By Michael D. Koppel, CPA, PFS, CITP, MSA, MBA
Retired Partner at Gray, Gray & Gray
December 1, 2015
In July, the U.S. Department of Labor’s (DOL’s) Wage and Hour Division issued Administrator’s Interpretation No. 2015-1, which addresses issues arising from the misclassification of employees as independent contractors. The interpretation addresses the application of the Fair Labor Standards Act (FLSA) to employees who are misclassified as independent contractors. Such a misclassification may deny employees significant workplace protections, such as minimum wages, overtime compensation, unemployment insurance, and workers’ compensation, and it lowers tax revenues. The DOL has identified misclassification as one of its top three issues.
In response to continual complaints it receives relating to the improper classification of workers as independent contractors, the Wage and Hour Division has provided additional guidance intended to clarify the standards used to determine whether a worker is an employee or an independent contractor under the FLSA.
Administrator’s Interpretation No. 2015-1 provides that the FLSA broadly defines the term “employ” as “to suffer or permit to work” and concludes that most workers are employees under the FLSA’s broad definition. The interpretation discusses the multifactored “economic realities” analysis applied by the courts in differentiating employees from independent contractors under the FLSA. This analysis centers on determining whether the worker is economically dependent on an employer or is in business for himself or herself. If the worker is economically dependent on an employer, he or she is “suffered or permitted to work” by the employer and therefore would be considered an employee. The economic realities factors include:
Is the work an integral part of the employer‘s business? If the work performed by the worker is integrated into an employer’s business, the worker is more likely economically dependent on the employer and therefore an employee. Work can be considered integral to an employer’s business even if it is performed away from the employer’s premises.
Does the worker‘s managerial skill affect the worker‘s opportunity for profit or loss? The primary focus with respect to this factor is whether a worker’s managerial skill can affect his or her opportunity for profit and loss, such as garnering future business or reducing the opportunity for future work. The possibility of experiencing a loss or profit is typical of workers in business for themselves. A worker’s ability to perform more work, or the amount of work available from an employer, has no bearing on a worker’s managerial skill. Therefore, these are not considered factors that relate to managerial skill. Performing one’s job well and the resultant effect on one’s earnings are not considered in determining the effect of managerial skill on opportunity for profit and loss because they are common to both independent contractors and employees. The focus should not rest on merely the opportunity for profit or loss but also on whether the worker can make decisions and use his or her managerial skill and initiative to affect the opportunity for profit or loss.
How does the worker‘s relative investment compare with the employer‘s investment? Courts consider the nature and extent of the relative investments of the employer and the worker. A worker is indicated to be in business for himself or herself when he or she makes an investment in the business and therefore undertakes at least some risk of loss. However, such an investment should not be considered in isolation and must be compared with the employer’s investment to determine whether the worker is an independent contractor. Independent contractors typically make investments supporting a business beyond any particular job, such as by affecting the business’s capacity to expand, its cost structure, or the reach of the independent contractor’s market. The interpretation says that investing in tools and equipment is not necessarily a business investment or capital expenditure that indicates that the worker is an independent contractor.
Does the work performed require special skill and initiative? In determining whether a worker is economically independent and therefore an independent contractor, consideration must be given to a worker’s business skills, judgment, and initiative—not his or her technical skills. Technical skills by themselves do not indicate any independence or business initiative.
Is the relationship between the worker and the employer permanent or indefinite? A worker is more likely to be an employee if there is a permanency or indefiniteness in the worker’s relationship with the employer. A worker who is in business for himself or herself will typically abstain from a permanent or indefinite relationship with an employer and the dependence that comes from it. The lack of permanence or indefiniteness does not automatically suggest an independent contractor relationship, and the relevant consideration is whether the reason for its absence indicates the worker is running an independent business. It is key to consider whether the lack of permanence or indefiniteness is due to operational characteristics intrinsic to the industry or the worker’s own business initiative. A worker’s lack of a permanent or indefinite relationship with an employer indicates a worker is an independent contractor if it results from the worker’s own independent business initiative.
What is the nature and degree of the employer‘s control? The employer’s control over the worker should be analyzed in light of whether the worker is economically dependent on the employer or in business for himself or herself. A truly independent businessperson must control meaningful aspects of the work performed such that one can view the worker as conducting his or her own business. A lack of employer control would be present if a worker has control over meaningful aspects of the work. This control must not be just theoretical—the worker must actually exercise it.
Conclusion
It is interesting that the interpretation implies that the first three criteria should be emphasized. It also indicates that no one criterion or group of criteria is definitive. It is important to note that the interpretation was issued without a request for comments.
It is also important to remember that the DOL works with the IRS and many states on this issue in a variety of ways—through, for example, information sharing and coordinated enforcement.
Administrator’s Interpretation 2015-1 really does not provide any new guidance for businesses in determining whether a worker is an employee or independent contractor. It may actually cause further confusion, as it introduces another set of guidelines. Unfortunately, it is likely that the definition’s uncertainty will be settled in the courts.
For additional information about these items or questions about other tax issues, please contact Gray, Gray & Gray.
This article was originally published in the AICPA “Tax Adviser” Newsletter on December 1, 2015.