WORKER CLASSIFICATION: EMPLOYEE vs. INDEPENDENT CONTRACTOR PREPARED BY THE OFFICE OF THE GENERAL COUNSEL. Updated as of September 2016

Transcription

1 WORKER CLASSIFICATION: EMPLOYEE vs. INDEPENDENT CONTRACTOR This memorandum is not intended to provide specific advice about individual legal, business or other questions. It was prepared solely as a guide, and is not a recommendation that a particular course of action be followed. If specific legal or other expert advice is required or desired, the services of an appropriate, competent professional should be sought. I. INTRODUCTION PREPARED BY THE OFFICE OF THE GENERAL COUNSEL Updated as of September 2016 A number of actions by the U.S. Department of Labor ( DOL ) during President Obama s administration, including an Administrator s Interpretation issued in July 2015 and revisions to the white collar exemptions to overtime and minimum wage requirements finalized in May 2016, have spurred many businesses to reevaluate how they classify their workers. This reevaluation includes consideration of whether a worker is properly classified as an employee or independent contractor, and if an employee, whether the employee is exempt or non-exempt from overtime pay requirements. This memorandum focuses on the issue of whether a worker should be classified as an employee or independent contractor. The Big I has prepared a separate Q&A memorandum that addresses exempt vs. non-exempt status, with a particular emphasis on the 2016 changes to the white collar exemptions. The Q&A can be found here. II. TRADITIONAL TESTS FOR DETERMINING EMPLOYEE OR INDEPENDENT CONTRACTOR STATUS Courts and administrative agencies have traditionally used one of three tests for determining whether a worker should be classified as an employee or independent contractor: The common law control test. o The IRS uses its own control test for federal tax purposes, and that test takes into account elements from the other three tests. The ABC test. The economic realities test. o The DOL set forth its own interpretation of the economic realities test in a July 2015 Administrative Interpretation, which further limits the ability of businesses to classify workers as independent contractors. The DOL s test is discussed in Section III of this memorandum. Although the common law control test is typically the most straightforward, all three tests require a fact-specific inquiry of the business and worker at issue. 1

2 A. The Common Law Control Test The common law control test states that a worker is an employee, and not an independent contractor, if the business has the right to control the means by which the worker performs his services. Absent the right to control the means by which the worker performs his services, a business can properly classify the worker as an independent contractor. Importantly, the right to control the means, not the actual exercise of that control, is determinative. For example, an outside website designer or marketing firm engaged by an insurance agency would likely be properly classified as an independent contractor if the agent lacks the right to control, and does not control, the means by which the designer or marketing firm provides its services. However, it is acceptable under the common law control test for the business to control the ends to be accomplished e.g., the development of a website and the creation of marketing materials. 1. The IRS Version of the Control Test For federal tax purposes, the IRS uses an expanded version of the control test, under which it considers three categories: (1) behavioral control; (2) financial control; and (3) the relationship of the parties. a. Behavioral Control The behavioral control category is closest to the common law control test. The IRS looks at the business right to control the manner in which a worker performs services. The IRS considers, among other things, whether the business provided the worker with instructions or training concerning the means or methods of performing the requested services. The IRS refers to periodic or on-going training by a business about procedures to be followed and methods to be used as strong evidence of an employer-employee relationship. If the business either controls or retains the right to control the manner in which a worker performs services, that factor weighs in favor of a finding of employee status. b. Financial Control Under the financial control category, the IRS identifies several factors for evaluating whether a business has the right to direct or control the economic aspects of the worker s activities. These factors include: (1) whether the worker has made a significant investment. The IRS recognizes, however, that some types of work do not require large expenditures and that a significant investment is not necessary for independent contractor status; (2) unreimbursed expenses, which are more common among independent contractors. The IRS advises not to focus on reimbursed expenses, which independent contractors may negotiate and contract to receive; (3) whether the work provides services to other clients in the relevant market, which favors a finding of independent contractor status, but the absence of which is neutral; (4) the method for calculating the payment owed to the worker, with a flat fee being most indicative of independent contractor status; and 2

