Say it with me: AI #2015-1. What is that, you ask? That’s the U. S. Department of Labor‘s (DoL) latest guidance on how to classify independent contractors (ICs). And if you’re a company who works with ICs, you’re not going to like this guidance any more than you liked the latest Fair Labor Standards Act (FLSA) update. This AI, or Administrator’s Interpretation, is a fuzzy one at best, and promises to cloud what had once been one of the most clear AIs. At worst, this AI promises to force some companies to reclassify some of their vendors from IC to EE (employee), and non-exempt EEs at that–meaning overtime-eligible.
As of July 15, 2015, the DoL narrowed the IC classification. As written, it looks as though more workers may be entitled to overtime and must be reclassified as employees. One portion of the AI is key, and that is the part that de-emphasizes the degree to which a business controls an individual’s work. Now, companies need to focus on the “economic realities test,” which reveals whether an individual is economically dependent on them or whether that person is truly in business for h/herself.
It’s no secret that many companies have mis-classified employees as ICs currently and in the past. This new guidance will at least force a re-evaluation of IC relationships so companies have an opportunity to get things straight. It will also force some new recordkeeping habits. For instance, now, at the beginning of a vendor relationship, business licenses should be shown, if not copied and kept in the vendor file, if vendors are to be paid on a 1099 basis.
The challenge for companies is the narrow focus on “economic dependence.” As written, the elements of the “economic realities test” seem understandable, but read carefully, you can see that there are no bright-line rules on which anyone can rely. The same person could be considered an IC or an EE simply based on the business at hand. The AI restricts the use of ICs to very few specific situations. No single factor listed in the AI can be relied on to tip the balance of classification one way or the other. As a result, executives (or even in-house counsels) will not always know what factor the DoL or a reviewing court will deem most important.
Economic Realities Test–Six Factors
The DoL has laid out six factors that need to be considered when conducting the economic realities test:
- The extent to which the work performed is an integral part of the company’s business.
- The vendor’s opportunity for profit or loss depending upon h/her managerial skills.
- The extent of the relative investments of the company and the vendor.
- Whether the work performed requires special skills and initiative.
- The permanency of the relationship.
- The degree of control exercised or retained by the company.
As guidance, the DoL writes, “In undertaking this analysis, each factor is examined and analyzed in relation to one another, and no single factor is determinative. The ‘control’ factor, for example, should not be given undue weight.”
“The factors should not be applied as a checklist,” the DoL continued, “but rather the outcome must be determined by a qualitative rather than a quantitative analysis.”
Qualitative rather than quantitative. What does that mean? It means you have to look at the task being performed and you have to ask yourself if what’s being performed is an employee function. Take, for example, a freelance carpenter who’s highly skilled. Say she has been contracted by a construction firm, but the carpenter does not independently exercise her skills. She doesn’t determine the sequence of work or order materials or think about bidding for the next job; rather, she is told what work to perform, where, and in what sequence. This carpenter, though highly skilled, is merely performing skilled labor. She isn’t thinking independently, and she’s not demonstrating the skill and initiative of an IC (e.g. managerial or business skills). As such, she is an employee (and a non-exempt one at that).
In contrast, the DoL notes that “a highly skilled carpenter who provides a specialized service for a variety of construction companies (for example, custom, hand-crafted cabinets that are made-to-order) may be demonstrating the skill and initiative of an IC if the carpenter markets her services, determines when to order materials and the quantity of materials to order, and determines which orders to fill.”
So, who should be responsible for monitoring the IC classifications? Human Resources? Finance? Executive secretary? Someone is going to have to own this issue. Moving forward, the DoL expects companies to make clear which department is responsible to understand the law, know which contractors have been engaged, and monitor compliance. Companies will have to maintain basic records based on the IC determination process, and the facts used to make the determination should be clear.
What should be kept on record? Copies of business licenses, business cards, tax records (1099s, not their filings), project work plans showing limited engagements, and correspondence from the contractor.
- The DoL believes most work should be performed by employees and IC should be used sparingly.
- Entering into IC agreements or hiring a business entity (rather than a person) does not necessarily protect you from liability under the FLSA.
- Before engaging the services of any non-employee, carefully review the type and scope of work to be performed.
- When entering into agreements with other service providers, ensure that you obtain appropriate indemnification provisions to protect your company from wage-and-hour claims of service provider’s workers.
Other things to consider:
- Avoid giving contractors rights or access that cut against contractor determination, e.g. internal e-mail accounts, server access, invitations to employee functions.
- Periodically audit existing contractors to ensure they have not inadvertently become employees. (If an otherwise valid contractor arrangement becomes economically dependent on the work, then the relationship may convert to an employee entitled to overtime).
Disclaimer: I am not a licensed attorney. My blogs are based on my own experiences, interviews (where credited), and loads of research, and do not represent legal advice.