Labor Department’s 6-Part Test for Classifying Employees, Independent Contractors

July 16, 2015
Female freelancer in her casual home clothing working from her dining table in the morning Home

The U.S. Department of Labor has issued a blog post with new guidance on classifying workers as employees or independent contractors under the federal Fair Labor Standards Act (FSLA), an issue that has attracted renewed attention in the on-demand economy.

Misclassification of employees as independent contractors is increasing, “in part reflecting larger restructuring of business organizations,” wrote David Weil, the administrator of the DOL’s Wage and Hour Division, in his blog post entitled, “The Application of the Fair Labor Standards Act’s ‘Suffer or Permit’ Standard in the Identification of Employees Who Are Misclassified as Independent Contractors.”

He said that misclassification, in addition to denying workers statutory protections, results in lower tax revenues for government and an uneven playing field for employers who properly classify their workers.

“Although independent contracting relationships can be advantageous for workers and businesses, some employees may be intentionally misclassified as a means to cut costs and avoid compliance with labor laws,” he wrote.

The 15-page DOL memo reviews the six-part “economic realities” test of the relationship between a worker and employee that should be used when classifying. This multi-factor test (see excerpts and discussion below) focuses on whether the worker is economically dependent on the employer and thus an employee, or in business for him or herself and thus an independent contractor.

The issue of classifying workers has taken on new importance in an economy where companies like Uber, Lyft and FedEx have built business models that classify their drivers as independent contractors, but some of those drivers contend they are employees.

Those classified as employees are entitled to the protections provided by FSLA including minimum wage, overtime compensation, unemployment insurance and workers’ compensation. Independent contractors are not covered by the FSLA. According to the DOL, Congress intended that the FSLA be interpreted broadly to classify workers as employees and courts have generally followed a liberal interpretation favoring the employee classification.

According to Weil, the economic realities of the relationship, and not the label an employer gives it, are determinative. While most misclassified employees are labeled “independent contractors,” DOL said it has seen an increasing number of instances where employees are labeled “owners,” “partners,” or “members of a limited liability company.” In these cases, the economic realities analysis must still be applied to determine whether the workers are employees, according to DOL.

State Views

While the DOL is trying to answer questions surrounding workers in the new gig economy, states are sending mixed messages on the issue.

The California Labor Commission last month ruled that a San Francisco-based driver for the ride-hailing service Uber is an employee, not a contractor.

Uber is “involved in every aspect of the operation,” said the commissioner in that case.

Uber disputes that characterization and defends its business model, claiming its drivers are independent contractors, not employees, and that it is “nothing more than a neutral technology platform.”

Uber faces a federal lawsuit over the issue in which a jury will decide.

This week, a New York’s top taxi regulator sided with ride-hailing car services such as Uber, calling their drivers freelance workers rather than employees. “We have wholeheartedly supported driver flexibility as independent contractors when we allow them, much to the consternation of the industry, to drive for several bases,” Meera Joshi, chairwoman of the New York City Taxi and Limousine Commission, said in an interview on Bloomberg Television.

The controversy has caused some to suggest that a new classification is needed,  something between the employee and the independent contractor.

DOL Memo and Economic Realities Test

The following contains edited text and excerpts from the DOL memo along with Weil’s examples of cases illustrating the six factors in the “economic realities” test used by officials and courts to determine if someone is an employee under the FSLA. The complete DOL memo can be read below.

When determining whether a worker is an employee or independent contractor, all of the factors of the “economics realities” test must be considered in each case, and no one factor is determinative of whether a worker is an employee. However, the factors themselves “should not be applied in a mechanical fashion, but with an understanding that the factors are indicators of the broader concept of economic dependence,” according to Weil.

The six factors or questions in the “economic realities” test include:

  1. Is the Work an Integral Part of the Employer’s Business?
  2. Does the Worker’s Managerial Skill Affect the Worker’s Opportunity for Profit or Loss?
  3. How Does the Worker’s Relative Investment Compare to the Employer’s Investment
  4. Does the Work Performed Require Special Skill and Initiative?
  5. Is the Relationship between the Worker and the Employer Permanent or Indefinite?
  6. What is the Nature and Degree of the Employer’s Control?
  1. Is the Work an Integral Part of the Employer’s Business?

