From the CLS Blue Sky Blog:
Weil Discusses Risks of Classifying Employees as Independent Contractors
This post comes to us from Weil, Gotshal & Manges LLP. It is based on the firm’s client alert, “The Dangers of Misclassifying Employees as Independent Contractors,” dated September 2017, and available here.
Recently, we have seen a rise in class actions filed against employers for improperly classifying their employees as independent contractors. While misclassification issues are nothing new, the proliferation of nontraditional jobs grows every year—especially with the advancement of technology and the ability of service providers to work remotely from anywhere in the world. In this brave new world, employers may struggle with how to define their workforce. Current labor laws recognize workers providing services can be categorized as either an independent contractor or an employee, and employees are generally protected by more employment rights. On one hand, classifying service providers as independent contractors can be more efficient and cost-effective for a company. On the other hand, misclassifying service providers can have dire consequences, leaving a company exposed to expensive class actions for wage, hour, and other Labor Code violations— not to mention staggering governmental fines and penalties.
In this article, we outline the current legal landscape governing classification of service providers and give guidance for employers on how to properly classify their work force.
Classification Standards
Both the federal government and various individual state governments have their own individual independent tests to determine whether a service provider is an employee or an independent contractor. To make things even more complicated, various departments within the federal and state governments may also have their own differing tests. However, at their common core, all these tests are primarily focused on the degree of control a company exerts over the service provider and the independence of the provider. By way of example, we highlight below the standards used by two federal departments most often interested in provider classification—i.e., the United States Department of Labor and the United States Internal Revenue Service—as well as by a state agency.
United States Department of Labor
The Department of Labor (“DOL”) is tasked with overseeing compliance with the Fair Labor Standards Act (“FLSA”)1. The FLSA2 includes minimum wage and overtime pay requirements for nonexempt employees.3 The DOL generally relies on the six elements identified by the U.S. Supreme Court4 and subsequent case law to determine whether to apply the FLSA.5 While the factors considered can vary and no one set of factors is exclusive, these are the following six elements generally considered when determining whether an employment relationship exists under the FLSA:
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- 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.
- Whether the worker’s managerial skills affect his or her opportunity for profit and loss. Analysis of this factor focuses on whether the worker exercises managerial skills and, if so, whether those skills affect that worker’s opportunity for both profit and loss.
- The relative investments in facilities and equipment by the worker and the 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.
- The worker’s skill and initiative. 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.
- The permanency of the worker’s relationship with the Permanency or indefiniteness in the worker’s relationship with the employer suggests that the worker is an employee, as opposed to an independent contractor.
- The nature and degree of control by the 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 helper.
United States Internal Revenue Service
The Internal Revenue Service (“IRS”) administers federal payroll taxes, including social security, Medicare, federal unemployment insurance, and federal income tax withholding, and ensures that employers pay taxes, make the appropriate withholdings, and obtain certain insurance coverage on behalf of their employees. To determine whether a service provider is an employee or an independent contractor, the IRS utilizes a test different from the DOL’s six-element test. Historically, the IRS utilized a 20-Factor Test, but the IRS has recently grouped the 20 factors into three primary categories of evidence to support the level of control and independence.6
The first category—“Behavioral”— refers to facts showing whether a company has a right to direct or control how the worker does the work. A worker is an employee when the business has the right to direct and control the worker. Within this category, the IRS examines four subcategories:...
