Contractors, Employees, and Economic Dependence

The dispute over what makes somebody an employee or a contractor continues to escalate. According to a study by Intuit, roughly 25% to 30% of U.S. workers are contingent, meaning they work as freelancers, temps, independent contractors or consultants. New guidance out this summer from the U.S. Department of Labor could soon have a large number of companies, particularly in Silicon Valley where the “on-demand economy” is part of the infrastructure, facing challenges over how they classify some of their staff.

Contractor and Employees

It’s not a new problem. Back in 1987, the IRS developed a list of 20 factors that help determine whether a worker is actually an employee. They include items such as whether the worker must attend training sessions, to whether the worker must keep set hours, do the work on premises or submit regular reports.

But just a few weeks ago, in response to a growing number of lawsuits against businesses with huge freelance workforces, Department of Labor Administrator David Weil issued 15 pages of fresh interpretations of the Fair Labor Standards Act to address the matter. It has created quite a stir.

Weil’s interpretation explains that an “economic realities” test, which many courts already use, affects whether a worker is an employee. Under that test, the question is whether the worker is “economically dependent” on the employer. And if he is, he’s an employee, Weil says.

It’s not the level of income that determines economic dependence, however. In general, six things come into play: how integral the worker’s output is to the employer’s business, whether the worker’s managerial skill affects the worker’s opportunity for profit or loss, the extent of the worker’s investment in the arrangement, whether the work requires special skills and initiative, how permanent the relationship is and how much control the employer exercises over the worker.

The DOL is quick to caution that it takes more than just a “yes” in a column to make a person an employee. But it is equally quick to say that just because a company calls a person an independent contractor does not make it so.

“The factors themselves should not be applied in a mechanical fashion, but with an understanding that the factors are indicators of the broader concept of economic dependence. Ultimately, the goal is not simply to tally which factors are met, but to determine whether the worker is economically dependent on the employer (and thus its employee) or is really in business for him or herself (and thus its independent contractor),” Weil writes.

“Workers who are economically dependent on the employer, regardless of skill level, are employees covered by the FLSA,” he said. “In sum,” Weil adds, “most workers are employees under the FLSA’s broad definitions.”

It’s important to note that the guidance isn’t the equivalent of a rule change; rather, it’s a peek into how the department evaluates compliance. Nonetheless, what does it mean for the 80% of large corporations that plan to substantially increase their use of a flexible workforce in coming years, according to Intuit — or to smaller companies that need workers’ skills on demand instead of full time?

Higher costs, for one. Requiring a company — especially a startup — to reclassify its workers as employees can radically change its business model and even its ability to stay afloat. It also means spending more on benefits, overtime, unemployment insurance, workers’ compensation and collective bargaining agreements.

Higher regulatory scrutiny might also be on the horizon. The language in the guidance “essentially declares war on the use of independent contractors in certain industries,” one labor attorney told the Wall Street Journal.

This doesn’t necessarily mean the independent contractor is dead. The guidance highlights the importance of obtaining advice and expertise as a company plans to build and work with an on-demand workforce.

But from now on, for the Department of Labor, if it looks like a duck and walks like a duck, it’s probably an employee.