On July 15, the Department of Labor’s Wage and Hour Division (WHD) issued an interpretation letter (Interpretation) discussing the classification of workers as either employees or independent contractors under the Fair Labor Standards Act (FLSA). In determining worker classification under the FLSA, the Interpretation noted courts apply a multifactor “economic realities” test which is generally construed broadly to enhance the protections provided by the FLSA due to the expansive definition of “employ” found in the FLSA (i.e., “to suffer or permit to work”). The ultimate inquiry under the economic realities test is whether the worker in question is economically dependent upon the employer.
The economic realities test differs substantially from the common law test historically used by the Internal Revenue Service (IRS) and courts to determine whether an employer-employee relationship exists for federal income tax purposes. In applying the common law test, the IRS has developed a list of twenty factors to examine when making a determination of worker classification, with the ultimate factor generally being whether or not the employer exercised “control” over the worker in question. The issuance of the Interpretation letter is evidence of the WHD’s distinction between the common law test and IRS factors that focus on “control”, versus the FSLA focus on whether the worker is economically dependent (or independent) of the employer.
A change in worker classification from independent contractors to employees can have a tremendous impact upon a business’s employee costs and tax reporting obligations. The wages of a worker who changes classification from an independent contract to an employee are immediately subject to income tax withholding and remittance at the employer level, as well as FICA withholding and remittance of both the employee potion (7.65% or 8.55% on wages above $200,000) and employer portion (7.65%) at the employer level. A worker who changes classification from an independent contract to an employee may be eligible for government mandated employee benefits (workers compensation insurance, Affordable Care Act, Family and Medical Leave Act coverage, etc.), as well as employer-offered benefits (qualified retirement plans, employer provided medical insurance, etc.). In addition, employers may face burdens to prove compliance with minimum wage, overtime and other federal and state labor laws that apply to employees rather than independent contractors.
If you would like to discuss the different standards for classifying employees versus independent contractors and how such worker classifications (and potential non-compliance with laws arising from misclassifications of workers) may affect your business, please call us to set up a consultation and employee classification review.
 The six factors typically applied in the economic realities test are as follows: (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 extent of the relative investments of the employer and worker; (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.