Your business at Risk. Misclassification: Are Your Independent Contractors Actually Employees? Why You Should Care and What It May Cost You.
By: Talin Haroutunian, Esq.
Business Counsel Group, P.C. · www.businesscounselgroup.com
July 28, 2015
It’s a problem many business owners face. How do you classify your new hire? Many opt to classify them as independent contractors rather than employees, either because they don’t know any better, or because (seemingly) they believe it to be in their best interest to do so. But simply placing the independent contractor label on a new hire doesn’t make them so. Just ask Uber, who earlier this month lost a suit for misclassification of its drivers as independent contractors rather than employees. The matter is up for appeal, and it will be interesting to see how the facts play out.
In a recently issued Administrative Interpretation, the Department of Labor’s Wage and Hour division concluded that “most workers are employees under the [Fair Labor Standards Act (the “FLSA”)]…..” The DOL’s conclusion was predicated on the “economic realities test”—a multifactorial test courts rely on in determining whether a worker is an employee or an independent contractor under the FLSA. In applying the test, the DOL used the FLSA’s broad definition of “to employ,” which broadened the test’s reach.
In its analysis, the DOL emphasized that the test should not be used in a “mechanical fashion,” and that rather than tallying which factors are met, focus should instead be on the larger picture: “whether the worker is economically dependent on the employer (and thus its employee) or is really in business for him or herself (and thus its independent contractor).” The DOL, taking a “totality of the circumstances” approach, analyzes each of the following factors:
- Is the Work an Integral Part of the Employer’s Business? The more integral the work, the more likely the individual is an employee. For instance, carpenters are an integral part of a construction company’s business, and are more likely employees; whereas software engineers who create billing software for the same construction company are not integral to the construction business, and are more likely independent contractors.
- Does the Worker’s Managerial Skill Affect the Worker’s Opportunity for Profit or Loss? If yes, the more the likely the individual is an independent contractor. For instance, workers who take whatever jobs are assigned to them by the company are more likely employees; whereas workers who do their own advertising, negotiate their own contracts, and decide for themselves whether or not to take work, are more likely independent contractors.
- How Does the Worker’s Relative Investment Compare to the Employer’s Investment? The less the investment, the more likely the individual is an employee. To be considered an independent contractor, the individual’s investment must be “significant in nature and magnitude” to the employer’s investment. For instance, construction workers supplied tools by their company, but who nonetheless purchase additional supplies, are more likely employees; whereas construction workers who buy all their tools/supplies, and arrange for storage and transport are more likely independent contractors.
- Does the Work Performed Require Special Skill and Initiative? A worker’s “business skills, judgment, and initiative, not his or her technical skills, will aid in determining whether the worker is economically independent.” The more business skills, judgment, and initiative used, the more likely the individual is an independent contractor.
- Is the Relationship between the Worker and the Employer Permanent or Indefinite? Although permanent engagements are more indicative of an employer-employee relationship, “[t]he key is whether the lack of permanence or indefiniteness is due to ‘operational characteristics intrinsic to the industry’.” For instance, seasonal workers, although temporary hires, are temporary because of the nature of their job, and therefore are more likely employees.
- What is the Nature and Degree of the Employer’s Control? “The worker must control meaningful aspects of the work performed such that it is possible to view the worker as a person conducting his or her own business.” Recognizing that the “FLSA covers workers of an employer even if the employer does not exercise the requisite control over the workers,” the DOL emphasizes that the ultimate determining factor is whether the worker is economically dependent on the employer.
So what’s the significance of all of this? Misclassification is a hot issue—one that’s aggressively pursued by the DOL and state legislatures. California Labor Code section 226.8 imposes penalties, including fines ranging from $5000 to $15,000 per violation, and up to $25,000, if the employer is considered a patterned, repeat offender. And in California, that’s just the tip of the iceberg. Once classified as an employee, the business owner may face additional penalties for other wage and hour claims, including meal and rest period violations. The agencies, departments, commissions, boards and divisions of the California Labor and Workforce Development Agency are ready, willing, and able to enforce the penalties administratively or through a civil suit.
Many owners, too busy running their business and focused on the bigger picture, make the potentially costly, and easily avoidable mistake of misclassification. Fortunately, there are steps you can take to address any prior missteps, and make certain you properly classify your employees on a going forward basis. Business Counsel Group is ready to assist in managing compliant independent contractor and employee/employer relationships. You may reach Talin via email at Talin.Haroutunian@businesscounselgroup.com.
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