Employers need to carefully analyze whether independent contractors meet the economic reality test

September 15, 2019

Your independent contractor might be an employee after all. That can be true even if the contractor signs an agreement not to be an employee or wants to be a “1099 employee” or works part time and only on occasion is not an employee.

There are many reasons why employers want to designate relationships as “independent contractor” and not “employee,” including avoiding overtime implications from the Fair Labor Standards Act, avoiding paying workers’ compensation and/or unemployment benefits, and avoiding the legal implications of discrimination laws. Some employers also are trying to avoid tipping their workforce above certain markers for such laws as federal discrimination laws and/or the Family Medical Leave Act. The tax laws favor businesses that don’t have to pay their portion of Social Security.

While it is entirely more convenient and less costly to avoid the employment relationship, whether an employment relationship exists cannot be left to the voluntary agreement between the two parties. An employment relationship exists when the law says it does. And the courts will use several factors to make that determination. For instance, if I see an independent contractor has worked solely for one company for two years, that person is probably an employee.

The Department of Labor issued an opinion letter this year spelling out six legal standards to determine if an individual is an employee or can be properly designated as an independent contractor. The department noted that the “touchstone of employee versus independent contractor status has long been ‘economic dependence,’ ” which is a fact-specific inquiry that is individualized to each worker. Employers need to analyze whether their contractors meet the economic reality test and, if so, either employ the individuals or terminate the relationship. Employers cannot let the contractor dictate whether he/she wants to be an employee, nor should the employer use any factor other than the legal test to make that determination. The risk of failing to properly compensate and to properly insure through the employment commission and workers’ compensation can create significant risk where misclassification occurs.

The department considers six factors in making the determination of economic dependence, which it derived from Supreme Court precedent:

  • Control: This factor analyzes how much control the employer exerts over the individual, including whether the employer requires the worker to work exclusively for the business and/or to disavow working for or interacting with competitors during the working relationship. While it’s fine to mandate confidentiality and non-disclosure, employers should not require independent contractors to enter into an exclusive employment agreement.
  • Permanency of relationship: Permanency occurs when an individual is required to work for a fixed term, disavows working for competitors when the relationship is over and/or faces restrictions to work with other organizations. Recently, an employer was accused of requiring independent contractors to enter into non-competition agreements, which will make the independent contractor status likely illegal.
  • Investment in facilities, equipment or helpers: The Labor Department considers the employer’s investment in these things to lead to a greater likelihood of an employment relationship.
  • Skill, initiative, judgment and foresight required for the worker’s services: A portion of this analysis involves determining whether the skills are independent of or integral to forming a larger piece of the enterprise. The analysis includes where the skills develop and whether the business provides the training.
  • Opportunity for profit and loss: The Labor Department makes this determination based not on efficiency but on the skill of the contractor to establish his or own compensation capabilities.
  • Integrality: This factor seems critical to the analysis — determining if the worker’s services are integrated into the business because they form the primary purpose of the organization.