Cracking Down on Independent Contractors
Recently, the U.S. Department of Labor issued an interpretive guidance addressing the issue of individuals who are misclassified as Independent Contractors. Under the DOL’s interpretive guidelines, it has now become much harder to classify individuals as Independent Contractors as opposed to employees. Misclassification of individuals as Independent Contractors is found in increasing number of workplaces, in part reflecting the restructuring of business organizations. Individuals misclassified as Independent Contractors may not receive important workplace protections such as minimum wage, overtime compensation, unemployment insurance and workers’ compensation. Many companies will try to avoid classifying individuals as employees so as not to have to pay certain payroll taxes. Intentional misclassification allows businesses to avoid compliance with the labor laws.
In order to make the determination as to whether an individual is truly an “employee” or an Independent Contractor, the Courts have traditionally relied on what has come to be known as the “economic realities” test. Simply put, a worker who is economically dependent upon an employer is likely to be found to be an employee, while a person who is in business for themselves is likely an Independent Contractor.
There are several factors that are used in determining an individual’s status, each one not carrying more weight than the others. The factors typically include: (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. Each of these factors are to be considered as a whole to determine whether a worker is economically dependent on the employer, and thus, an employee.
The economic realities of the relationship and not the label an employer gives it are determinative. Simply drafting an agreement between an employer and an individual designating the worker as an Independent Contractor is not indicative of the economic realities of the working relationship and is not relevant to the analysis. For example, merely putting together a contract that states the individual is an Independent Contractor is likely to fail the test. Further, under the labor laws, an individual is not permitted to waive his or her employee status or contract away their rights to wage and hour protections such as overtime pay.
Discussed briefly below are the factors used to determine the economic realities tests:
- Is the Work an Integral Part of the Employer’s Business?
Workers are more likely to be employees under the Fair Labor Standards Act (FLSA) if they perform the primary work of the employer. A true Independent Contractor’s work, on the other hand, is unlikely to be integral to the employer’s business.
Example: For a cleaning company that cleans office buildings, people who scrub floors are likely to be integral to the employer’s business because the company is in business to clean offices, and floor scrubbing or vacuuming is an integral part of providing that service.
In contrast, the same cleaning company may contract with a software developer to create software that, among other things, assists the company in tracking bids, scheduling projects and crews and tracking material orders. The software developer is performing work not integral to the cleaning company’s business, which is indicative of Independent Contractor status.
- Does the Worker’s Managerial Skill Affect the Worker’s Opportunity for Profit or Loss?
The focus here is on whether the worker’s managerial skills can affect his profit or loss. A worker in business for himself or herself faces the possibility to not only make a profit but also suffer a loss.
On the other hand, a worker’s ability to work more hours and the amount of work available from the employer has nothing to do with managerial skills. The effect on one’s earnings of doing one’s job well or working more hours is no different for an employee or an independent contractor.
- How Does the Worker’s Relative Investment Compare to the Employer’s Investment?
The worker should make some investment (and therefore undertake at least some risk) in order for there to be an indication that he or she is an independent business. An Independent Contractor typically makes investments that support a business as a business beyond a particular job. Often they will purchase supplies or equipment that will outlast a particular assignment and which can be used in other assignments.
Even if the worker has made an investment, it should not be considered in isolation. It is the nature of the investment, not necessarily the cost that is important. For example, investing in tools is not necessarily a business investment or capital expenditure that indicates a worker is an Independent Contractor. Instead, the tools and equipment may simply be necessary in order to perform the job.
Example: A worker providing cleaning services for a company is issued a Form 1099Misc each year and signs a contract stating he or she is an Independent Contractor. The company provides insurance, a vehicle to use, and all equipment and supplies for the worker. The Company invests in advertising and finding clients for the business. The worker occasionally brings his or her preferred cleaning supplies to certain jobs. Here, the relative investment of the worker compared to the company is indicative of an employment relationship between the worker and the cleaning company. The worker’s investment in cleaning supplies does little to further a business beyond a particular job.
- Does the Work Performed Require Special Skills and Initiative?
A worker’s skills, judgment and initiative, not his or her technical skills will aid in determining whether the worker is economically independent. Even specialized skills do not indicate that workers are in business for themselves, especially if those skills are technical and used to perform the work.
Example: A highly skilled carpenter provides carpentry skills for a construction firm; however, such skills are not exercised in an independent manner. A carpenter does not make any independent judgments at the job site beyond the work he is doing for that job; he does not determine the sequence of the work, order additional materials, or think about bidding the next job, but rather is told what work to perform where. In this scenario, the worker is likely to be classified as an employee. In contrast, a highly skilled carpenter who provides specialized services for a variety of companies by making handcrafted cabinets that are made to order may be demonstrating the skills and initiative of an Independent Contractor if the carpenter markets his services, determines when to order materials and the quantity to order, and determines which orders to fill.
- Is the Relationship Between the Worker and the Employer Permanent or Indefinite?
Permanency or indefiniteness in the worker’s relationship with the employer suggests that the worker is an employee. After all, a worker who is truly in business for him or herself will not necessarily want a permanent or indefinite relationship with an employer and the dependence that comes with such permanence. A true Independent Contractor will want to build his or her own business which will often entail taking on other jobs and not being tied to one specific assignment. By being tied to one specific job, the individual does not have the opportunity to broaden his or her business and the ability to earn additional fees. Most employees are engaged on a permanent or indefinite basis (for example an “at-will” employee). The longer an individual performs work for a specific company, the less likely it will be that he or she will be classified as an Independent Contractor.
- What is the Nature and Degree of the Employer’s Control?
This has long been thought to be the most important of the factors.
However, as has been made clear earlier, this factor should be given no more weight than any other one. The worker must control meaningful aspects of the work performed. The more direction, control and supervision a company exercises over the individual performing the work, the more likely it is that an employment relationship will be found. A true Independent Contractor decides on how the end result will be achieved.
Classification of an individual as either an employee or an Independent Contractor can have a dramatic impact on a business, as well as the individual. The U.S. Department of Labor, as well as the Illinois Department of Labor are extremely active in enforcing “misclassification” actions. Do not let your business make the wrong choice!
With over 30 years’ experience in advising employers and employees on workplace issues, let Boznos Law work with you to ensure you are ready to meet the challenges posed by regulatory or court interpretations of who is really an Independent Contractor as opposed to an employee. Call Bill Boznos today at (630) 375-1958 or contact us at www.boznoslawoffice.com/contact-us through our website at www.boznoslawoffice.com