New Guidance for Independent Contractor Classifications May Broaden Workplace Protections

Recently the Wage and Hour Division of the U.S. Department of Labor tried to clarify an issue that has perplexed employers for years – When is a person properly classified as an Independent Contractor or an Employee? Throughout the years, there have been several tests used by various government agencies, the IRS, the Illinois Department of Employment Security, the Department of Labor, state and federal courts etc., with overlapping or completely different analysis used to make the determination.

For example, previously, the Internal Revenue Service had relied on an arcane, “20 factors” analysis to make the determination. Courts, on the other hand, gravitated to an “economic realities” test to make the determination. Other agencies, such as the Illinois department of Employment Security, focus on the contractual (if any) relations between the business and the individual. Hoping to put some clarity to this confusion, the U.S. Department of Labor has weighed in and explained how it believes the distinction should be made. The DOL analysis boils down to a set of six factors, each carrying equal weight to make the distinction between an Independent Contractor and an Employee. When combined, these factors all point to the economic reality of the situation. Based on the DOL’s position, an overwhelming majority of individuals would be classified as “Employees” rather than Independent Contractors.

The factors used by the DOL include: (a) the extent to which the work performed is an integral part of the employer’s business; (b) the worker’s opportunity for profit or loss depending on his or her managerial skill; (c) the relative investments of the employer and the worker; (d) whether the work performed requires special skills and initiative; (e) the permanency of the relationship; and (f) the degree of control exercised or retained by the employer. Each of these factors are to be considered as a whole to determine whether a worker is economically dependent on the employer, and thus, an employee.

Discussed briefly below are the factors used to determine the economic realities tests:

  1. Is the Work an Integral Part of the Employer’s Business?

    A true independent contractor conducts business on his or her own terms and is not tied in as an integral part of the business he or she is serving at that particular moment. What this means is that the individual has his or her own business, comes and goes as they please and is not tied in at all to the general business of the person for whom he or she is performing service.

    For example, an individual who has an independent bookkeeping business and is hired on to perform bookkeeping for a construction company is not integrally necessary for the day to day general operations of the construction company.

  2. Does the Worker’s Managerial Skill Affect the Worker’s Opportunity for Profit or Loss?

    The ability for individual profit or loss related to the performance of service is crucial in determining the status of an individual. For example, an individual that is truly an employee has no ability to effect a loss or generate a profit on a project that will directly flow to his or her bottom line. The impact may be felt on the Employer’s bottom line, but not on the individual’s. An independent contractor however, suffers a direct profit or loss related to his or her managerial skills and abilities to perform the work.

  3. How Does the Worker’s Relative Investment Compare to the Employer’s Investment?

    Generally, an employee will not make any investment of his or her own in an employer’s business. They show up to work, are provided the tools and resources to perform their work by the employer, and begin work. It is the business that has incurred all the costs. An independent contractor, on the other hand, provides their own supplies and resources to perform the task. The cost of these supplies or resources are borne solely by the independent contractor. The business does not have any investment in these costs at all.

  4. Does the Work Performed Require Special Skills and Initiative?

    Often, a specialized skill set, not indigenous to those who are performing work for a business, will set aside an individual as an independent contractor. For example, while a business may have an array of computers at its disposal with which it performs work, the programming or maintenance of these high tech tools often falls outside the purview of normal work and requires a specialist with highly technical skills to ensure proper functioning of this equipment.

  5. Is the Relationship Between the Worker and the Employer Permanent or Indefinite?

    The longer the arrangement in terms of time to perform the task, the more likely it will be that an individual will be considered an employee as opposed to an independent contractor. An independent contractor is an individual who will move from job to job frequently without any long term ties to a business, whereas a true employee may remain with a business for years.

  6. What is the Nature and Degree of the Employer’s Control?

    This has long been believed to be the most important of the factors. However, as was made clear earlier, this factor should be given no more weight than any other. If an employer closely monitors, supervises and exerts control over an individual and how they perform a task, the more likely it is that an employment relationship exists. A true independent contractor controls how, when and with what resources a task is accomplished.

Conclusion

Classification of an individual as either an employee or an Independent Contractor can have a dramatic impact on a business, as well as the individual. The U.S. Department of Labor, as well as the Illinois Department of Labor are extremely active in enforcing “misclassification” actions. While other agencies, such as the IRS and Illinois Department of Employment Security have not weighed in yet on the DOL’s Interpretive Guidance, they are likely to lean in that direction. Similarly, courts, which like to apply an “economic realities” analysis, may well be guided by the new Interpretive Guidance since it seems to explain what ‘economic realities” are. Employers must take note of this development and examine all working arrangements so as not to be caught misclassifying individuals. Do not let your business make the wrong choice!

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