“Are They, or Aren’t They?”

One area of labor and employment law that is getting recent attention is the definition of employee and the classification of workers that are either employees or independent contractors.  In 2024, the United State Department of Labor issued a fact sheet that addressed the issue of what constitutes an employee, who receives the protections of the Fair Labor Standards Act and other worker protection laws, and what constitutes an independent contractor.  Independent contractors are generally individuals who work for themselves and provide services to a variety of companies.  The 2024 guidance focused on six primary factors to determine what constitutes an independent contractor:

  • Opportunity for profit or loss depending on managerial skill,
  • Investments by the worker and the employer,
  • Permanence of the work relationship,
  • Nature and degree of control,
  • Whether the work performed is integral to the employer’s business, and
  • Skill and initiative.

These considerations are more fully described in the Fact Sheet issued by the Department of Labor in March 2024, which can be found here: https://www.dol.gov/agencies/whd/fact-sheets/13-flsa-employment-relationship.

The guidance issued in March 2024 was challenged in court and, as a result, the Department of Labor issued a Field Assistance Bulletin stating that it was reconsidering the guidance in Fact Sheet 13 and would be applying the analysis in place prior to the issuance of the March 2024 guidance.  Since then, the Department of Labor has issued a new proposed rule that would rescind the March 2024 guidance and would implement an economic reality test that is primarily focused on two factors: the nature and degree of control over the work and the worker’s opportunity for profit or loss based on initiative and/or investment.  The news release describing the proposed rule can be found here:  https://www.dol.gov/newsroom/releases/whd/whd20260226. 

While this would seem to make it easier for employers to properly classify individuals who perform services for them, the Department of Labor’s approach is only one element to determining the employee/employer relationship.  In addition to the federal Department of Labor’s definition and test for determining the appropriate classification of workers, the Internal Revenue Service has a test for determining whether an employee is properly classified as an independent contractor and each state may also have laws relating to employee classification.  The IRS discusses the classification issue here (https://www.irs.gov/businesses/small-businesses-self-employed/independent-contractor-defined) and has basically stated that the determination of whether an individual is an independent contractor rests on the right to control the work: “The general rule is that an individual is an independent contractor if the person for whom the services are performed has the right to control or direct only the result of the work and not what will be done and how it will be done.”

States apply their own tests to determine whether an individual is properly classified as an employee or an independent contractor.  The prime example of where a state might apply a more stringent test is California – a state that is very pro-employee.  Under California law, an individual is deemed to be an employee unless the employer can show that the individual’s relationship with the employer passes the “ABC Test.”  Under the ABC Test, described here (https://www.dir.ca.gov/dlse/faq_IndependentContractor.htm), a worker is considered an employee and not an independent contractor, unless the hiring entity satisfies all three of the following conditions:

  • The worker is free from the control and direction of the hiring entity in connection with the performance of the work, both under the contract for the performance of the work and in fact;
  • The worker performs work that is outside the usual course of the hiring entity’s business; and
  • The worker is customarily engaged in an independently established trade, occupation, or business of the same nature as that involved in the work performed.

When it is found that individuals who are misclassified as independent contractors when they were really functioning as employees, employers who are responsible for that misclassification can be subject to fines and penalties related to the misclassification.  These include liability for restitution and penalties for violation of employee rights and protections, such as payment of minimum wages and overtime, payment of unemployment insurance taxes, and providing workers’ compensation insurance.  Employers may have to pay their employees’ share of payroll taxes, and may incur penalties and interest on those amounts. Willful violations are subject to even greater penalties.  In fact, recent misclassification findings in California involving home care workers have resulted in penalties and damages in the amount of $10 million and $4.4 million.  While California provides a great and recent example, there are similar lawsuits regarding misclassification that have occurred in other states, including New York and Minnesota. 

Why is this important for employers?  Because these variations in how state and federal laws are applied to employees cover not only the classification of employees, but the payment and other treatment of employees.  Labor and employment law is an ever-changing area of the law and it involves statutes and jurisdictions that are interrelated.  If an employer focuses only on federal law, for example, they may be violating state law.  This is particularly true, not only with regard to the classification of employees, but also with respect to the payment of employees.  Wage and hour laws vary between state and federal laws.  Generally, the federal law is the floor and the state law is the ceiling – or, in other words, an employer’s treatment of employees must not be less than what is required by federal law but must also meet more protective standards set forth in state laws. 

To add additional complications, worker protection laws can also be found in large cities and metropolitan areas that have added their own ordinances and requirements and provide even greater protection for employees.  New York City and Chicago are examples of this and one area that this is particularly true involves paid sick leave ordinances. 

myHRcounsel can assist employers in ensuring that they are meeting all of their obligations under the patchwork of labor and employment laws.  By staying on top of changes in the law at every level of government, we can help you be proactive in developing employment policies and in making decisions regarding your employee’s terms and conditions of employment that are compliant with those laws.