3 (5) opportunity for profit or loss, which considers the foregoing factors, as well as whether the worker is free to make business decisions that affect the worker s profit or loss. Significantly, unlike the economic realities test used by the DOL (see Section III of this memorandum), the IRS emphasizes as part of the financial control category that a worker s economic dependence on or economic independence from the business is inappropriate for use in analyzing worker status. c. Relationship of the Parties Finally, the IRS looks at how the worker and business perceive their relationship. The IRS views the parties actions as reflecting on their intent concerning control, and it looks at the following factors: (1) the expressed intent of the parties, such as through a written contract or use of a 1099 or W-2; (2) whether the worker has created her own business entity through which she provides services, which is indicative of independent contractor status, particularly when corporate formalities are followed; (3) whether the worker received benefits traditionally associated with employee status e.g., paid vacation, paid sick days, and insurance; (4) the length of the relationship, with an indefinite relationship indicative of employee status and a long-term relationship, absent more, indicative of neither employee nor independent contractor status; and (5) whether the worker s services are a key aspect of the regular business activity of the company. If the worker s services are a key aspect, the IRS considers whether the business has the right to direct or control the means or methods of the worker s performance. d. Factors of Lesser Importance Notably, the IRS states that factors including whether the worker is engaged on a part-time or fulltime basis, where the worker performs the services, and the hours of work provide less useful evidence of whether a worker is an independent contractor or an employee. B. The ABC Test The so-called ABC test, which is used by approximately half of the states to determine worker status pursuant to state unemployment insurance laws, provides a worker is an independent contractor if: (1) there is a near total Absence of control, both by contract and in fact; (2) the Business is outside the usual course of the workplace s business or performed away from workplace s offices; and (3) the work is Customarily done by independent contractors. This test is generally viewed as leading to more findings of employee status than are found under the common law control test. 3

4 C. Economic Realties Test Finally, some courts apply an economic realities test that looks first at whether the business has the right to control how the work is performed, and then considers factors such as the extent to which the worker s services are an integral part of the business, the worker s investment in her own business, and the worker s opportunity for profit or loss. Courts have applied this test mostly in cases involving laws, such as the federal Fair Labor Standards Act ( FLSA ) and the Family and Medical Leave Act that define employee more broadly than it is defined under the common law. III. JULY 2015 ADMINISTRATOR S INTERPRETATION A. Introduction Unlike the common law control test, the IRS control test, the ABC test, and the economic realities test present challenges for businesses because they require significant fact-based inquiries that may lead to close calls between independent contractor or employee status. Complicating matters further, different statutes that apply to a business may require the application of different classification tests with regard to the same worker. This could lead to a worker being properly considered an independent contractor under one statute while being considered an employee under another statute. Now layered on top of this already complex field is the DOL s take on the economic realities test. By way of an Administrator s Interpretation ( AI ) issued in July 2015, the DOL has sought to drastically limit the ability of businesses to classify workers as independent contractors under the FLSA, which is the federal law that addresses issues such as the payment of minimum wage and overtime and the classification of employees for minimum wage and overtime purposes i.e., exempt or non-exempt from overtime pay. The DOL did so by relegating to the backburner the issue of the business control over the worker, even though it is an important consideration in the traditional tests of worker classification. As discussed in greater detail below, the DOL also rejected or gave greater weight to other aspects of the traditional tests. Although the DOL s interpretation of the FLSA does not have the same weight as a law or regulation, and is not binding on the courts, it has had an immediate impact by guiding DOL investigations and enforcement actions and may serve as an impetus for plaintiffs lawyers to pursue more misclassification claims. The courts will likely determine how much weight, if any, to give the DOL s interpretation, which was not subject to the notice-and-comment period typically provided before federal regulations go into effect. If the courts adopt the DOL s interpretation, the effects will be significant. Many businesses could be liable for damages and fines associated with unpaid overtime, as well as Social Security taxes and unemployment taxes for workers who were initially classified as independent contractors but are later determined to be employees. Employers may also have to deal with compliance issues associated with laws that apply to employees but not independent contractors, such as the Family and Medical Leave Act, the Affordable Care Act, and ERISA, all of which are affected by employee headcount. 4

