Independent contractors not so independent

When employers use independent contractors instead of hiring employees, they avoid myriad costs, from payroll taxes to health insurance. But employers beware: In the current environment, your independent contractors are likely to be considered employees, and getting it wrong can cost you a bundle.

In July, the U.S. Department of Labor‘s Wage and Hour Division issued its first administrator’s interpretation on the Fair Labor Standards Act in more than a year, focusing on the classification of independent contractors versus employees.

“The biggest takeaway is that in the opinion of the DOL, virtually all workers are employees and not independent contractors,” said Scott Green, a partner in the employment law group at Rivkin Radler in Uniondale.

The administrator’s interpretation didn’t provide any new clarification on worker classification as a matter of law. Rather, “it speaks volumes not by its content but by its mere issuance,” said Craig Olivo, an employment lawyer who is a co-managing member of the Garden City office of Bond, Schoeneck & King, which also has a Rochester office. “It’s a shot across the bow at employers, putting them on notice that this is going to be a significant area that the DOL will focus on.”

This interpretation, coupled with the DOL’s budget request for an addition of $32 million and 300 full-time enforcement and support staff employees, clearly indicates a crackdown is coming.

“Employers need to be aware that this is a warning – that if they don’t examine their own internal employment structure carefully, they can be in for a world of hurt,” Olivo said.

From the DOL’s standpoint, stepping up enforcement makes all the sense in the world because the effort will pay for itself, Green said.

“When companies use independent contractors, the government gets cheated out of a lot of tax revenue,” he said.

Even before the bulletin was released, the DOL had been collaborating with the Internal Revenue Service and other government agencies to root out misclassification. In fiscal 2014, Wage and Hour Division investigations resulted in more than $79 million in back wages for more than 109,000 workers in industries that included janitorial, garment, temporary help, food service, daycare and hospitality.

In the recent bulletin, Wage and Hour Division Administrator David Weil indicated the department will seek to severely restrict the use of independent contractors, requiring businesses to reclassify those workers as employees subject to the minimum wage and overtime requirements of the FLSA as well as other laws offering employee protections.

In determining if a worker should be classified as an employee, the DOL looks at an “economic realities” test to uncover whether the worker is economically dependent on the business he is working for, and thus in reality an employee, said Howard Wexler, a senior associate at Seyfarth Shaw in Manhattan.

While the test isn’t new, the broader interpretation indicated by the DOL will mean that many employees previously classified as independent contractors will now be considered employees, he said.

The economic realities test takes six factors into account. While all are important, the DOL implied it may place heightened importance on whether the work performed by the independent contractor is integral to the employer’s business, according to a management alert Seyfarth Shaw issued to its clients.

“If someone comes into your office to paint, that’s a textbook example of an independent contractor relationship,” said Kimberly Malerba, partner and chair of the employment law practice group at Ruskin Moscou Faltischek in Uniondale. But if a contractor is hired to perform tasks integral to the company’s business, and similar to those done by the company’s employees, it will be more difficult to establish that it’s truly an independent contractor relationship. An example would be a marketing agency using a consultant to design brochures or advertisements for its clients.

How much control is exercised over the individual is also taken into consideration, Olivo said.

“Can the worker establish his own schedule?” he said. “If he has the discretion to complete the work in the middle of the night, on his coach or wherever – as long as he meets the deadline – that would favor the independent contractor relationship.”

The DOL also considers the permanency of the relationship, Olivo said, noting long-term, ongoing relationships tend to lean toward employer-employee relationships, as opposed to hiring a contractor to complete a discrete project.

It helps make a case for an independent contractor relationship if the individual doing the work has additional clients along with business cards, stationery, an office and other trappings of an established business, Wexler said.

Another factor to consider is whether the independent contractor can make decisions that determine whether she makes a profit or loss – for instance, hiring subcontractors if she deems it to be necessary.

“If independent contractors are really in business for themselves, they take the risk of profit or loss when performing the work,” Green said.

Employers should proactively perform self-audits before they find themselves facing a DOL audit or a private lawsuit, attorneys say.

Employers who misclassify could be on the book for unpaid taxes and penalties, as well as back pay of overtime and/or wages under minimum wage, if applicable, as well as certain employee benefits. In New York the look-back period is two years, or three if the employer’s conduct was deemed willful. It is six years on the federal level.

Beyond the DOL, plaintiff’s lawyers are taking greater interest in misclassification issues.

“It’s a very hot area for litigation, because plaintiff’s lawyers see it as fertile ground,” Olivo said. “The employee can recoup significant amounts of money, the lawyer can get his fees paid by the employer’s attorney and the deck is increasingly stacked against employers.”

Penalties for noncompliance will be magnified if an employer has a class of people in the same boat.

“If you have a few hundred workers misclassified as independent contractors, and the DOL finds one should have been an employee, it’s likely to be applicable to the entire category,” Malerba said. “It can be financially disastrous.”