Courts have found the “integral” factor to be compelling, according to Weil. 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. A true independent contractor’s work, on the other hand, is unlikely to be integral to the employer’s business.

Example:

For a construction company that frames residential homes, carpenters are integral to the employer’s business because the company is in business to frame homes, and carpentry is an integral part of providing that service.

In contrast, the same construction company may contract with a software developer to create software that, among other things, assists the company in tracking its bids, scheduling projects and crews, and tracking material orders. The software developer is performing work that is not integral to the construction company’s business, which is indicative of an independent contractor.

  1. Does the Worker’s Managerial Skill Affect the Worker’s Opportunity for Profit or Loss?

A worker in business for him or herself faces the possibility to not only make a profit, but also to experience a loss. For example, a 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 or her opportunity for profit or loss beyond a current job.

On the other hand, the worker’s ability to work more hours and the amount of work available from the employer have nothing to do with the worker’s managerial skill and do little to separate employees from independent contractors—both of whom are likely to earn more if they work more and if there is more work available. The effect on one’s earnings of doing one’s job well or working more hours is no different for an independent contractor than it is for an employee.

Also, it is important not to overlook whether there is an opportunity for loss, as a worker truly in business for him or herself faces the possibility of experiencing a loss.

Example:

A worker provides cleaning services for corporate clients. The worker performs assignments only as determined by a cleaning company; he does not independently schedule assignments, solicit additional work from other clients, advertise his services, or endeavor to reduce costs. The worker regularly agrees to work additional hours at any time in order to earn more. In this scenario, the worker does not exercise managerial skill that affects his profit or loss. Rather, his earnings may fluctuate based on the work available and his willingness to work more. This lack of managerial skill is indicative of an employment relationship between the worker and the cleaning company.

In contrast, a worker provides cleaning services for corporate clients, produces advertising, negotiates contracts, decides which jobs to perform and when to perform them, decides to hire helpers to assist with the work, and recruits new clients. This worker exercises managerial skill that affects his opportunity for profit and loss, which is indicative of an independent contractor.

  1. How Does the Worker’s Relative Investment Compare to the Employer’s Investment?

An independent contractor typically makes investments that support a business as a business beyond any particular job. The investment of a true independent contractor might, for example, further the business’s capacity to expand, reduce its cost structure, or extend the reach of the independent contractor’s market.

Even if the worker has made an investment, it should not be considered in isolation; it is the relative investments that matter. Looking not just to the nature of the investment, but also comparing the worker’s investment to the employer’s investment helps determine whether the worker is an independent business. If so, the worker’s investment should not be relatively minor compared with that of the employer. If the worker’s investment is relatively minor, that suggests that the worker and the employer are not on similar footings and that the worker may be economically dependent on the employer.

Example:

A worker providing cleaning services for a cleaning company is issued a Form 1099-MISC each year and signs a contract stating that 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. The worker occasionally brings her own preferred cleaning supplies to certain jobs. In this scenario, the relative investment of the worker as compared to the employer’s investment 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 that particular job.

A worker providing cleaning services receives referrals and sometimes works for a local cleaning company. The worker invests in a vehicle that is not suitable for personal use and uses it to travel to various worksites. The worker rents her own space to store the vehicle and materials. The worker also advertises and markets her services and hires a helper for larger jobs. She regularly (as opposed to on a job-by-job basis) purchases material and equipment to provide cleaning services and brings her own equipment (vacuum, mop, broom, etc.) and cleaning supplies to each worksite. Her level of investments is similar to the investments of the local cleaning company for whom she sometimes works. These types of investments may be indicative of an independent contractor.

