contractor status because the impermanent relationship may be due to industry-specific factors, or the fact that an employer routinely uses staffing agencies.

6)      The nature and degree of control by the employer. Analysis of this factor includes who sets pay amounts and work hours and who determines how the work is performed, as well as whether the worker is free to work for others and hire helpers. An independent contractor generally works free from control by the employer (or anyone else, including the employer’s clients). This is a complex factor that warrants careful review because both employees and independent contractors can have work situations that include minimal control by the employer. However, this factor does not hold any greater weight than the other factors. For example, a worker’s control of his or her own work hours is not necessarily indicative of independent contractor status; instead, the worker must control meaningful aspects of the working relationship. Further, the mere fact that a worker works from home or offsite is not indicative of independent contractor status because the employer may exercise substantial control over the working relationship, even if it exercises less day-to-day control over the employee’s work at the remote worksite.

We note that the IRS has a 20-factor test, but for purposes of this blog post, we focus only on the 6 factor economic realities test; as this is the test the DOL uses when determining whether a worker has been improperly denied minimum wage and overtime by misclassification as an independent contractor.  Generally, a worker is an employee if the economic realities of the relationship are such that the worker is economically dependent on the purported employer and/or the person for whom he or she works has the right to direct and control the manner and means of the work performed.

As a best practice, worker classification should be done in conjunction with employment counsel.  We also suggest that in the appropriate circumstances, Independent Contractor Agreements incorporate legal terms that solidify such a relationship under the DOL economic realities test and the IRS test.  If this blog is of interest to you or your business, Melanie M. Dunajeski and Shelbie J. Luna of the firm’s Crown Point office have an upcoming seminar in Carmel and Northwest Indiana on worker misclassification.  Be on the lookout for a DSV email with the date and location.  We hope to see you there.