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Worker classification has a direct impact on employee eligibility for benefits, legal protections (such as minimum wage and overtime rights) and taxation. Employee misclassification is a growing concern for the Department of Labor (DOL).
Several tests exist to determine whether a worker is an employee or an independent contractor. The most common tests include the common law or agency test, the economic realities test, the hybrid test, and the Internal Revenue Service (IRS) test. HSA
The DOL has favored using the economic realities test, which looks at whether a worker is economically dependent on the employer or engaged in business for him- or herself. According to the DOL, if the worker is economically dependent on the employer, the worker is an employee and should be protected by employment laws, including the Fair Labor Standards Act (FLSA) and the Family and Medical Leave Act (FMLA).
The Economic Realities Test
The factors to consider under the economic realities test are:
- The extent to which the services rendered are an integral part of the principal’s business.
- The permanency of the relationship.
- The amount of the alleged contractor’s investment in facilities and equipment.
- The nature and degree of control by the principal.
- The alleged contractor’s opportunities for profit and loss.
- The amount of initiative, judgment, or foresight in open market competition with others required for the success of the claimed independent contractor.
- The degree of independent business organization and operation.
No one factor is determinative. Instead, the total activity or situation must be considered when determining whether an employment relationship exists.
Certain factors do not impact the determination of whether there is an employment relationship, such as the place where work is performed, the absence of a formal employment agreement or whether a worker is licensed by the state or local government. Additionally, the time or mode of payment does not affect the determination of employee status.
A May 2014 fact sheet provided the DOL’s interpretation of how the economic realities test should be applied by employers in their worker classification efforts. Notably, this fact sheet provided that “workers who are economically dependent on the business of the employer, regardless of skill level, are considered to be employees, and most workers are employees.”
This guidance indicated that the DOL believed that most workers will be considered employees covered by the FLSA under the economic realities test. A 2015 administrative interpretation reiterated and clarified this DOL interpretation.
However, in 2017, the DOL withdrew the 2015 administrative interpretation. Then, in early 2018, the DOL withdrew the May 2018 fact sheet, replacing it with a 2008 version that omits the language indicating that “most workers are employees.”
These updates indicate that the DOL no longer advises that “most workers are employees.” However, these updates do not abolish the economic realities test nor the DOL’s preference of this test for employee classification purposes.
Like the 2014 guidance, the 2008 fact sheet includes the same factors to consider under the economic realities test (listed above). By updating this guidance, the DOL is returning to more reliance on existing judicial interpretations of the law’s requirements, rather than providing its own interpretations on how employers should follow the law. This may provide more flexibility for employers in applying the economic realities test when classifying their workers.
The DOL identified the following common scenarios where workers may be improperly classified as independent contractors. Employers should carefully consider their employment relationships to ensure that they are properly classifying their workers.
- The construction industry: Contractors may hire so-called independent contractors who, in reality, should be considered employees because they do not meet the tests for independence.
- Franchise arrangements: Depending on the level of control the franchisor has over the franchisee, employees of the franchisee may be considered to be employed by the franchisor.
- Volunteers: A situation involving a person volunteering his or her services for another may also result in an employment relationship. For example, a person who is an employee cannot “volunteer” his or her services to the employer to perform the same type service performed as an employee. However, individuals may volunteer or donate their services to religious, public service and non-profit organizations without contemplation of pay and not be considered employees of the organization.
- Trainees/students: Trainees or students may also be employees, depending on the circumstances of their activities for the employer.
- Home workers: People who perform work at their own home are often improperly classified as independent contractors. The FLSA covers home workers as employees, and they are entitled to all benefits of the law.
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