The Department of Labor (DOL)’s Misclassification Initiative means employers need to review whether employees are correctly classified as employees or independent contractors. Business models that attempt to change, obscure or eliminate the employment relationship are not inherently illegal, unless they are used to evade compliance with federal labor law. According to the DOL, the misclassification of employees as something other than employees, such as independent contractors, presents a serious problem for affected employees, employers, and to the entire economy. Misclassified employees are often denied access to benefits and protections – such as family and medical leave, overtime, minimum wage and unemployment insurance – to which they are entitled. Employee misclassification also generates substantial losses to the Treasury and the Social Security and Medicare funds, as well as to state unemployment insurance and workers compensation funds. Misclassification can create economic pressure for law-abiding business owners, who often find it difficult to compete with those who are skirting the law.
In September 2011, Secretary of Labor Hilda L. Solis announced the signing of a Memorandum of Understanding (MOU) between the DOL and the Internal Revenue Service. Under this agreement, the agencies will work together and share information to reduce the incidence of misclassification of employees, to help reduce the tax gap, and to improve compliance with federal labor laws.
Additionally, labor commissioners and other agency leaders representing eleven states have signed MOUs with the DOL’s Wage and Hour Division, and in some cases, with its Employee Benefits Security Administration, Occupational Safety and Health Administration, Office of Federal Contract Compliance Programs, and the Office of the Solicitor. The DOL is actively pursuing MOUs with additional states as well.
These MOUs will enable the DOL to share information and to coordinate enforcement efforts with participating states in order to level the playing field for law-abiding employers and to ensure that employees receive the protections to which they are entitled under federal and state law.
The DOL says that employee misclassification is a growing problem. In 2010, the Wage and Hour Division collected nearly $4 million in back wages for minimum wage and overtime violations under the Fair Labor Standards Act (FLSA) that resulted from employees being misclassified as independent contractors or otherwise not treated as employees.
The FLSA only covers employees. The FLSA defines employee as “any individual employed by an employer” and employ is defined as including “to suffer or permit to work.” The concept of employment in the FLSA is very broad and is tested by “economic reality.”
Factors such as the place where the work is performed, the absence of a formal employment agreement, the time or method of payment, and whether an individual is licensed by the state or local government have no bearing on whether an individual is an employee under the FLSA.
Not all Federal laws share common definitions. Therefore a determination of employment status must be made separately under each law. For example, if a worker is not an employee for purposes of tax law, he or she may still be an employee under the FLSA.
The most common misconceptions associated with the employment relationship under the FLSA relate to:
- Independent Contractors
- Trainees (including School-to-Work programs)
- Volunteers
The Supreme Court has said that there is no definition that solves all problems relating to the employer-employee relationship under the FLSA. The Court has also said that determination of the relation cannot be based on isolated factors or upon a single characteristic, but depends upon the circumstances of the whole activity. The goal of the analysis is to determine the underlying economic reality of the situation and whether the individual is economically dependent on the supposed employer. In general, an employee, as distinguished from an independent contractor who is engaged in a business of his own, is one who “follows the usual path of an employee” and is dependent on the business that he serves. The factors that the Supreme Court has considered significant, although no single one is regarded as controlling are:
- The extent to which the worker’s services are an integral part of the employer’s business (examples: Does the worker play an integral role in the business by performing the primary type of work that the employer performs for his customers or clients? Does the worker perform a discrete job that is one part of the business’ overall process of production? Does the worker supervise any of the company’s employees?);
- The permanency of the relationship (example: How long has the worker worked for the same company?);
- The amount of the worker’s investment in facilities and equipment (examples: Is the worker reimbursed for any purchases or materials, supplies, etc? Does the worker use his or her own tools or equipment?);
- The nature and degree of control by the principal (examples: Who decides on what hours to be worked? Who is responsible for quality control? Does the worker work for any other company(s)? Who sets the pay rate?);
- The worker’s opportunities for profit and loss (examples: Did the worker make any investments such as insurance or bonding? Can the worker earn a profit by performing the job more efficiently or exercising managerial skill or suffer a loss of capital investment?); and
- The level of skill required in performing the job and the amount of initiative, judgment, or foresight in open market competition with others required for the success of the claimed independent enterprise (examples: Does the worker perform routine tasks requiring little training? Does the worker advertise independently via yellow pages, business cards, etc.? Does the worker have a separate business site?).
Remember that some employees are exempt from various provisions of the law.