  1. 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. 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 services for a construction firm; however, such skills are not exercised in an independent manner. For example, the carpenter does not make any independent judgments at the job site beyond the work that he is doing for that job; he does not determine the sequence of work, order additional materials, or think about bidding the next job, but rather is told what work to perform where. In this scenario, the carpenter, although highly-skilled technically, is not demonstrating the skill and initiative of an independent contractor (such as managerial and business skills). He is simply providing his skilled labor.

In contrast, a highly skilled carpenter who provides a specialized service for a variety of area construction companies, for example, custom, handcrafted cabinets that are made-to-order, may be demonstrating the skill and initiative of an independent contractor if the carpenter markets his services, determines when to order materials and the quantity of materials to order, and determines which orders to fill.

  1. 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. Even if the working relationship lasts weeks or months instead of years, there is likely some permanence or indefiniteness to it as compared to an independent contractor, who typically works one project for an employer and does not necessarily work continuously or repeatedly for an employer. A worker’s lack of a permanent or indefinite relationship with an employer is indicative of independent contractor status if it results from the worker’s own independent business initiative.

Example:

An editor has worked for an established publishing house for several years. Her edits are completed in accordance with the publishing house’s specifications, using its software. She only edits books provided by the publishing house. This scenario indicates a permanence to the relationship between the editor and the publishing house that is indicative of an employment relationship.

Another editor has worked intermittently with fifteen different publishing houses over the past several years. She markets her services to numerous publishing houses. She negotiates rates for each editing job and turns down work for any reason, including because she is too busy with other editing jobs. This lack of permanence with one publishing house is indicative of an independent contractor relationship.

  1. What is the Nature and Degree of the Employer’s Control?

As with the other economic realities factors, the employer’s control should be analyzed in light of the ultimate determination whether the worker is economically dependent on the employer or truly an independent businessperson. 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. And the worker’s control over meaningful aspects of the work must be more than theoretical—the worker must actually exercise it. For example, an employer’s lack of control over workers is not particularly telling if the workers work from home or offsite.

Technological advances and enhanced monitoring mechanisms may encourage companies to engage workers not as employees yet maintain stringent control over aspects of the workers’ jobs, from their schedules, to the way that they dress, to the tasks that they carry out. Some employers assert that the control that they exercise over workers is due to the nature of their business, regulatory requirements, or the desire to ensure that their customers are satisfied.

However, control exercised over a worker, even for any or all of those reasons, still indicates that the worker is an employee.

Example:

A registered nurse who provides skilled nursing care in nursing homes is listed with Beta Nurse Registry in order to be matched with clients. The registry interviewed the nurse prior to her joining the registry, and also required the nurse to undergo a multi-day training presented by Beta. Beta sends the nurse a listing each week with potential clients and requires the nurse to fill out a form with Beta prior to contacting any clients. Beta also requires that the nurse adhere to a certain wage range and the nurse cannot provide care during any weekend hours. The nurse must inform Beta if she is hired by a client and must contact Beta if she will miss scheduled work with any client. In this scenario, the degree of control exercised by the registry is indicative of an employment relationship.

Another registered nurse who provides skilled nursing care in nursing homes is listed with Jones Nurse Registry in order to be matched with clients. The registry sends the nurse a listing each week with potential clients. The nurse is free to call as many or as few potential clients as she wishes and to work for as many or as few as she wishes; the nurse also negotiates her own wage rate and schedule with the client. In this scenario, the degree of control exercised by the registry is not indicative of an employment relationship.

 

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Latest Comments

  • July 27, 2015 at 10:54 am
    David says:
    Sadly, most of these agents vote for the very people that allow this scam to perpetuate. We all know 1099 agents from captive carriers are slaves but they skirt around it.
  • July 27, 2015 at 10:27 am
    mateo says:
    ...independent contractor is available to OTHER companies for a work involved relationship.... whenever that contractor works for that co..for that day... the co that employs ... read more
  • July 20, 2015 at 6:26 pm
    maxine says:
    DC- 1099 doesn't mean the person is actually an "Independent Contractor". The courts have sided over and over again with an Independent 1099 contractor who got hurt or became ... read more
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