Employee or Independent Contractor…and Why You Need to Know

Earlier this year, a court ruled that Federal Express drivers should have been classified as employees, when the company had classified them as independent contractors. And the U.S. Department of Labor announced that a five-year investigation in Utah and Arizona yielded $700,000 in back wages, damages, penalties and other guarantees for more than 1,000 construction industry workers.

In the case of the Southwestern construction workers, the employers required workers to become “member/owners” of limited liability companies, stripping them of federal and state protections that come with employee status. These construction workers were building houses in Utah and Arizona as employees one day and then the next day were performing the same work on the same job sites for the same companies, but without the protection of federal and state wage and safety laws. The companies, in turn, avoided paying hundreds of thousands of dollars in payroll taxes and other benefits.

In recent years, employers have increasingly contracted out or otherwise shed activities to be performed by other entities through the use of subcontractors, temporary agencies, labor brokers, franchising, licensing and third-party management. Legitimate independent contractors play an important role in our economy — but when employers deliberately misclassify employees in an attempt to cut costs, everyone loses.

Employers often misclassify workers to reduce labor costs and avoid employment taxes. A misclassified employee — with independent contractor or other non-employee status — lacks minimum wage, overtime, workers’ compensation, unemployment insurance, and other workplace protections. By not complying with the law, these employers have an unfair advantage over competitors who pay fair wages, taxes due, and ensure wage and other protections for their employees.

The Fair Labor Standards Act governs federal wage/hour standards and provides a minimal level of protection for employees. (States may enact stricter employee protection laws.) Whether a worker meets the Fair Labor Standards Act’s definition of employee depends on the working relationship between the employer and the worker, not job title or any agreement that the parties may make. To guide employers, the U.S. Department of Labor issued Administrator’s Interpretation No. 2015-1 in July. You can find the entire document at dol.gov/whd/workers/Misclassification/AI-2015_1.pdf.

In summary, the interpretation uses an “economic realities” test to determine whether the worker is economically dependent on the employer or in business for him or herself.

Factors to consider include:

1. the extent to which the work performed is an integral part of the employer’s business;
2. the worker’s opportunity for profit or loss depending on his or her managerial skill;
3. the investments made by the employer and the worker, including materials and equipment, training, advertising, etc.
4. whether the work performed requires special skills and initiative;
5. the permanency of the relationship; and
6. the degree of control exercised or retained by the employer.

The Department of Labor says “…most workers are employees under the FLSA’s broad definitions. The very broad definition of employment under the FLSA as ‘to suffer [allow] or permit to work’ and the Act’s intended expansive coverage for workers must be considered when applying the economic realities factors to determine whether a worker is an employee or an independent contractor.”

The Consequences of Misclassification

Employers caught misclassifying employees — whether deliberately or not — can be required to pay fines, penalties, and back taxes.

Please note that the commercial general liability and business owner’s policy exclude coverage for employment-related claims. Specialized employment practices liability insurance (EPLI) often excludes coverage for violations of federal employment laws, such as the Fair Labor Standards Act, Americans with Disabilities Act, Occupational Safety and Health Act, COBRA, ERISA and state employment laws.