Originally posted by Allen Smith on July 16, 2015 on shrm.org.

More workers may be entitled to overtime due to July 15, 2015, Department of Labor (DOL) guidance that defines “independent contractor” narrowly enough for many previously classified as independent contractors to now be properly classified as employees.

This narrowing of the definition of independent contractor is due partly to the DOL deemphasizing the degree to which a business controls an individual’s work, and focusing instead on the economic realities test, which looks at whether the worker is economically dependent on the employer or in business for him or herself.

“This is part and parcel of the Obama administration’s push to give America a raise,” said Allan Bloom, an attorney with Proskauer in New York City, who added, “There certainly have been companies that have misclassified workers.”

He remarked that the latest guidance is important because “the DOL significantly downplays the ‘control test,’ which has long been the guide many businesses consider when determining whether or not a worker is truly an ‘employee’.”  Bloom recommended that, “Businesses worried about staying under the DOL radar on this issue should make sure that they are doing business with established independent service providers if they intend to pay on a 1099 basis.”

Matthew Disbrow, an attorney with Honigman in Detroit, said, “The subjective nature of the DOL’s interpretation, and its narrow focus on ‘economic dependence,’ creates substantial challenges for companies who wish to maintain their independent-contractor relationships. Furthermore, although the elements of the ‘economic realities’ test may appear understandable at first blush, a careful reading of the DOL’s guidance reveals that there are no bright-line rules upon which to rely. The same person could be considered an independent contractor or an employee simply based on the business at issue.”

He added that the administrator’s interpretation [AI] “arguably restricts the use of independent contractors to very few specific situations.” Disbrow explained, “Because no factor is determinative, and the AI rejects any ‘mechanical’ application of the test, inside counsel or other executives will not always know what factor the DOL or a reviewing court might find most important. Such ‘fuzzy’ multifactored tests usually create more problems than they solve.”

Six Factors

In conducting an economic realities test, an employer should look to six factors, the DOL noted:

  • The extent to which the work performed is an integral part of the employer’s business.
  • The worker’s opportunity for profit or loss depending on his or managerial skill.
  • The extent of the relative investments of the employer and the worker.
  • Whether the work performed requires special skills and initiative.
  • The permanency of the relationship.
  • The degree of control exercised or retained by the employer.

“In undertaking this analysis, each factor is examined and analyzed in relation to one another, and no single factor is determinative,” the DOL noted. “The ‘control’ factor, for example, should not be given undue weight.”

“The factors should not be applied as a checklist, but rather the outcome must be determined by a qualitative rather than a quantitative analysis,” the DOL stated.

“The subjective nature of such a test is a slippery slope and provides no practical, objective criteria on which businesses can rely,” Disbrow said.

Under the department’s analysis of the six factors, positions frequently considered as independent contractors—such as carpenters, construction workers, cable installers and electricians—aren’t necessarily independent contractors if they don’t satisfy the factors.

Suppose, the department hypothesized, a highly skilled carpenter provides carpentry services for a construction firm. But the carpenter does not exercise his skills in an independent manner. He does not determine the sequence of work, order additional materials or think about bidding for the next job, but instead is told what work to perform where. “In this scenario, the carpenter, although highly skilled technically, is not demonstrating the skill and initiative of an independent contractor (such as managerial and business skills),” the DOL emphasized. “He is simply providing his skilled labor.”

By contrast, “a highly skilled carpenter who provides a specialized service for a variety of area construction companies (for example, custom, handcrafted cabinets that are made to order) may be demonstrating the skill and initiative of an independent contractor if the carpenter markets his services, determines when to order materials and the quantity of materials to order, and determines which orders to fill,” the DOL stated.

Monitor Classifications

“While the human resources function clearly ‘owns’ employee issues in corporate America, many companies do not monitor their independent contractor relationships,” said Michael Droke, an attorney with Dorsey and Whitney in Palo Alto, Calif., and Seattle.

“Companies should make clear which department within the organization is responsible to understand the law, know which contractors have been engaged and monitor compliance. Often, the human resources or finance department is put in charge,” he noted.

“Employers should maintain basic records on the independent contractor determination process, and the facts used to make that determination. For example, they should keep records of business licenses, business cards, contractor tax records, project work plans showing limited engagements and correspondence from the contractor,” according to Droke.

For Disbrow, some main takeaways from the guidance are:

  • The DOL believes most work should be performed by employees. So, independent contractors should be used sparingly.
  • Entering into independent contractor agreements or hiring a business entity (rather than a person) does not necessarily protect you from liability under the Fair Labor Standards Act.
  • A careful review of the type and scope of work being performed should be completed before engaging the services of any nonemployee.
  • When entering into agreements with other service providers, ensure that you obtain appropriate indemnification provisions to protect the company from the wage and hour claims of the service provider’s workers.

“Companies should avoid giving contractors rights or access that cut against contractor determination. For example, contractors should not have internal e-mail accounts, should not be given server access and should not be invited to employee functions,” Droke observed. “The DOL guidance reminds employers to periodically audit existing contractors to make sure they have not inadvertently slipped from contractors to employees. If an otherwise-valid contractor arrangement becomes economically dependent on the work, then the relationship may convert to an employee entitled to overtime.”

This guidance is Administrator’s Interpretation No. 2015-1.