DOL Issues Guidance on the Economic Realities Test and Independent Contractor Classification | Practical Law

DOL Issues Guidance on the Economic Realities Test and Independent Contractor Classification | Practical Law

This wage and hour update discusses the US Department of Labor (DOL) Wage and Hour Division's (WHD) July 15, 2015 guidance analyzing how the Fair Labor Standards Act's (FLSA) definition of "employ" and application of the "economic realities" test by federal courts affect the classification of workers as employees or independent contractors.

DOL Issues Guidance on the Economic Realities Test and Independent Contractor Classification

by Practical Law Labor & Employment
Published on 21 Jul 2015 • USA (National/Federal)
This wage and hour update discusses the US Department of Labor (DOL) Wage and Hour Division's (WHD) July 15, 2015 guidance analyzing how the Fair Labor Standards Act's (FLSA) definition of "employ" and application of the "economic realities" test by federal courts affect the classification of workers as employees or independent contractors.
On July 15, 2015, the DOL's Wage and Hour Division (WHD) issued Administrator's Interpretation 2015-1, The Application of the Fair Labor Standards Act's "Suffer or Permit" Standard in the Identification of Employees Who Are Misclassified as Independent Contractors (Administrator's Interpretation 2015-1), which analyzes how the FLSA's definition of "employ" affects classification of workers as independent contractors. Administrator's Interpretation 2015-1 also provides guidance on application of the "economic realities" test used by courts to determine if an independent contractor should instead be classified as an employee. More information about independent contractor classification can be found at the WHD's Misclassification of Employees as Independent Contractors page.
Administrator's Interpretation 2015-1 reiterates the DOL's position that independent contractor misclassification continues to be a top priority.
In addition, the DOL provides the following broad guidelines for independent contractor classification:
  • The FLSA's definition of "employ" as "to suffer or permit to work" and the economic realities test provide a broader scope of employment than the common law control test. The economic realities test:
    • should be applied in view of the "suffer or permit" standard; and
    • focuses on factors that act as a guide to determine if the worker is economically dependent on the employer or is truly in business for himself.
  • Application of the economic realities test must be guided by the broad scope of the employment relationship under the FLSA, which results in most workers being employees under the law.
  • The actual economic realities of the relationship between the employer and worker are determinative of whether the individual is an employee or independent contractor. The following factors are not relevant to that analysis:
    • how the employer labels the worker, including as an independent contractor, owner, partner or member of a limited liability company;
    • agreements identifying a worker by a particular work classification; and
    • the worker's receipt of a Form 1099-MISC.
  • The analysis in Administrator's Interpretation 2015-1 should also be applied in determining employment classification status under the Migrant and Seasonal Agricultural Worker Protection Act (MSPA) and the FMLA, which both adopt the FLSA's definition of "employ."
The majority of Administrator's Interpretation 2015-1 is devoted to the DOL's analysis of the six factors of the economic realities test. The DOL emphasized that all six factors must be considered and none is dispositive of a worker's employee status. In particular, the DOL explained that the "control" factor should not be given "undue weight." In addition, consideration of the factors should not be a mechanical, quantitative analysis. The DOL discusses each of the six factors, including the following analysis and examples:
  • Whether the work performed is an integral part of the employer's business. If the work performed by the worker is integral to the employer's business, it is more likely that the worker is economically dependent on the employer. Work can be integral to a business even if the work is just one component of the business, is performed by hundreds of other workers (such as in a call center) or is performed away from the employer's premises. For example:
    • a carpenter is integral to a construction company that is in the business of framing residential homes (indicative of the worker being an employee); and
    • a software developer who creates scheduling and tracking software for the construction company is not integral to its business (which suggests the worker may be an independent contractor).
  • Whether the worker's opportunity for profit or loss is affected by his managerial skills. The worker's decisions to hire others, purchase materials and equipment, advertise, rent space and manage time tables may reflect managerial skills that will affect his opportunity for profit or loss. The worker's ability to do his job well, his ability to work more hours and the amount of work available from the employer do not. For example:
    • a cleaning services worker whose assignments and schedule are set by a client and who does not solicit work from other clients or advertise her services does not exercise managerial skill that affects profit or loss (indicative of the worker being an employee); and
    • a cleaning services worker who controls job assignments and scheduling, negotiates contracts and hires helpers exercises managerial skill that affects his opportunity for profit and loss (indicative of an independent contractor relationship).
  • The extent of the worker's investments relative to those of the employer. Even if it is substantial, the worker's investment should not be considered alone, but by comparing it to the employer's investment. If the worker's investment is relatively minor, that suggests the worker may be economically dependent on the employer. For example:
    • a company provides a cleaning services worker with insurance, a vehicle and all equipment and supplies, and invests in advertising and finding clients. Although the worker is issued a Form 1099-MISC, has a contract stating that she is an independent contractor and brings her own preferred cleaning supplies to some jobs, the relative investment of the worker as compared to the employer's investment is indicative of an employment relationship; and
    • a worker for the same company invests in her own vehicle, materials and equipment for work, rents space to store them, advertises and markets her services and hires helpers. She has provided investments similar to the investments of the company for whom she sometimes works. These investments may be indicative of an independent contractor relationship.
  • Whether the work performed requires special skills and initiative. This factor involves the worker's business skills, judgment and initiative, not his technical skills. For example:
    • a skilled carpenter providing carpentry services for a construction firm does not make independent job-site judgments, determine the work sequence or order materials, but is told what work to perform where. He has provided skilled labor, but has not demonstrated managerial and business skill and initiative of an independent contractor relationship; and
    • a skilled carpenter who provides a specialized service for several construction companies, such as custom, made-to-order handcrafted cabinets, may demonstrate the skill and initiative of an independent contractor if he markets his services, determines the timing and quantity of material orders and determines which orders to fill.
  • The level of permanence in the relationship. Permanency or indefiniteness in the working relationship suggests that the worker is an employee, but lack of permanence is not dispositive. For example:
    • an editor has worked for a publishing house for several years, completes her edits according to company specifications and only edits books provided by the publishing house. This shows a permanence to her relationship with the publishing house that is indicative of employment; and
    • an editor working with many different publishing houses over several years, who markets her own services to numerous houses, negotiates rates for editing jobs and turns down work for any reason, including being too busy with other jobs, lacks permanence with one publishing house. This is indicative of an independent contractor relationship.
  • The degree of control the employer exercises or retains over the worker. To be properly classified as an independent contractor, the worker must control meaningful aspects of the work. Workers that work from home are not necessarily independent contractors simply because the employer does not control the work environment or because the workers are subject to little direct supervision. Similarly, a worker's control over the hours he works is not indicative of independent contractor status. As with the other five factors, the control factor should not be given undue weight. For example:
    • a registered nurse is interviewed before being listed with a nursing home client registry, is required to undergo extensive training and fill out a form before contacting any potential clients from a weekly list, is required to adhere to a certain wage range and cannot provide extra weekend hours. She must inform the registry if she is hired by a client and if she will miss scheduled client work. The registry's degree of control is indicative of an employment relationship; and
    • another registered nurse receives a registry listing each week with potential clients, but is free to call and work with as many potential clients as she wants and negotiate her own wage rate and schedule with the client. The degree of control exercised by the registry is not indicative of an employment relationship.

