Is Your Contractor Really Independent?

September 15, 2015

With the evolving business environment, business owners have trended to outsourcing a great deal of their daily workload to independent contractors. From a strategic standpoint, this is often a wise business decision. It saves time, money, and allows the business to focus on their core functions. This strategy frees business owners from the time it takes to document payroll and benefits, ensure compliance with EEOC and FLSA guidelines, and save the cost of unemployment and workers’ compensation insurance.

The U.S. Department of Labor (USDOL) has made the proper classification of workers a priority. Through the “Misclassification Initiative”, the Wage and Hour Division (WHD) is actively seeking to address the classification of workers, whether they are an independent contractor or employee

To help investigate classification claims brought by employees, the USDOL signed a memorandum of understanding with several states and other federal agencies, including the IRS. The USDOL hired hundreds of investigators to address this directive and investigate claims brought by workers. Also, the USDOL issued grants to individual states to assist with identification and investigation of claims. In 2012 & 2013, the WHD collected approximately $18M in back wages for employees. In the 2010 budget, the USDOL estimated these investigations may recover $7B over 10 years.

Although it may seem the federal government is bearing down on small businesses, there is hope and guidance to ease the fears. In July, the USDOL issued an Administrator’s Interpretation (No. 2015-1) that set forth guidance on how to determine the status of a worker.

The USDOL analyzes workers through 6-point criteria. This is known as the “economic realities” test:

1. Is the work an integral part of the employer’s business?
2. Does the worker’s managerial skill affect his or her opportunity for profit and loss?
3.  Relative investments of the worker and the employer
4. The worker’s skill and initiative
5. The permanency of the worker’s relationship with the employer
6. Employer control of employment relationship

None of the above factors are an independent determinant of a worker’s status as an employee or contractor. Each factor is exclusive and used to establish the totality of the circumstances. These factors should not be considered a scorecard or checklist. A very small change could alter the administration’s determination.

Here are two examples of how the economic realities test could be applied:

A full-time manager works 100% for an employer, but only for a 180 day engagement. Although the worker signed an Independent Contractor agreement, they enforce managerial decisions for the company (such as hiring and vendor management). The company pays all expenses and the worker does not share any risk for profit & loss, as they are paid a standard rate and make no personal investment. In this scenario, several of the 6 point criteria are known and the USDOL will classify the worker as either contractor or employer, depending on the level of economic dependence on the company.

Another example of the complexities of this matter can be seen as we examine a typical relationship between an outsourced bookkeeper and a company they provide services for. The engagement is indefinite. The worker provides 40-45 hours of services per week. This worker serves 4-5 other companies and determines the working hours for each client. This appears to be an independent contractor. Let’s examine the potential outcome if we change a single factor: the worker has only one client. Based on new information, the USDOL may consider this worker “economically dependent” on the employer. Thus, the worker is considered an employee and back pay, overtime, minimum wage, and employee benefits may be applied retroactively.

“That person works from home…” or “We have an independent contractor agreement…” are common responses to this issue. Unfortunately, these two examples are merely one factor in a broader view. We have worked with several clients on this matter and during annual audits of sub-contractor files, we recommend a business address these factors during the assessment. The outcome is that a business will lower their risk and exposure through preparation and understanding of this issue.

About the author:

Michael Conroy is a partner at Synergy HR, an outsource Human Resources company. The firm serves clients nationally and assists companies to address all HR issues. He can be reached at mconroy@synhr.com