DOL Issues Misclassification Guidance Broadly Defining “Employee”

By Martha J. Zackin

On July 15, 2015, the Wage and Hour Division of the Department of Labor issued guidance aimed at clarifying the distinction between “employees” and “independent contractors.”   Published as an Administrator’s Interpretation, the DOL states that in its view, “most workers are employees under the Fair Labor Standards Act” (FLSA).  The Administrator’s Interpretation also states that its analysis and the broad definition of employee it espouses also applies to certain other federal laws, specifically referencing the Family and Medical Leave Act.   Importantly, the DOL announced a “misclassification initiative,” pursuant to which it has entered into numerous memorandum of understanding with states and the IRS to combat what it perceives as a significant, nation-wide problem of misclassification that deprives workers of important protections such as minimum wage, overtime compensation, unemployment insurance, and workers’ compensation.

By way of background, the FLSA defines “employee” as “any individual employed by an employer,” and “employer” as including “any person acting directly or indirectly in the interest of an employer in relation to an employee.”   The FLSA further defines “employ” as “to suffer or permit to work.” This “suffer or permit” concept has broad applicability, according to the DOL, and is critical to determining whether a worker is an employee and thus entitled to the Act’s protections.

Rejecting the “common law” employee test used by some courts in determining proper classification (which looks simply at whether the employer has the right to exert control over the worker), the DOL endorsed the “economic realities” test.  Under this test, an entity suffers or permits an individual to work if, as a matter of economic reality, the individual is dependent on the entity.   The factors that must be analyzed to determine whether a worker is dependent on an entity include:

  •  the extent to which the work performed is an integral part of the employer’s business;
  • the worker’s opportunity for profit or loss depending on his or her managerial skill;
  • the extent of the relative investments of the employer and the worker;
  • whether the work performed requires special skills and initiative;
  • the permanency of the relationship; and
  • the degree of control exercised or retained by the employer.

No one factor is determinative.  Rather, the application of the economic realities test is “guided by the overarching principle that the FLSA should be liberally construed to provide broad coverage.”  Thus, the ultimate inquiry under the FLSA is whether the worker is economically dependent on the employer or truly in business for him or herself. If the worker is economically dependent on the employer, then the worker is an employee. If the worker is in business for him or herself (i.e., economically independent from the employer), then the worker is an independent contractor.

This entire subject matter is made more complicated by the fact that this is not simply a federal law issue, but one that arises under numerous state laws, many of which have different definitions.  By way of example, the Massachusetts definition of “employee “is one of (if not the) broadest among the states, and makes it nearly impossible to engage anyone as an independent contractor who is performing services of the type and nature also performed by the business.

It is important for a business to do a risk assessment when deciding under what circumstances it will engage a worker who might be in the “gray zone” between “employee” and “independent contractor.”  Risk areas include application of state and federal wage and hour laws (including both overtime and minimum wage), tax liabilities relating to payment and withholding of employment taxes, benefits coverage, unemployment insurance, workers’ compensation coverage, as well as exposure to claims for discrimination.  Also, to the extent that an employer engages a “contractor” through a staffing firm that treats the individual as its employee, the practical risk is greatly diminished.  To minimize risk and liability, it is important that the staffing firm affirms its compliance with employment and wage payment laws and, importantly, specifically names the client company as an “additional insured” on its workers’ compensation policy.