Practical Implications

The DOL's guidance in Administrator's Interpretation 2015-1:
  • Underscores the fact that independent contractor misclassification continues to be a top priority for the DOL.
  • Suggests the DOL favors less emphasis on:
    • an employer's "control" over the worker and greater focus on the worker's economic independence; and
    • written agreements labeling a work relationship with a particular classification status. The DOL takes the position that the labels are not relevant to the analysis and the focus should be the actual economic reality of the working relationship.
Written agreements establishing the independent contractor relationship remain good practice, but companies should ensure that the working relationship in actual practice satisfies the six factors of the economic realities test.
Companies should regularly review their independent contractor relationships for compliance, with the understanding that employee status is construed broadly by the DOL. Exceptions from the FLSA's minimum wage and overtime pay protections are construed narrowly in favor of employees and independent contractor misclassification is a top enforcement priority of the DOL and several state and local agencies.

Employee Benefits Implications under the Affordable Care Act

The DOL's guidance also may have employee benefits implications, particularly regarding the following provisions, which were added to the FLSA under the Affordable Care Act (ACA):
(For more information about the ACA, see Affordable Care Act (ACA) Overview and Affordable Care Act (ACA) Toolkit.)
For example, although the government has not yet issued implementing regulations addressing the ACA's automatic enrollment requirement, it is likely that the principles and factors addressed in Administrator's Interpretation 2015-1 will inform that guidance.
Also, the DOL emphasizes in Administrator's Interpretation 2015-1 that it has entered into a memorandum of understanding with the Internal Revenue Service under which the two agencies expressly agreed to enhanced information sharing and other collaboration to reduce misclassification of employees as independent contractors. For more information about independent contractor issues in the benefits context, see Standard Document, Employee Benefits and Executive Compensation Due Diligence Request Checklist (Long Form).