5 B. The DOL s Economic Realities Test In reaching its conclusion that most workers are employees under the FLSA, the DOL set forth six factors modifying the economic realities test. According to the DOL, its economic realities test is applied to determine whether a worker is economically dependent on a business to which the worker provides services and is therefore an employee or an economically independent worker operating their own business and therefore properly classified as an independent contractor. As noted above, the IRS has referred to consideration of economic dependence as inappropriate for use in analyzing worker status. Although the AI states that no single factor is determinative and every factor must be considered, the AI emphasizes the first three of the following six factors to some degree, while de-emphasizing the last factor: 1. Whether the work is an integral part of the business 2. Whether the worker s managerial skill affects his or her opportunity for profit and loss 3. The relative investments of the business and worker 4. Whether the work performed requires special skills and initiative 5. Whether the relationship between the worker and the business is permanent or indefinite 6. The nature and degree of the business control over the worker i. Factors Emphasized by the DOL Considering the first three factors, the DOL posited that a worker who performs work that is integral to a business is more likely to be an employee a factor the DOL said the courts have found compelling and one that should always be analyzed in misclassification cases. The DOL also considered whether the worker s managerial skill will affect the opportunity for profit or loss beyond the current job, such as making it more or less likely that the worker will have business opportunities with other parties. Such managerial skill and the ability to experience a profit or loss weigh in favor of independent contractor status. Finally, the AI stated that the worker s investment must be significant in nature and magnitude relative to the employer s investment in its overall business to indicate that the worker is an independent businessperson. The DOL stated that it may discount a worker s significant investment in his or her own business, if the DOL determines that the investment of the business using the worker is relatively more significant. The DOL s emphasis on managerial skill affecting the opportunity for profit or loss beyond the current job was a departure from traditional analyses, which focus on the opportunity for profit or loss on the current job. However, the most significant departure from the traditional tests related to the importance of the worker s relative investment. Unlike the DOL, the IRS control test recognizes that some types of work do not require large expenditures and that a significant investment is not necessary for independent contractor status. Under the DOL s test, the result could be affected by the size of the business receiving the worker s services; even a large and established independent contractor could be classified as an employee when it provides services to an even larger business whereas the same independent contractor could be classified as such when it provides services to a smaller business. 5

6 ii. Factors De-Emphasized by the DOL Equally important as the factors the DOL appeared to consider more compelling and persuasive were those that the DOL appeared to view as either less important or traditionally overemphasized. Perhaps most troubling was the DOL s view that the degree of control the business has over the worker which, as noted above, is a consideration courts and businesses typically give significant weight should not play an oversized role. Examples cited in the AI include a worker s flexibility in when and where they perform services, as well as number of hours worked. Moreover, the DOL deemed irrelevant the parties classification of the relationship as that of an independent contractor and appeared to downplay the worker s skill level and use of skills to obtain more work from the business as opposed to obtaining more work from other businesses. The DOL also indicated it would be skeptical of purported independent contractor relationships where the worker continuously or repeatedly worked for one business, even if the worker has the option to work for other businesses. As noted above, the DOL s treatment of the control factor is a significant departure from the traditional tests. Additionally, the DOL s position that the parties classification of the relationship is irrelevant differs substantially from the IRS position, which expressly considers the parties classification as reflecting on their intent concerning control. Moreover, the IRS views continual or repeated work for one business as a sign that the worker meets the business needs, and not as a sign that the business is trying to evade the requirements of the FLSA. IV. CONSIDERATIONS FOR INDEPENDENT INSURANCE AGENCIES The AI is just one part of the DOL s focus on worker classification under the FLSA, which the DOL continues to treat as a top enforcement priority. The DOL has entered into partnerships with 31 states to work on joint investigations and enforcements of the FLSA and other employment laws. Several states have expanded their investigatory and enforcement efforts, particularly in low-wage fields. The federal and state efforts are predicated in large part on the belief that many businesses are skirting the FLSA and other employment laws for their own financial benefit e.g., to avoid taxes and to the detriment of their workers, who do not receive minimum wage, overtime, family leave, and other protections afforded to employees. Of particular importance to independent insurance agencies is the potential for the AI to recast the analysis of whether an outside insurance producer can be classified as an independent contractor. This work may be considered an integral part of an agency s business, and restrictions may be placed on the outside producer s ability to generate accounts for other agencies two factors the DOL would likely consider indicative of an employer-employee relationship. Furthermore, outside insurance producers may make a relatively small investment compared to the investment an agency makes. As noted above, considerations such as control, schedule flexibility, the ability to work for other businesses and the parties classification of the relationship are likely to hold less sway with the DOL than they do with the IRS and the courts. Finally, independent insurance agencies should also consider their business clients potential exposure to DOL enforcement actions and private misclassification claims, particularly those clients in low-wage industries that have drawn significant scrutiny from the DOL. 6

7 Independent insurances that classify workers performing core agency functions as independent contractors may want to consult with experienced employment and tax attorneys on whether the classification comports with applicable state laws, as well as the IRS control test and the DOL s AI. 7