Independent-Contractor Classifications May Need to Be Reviewed

Now that the Biden administration has announced plans to crack down on the misclassification of employees as independent contractors, employers should audit who they have classified as independent contractors and avoid micromanaging them, legal experts say. Proper classification of workers depends on applying the right test, which may differ under federal and state law.

Earlier this month, the Department of Labor (DOL) withdrew the prior administration's independent-contractor rule. That rule, which never took effect, would have made it easier for businesses to classify workers as independent contractors rather than employees. Secretary of Labor Marty Walsh recently said many gig workers should be classified as employees, Reuters reported.

Approximately 55 million people in the U.S.—or 34 percent of the workforce—were gig workers in 2017, according to the International Labor Organization, and that percentage was estimated to rise to 43 percent in 2020. Independent contractors are not covered by the Fair Labor Standards Act (FLSA) and consequently aren't subject to minimum-wage or overtime requirements. In addition, gig workers aren't entitled to employee benefits.

Misclassification "has been and will continue to be a source of risk for employers, and the potential liability for unpaid overtime, for example, in the event of misclassification can be significant," said Aimee Delaney, an attorney with Hinshaw & Culbertson in Chicago. "If you rely on independent contractors and haven't done an audit or assessment in the past year or two to determine whether the positions are properly classified, now is the time to do so."

What's the Test Under Federal Law?

The U.S. Supreme Court has indicated that there is no single test for determining whether an individual is an independent contractor or an employee for FLSA purposes, said Michael Wietrzychowski, an attorney with Schnader in Philadelphia and Cherry Hill, N.J.

But he said factors that are considered significant in the determination are:

• The extent to which the services rendered are an integral part of the hiring entity's business.
• The permanency of the relationship.
• The amount of the worker's investment in facilities and equipment.
  
• The hiring entity's nature and degree of control.
• The worker's opportunities for profit and loss.
• The amount of initiative, judgment or foresight in open-market competition with others that is required for the worker's success.
• The degree of independent business organization and operation on the worker's part.

The Supreme Court has provided that the time worked or mode of pay does not control the determination of employee status.

The DOL says there are certain factors that are immaterial in determining whether there is an employment relationship, Wietrzychowski added. Where work is performed and whether the worker is licensed by state or local government are not considered to have a bearing on determinations as to whether there is an employment relationship, he said.

A written independent-contractor agreement can be helpful but won't alone be enough for a hiring entity to prevail if its classification is challenged, according to Koray Bulut, an attorney with Goodwin in San Francisco.

'ABC Test'

Some states, such as California, Illinois, Massachusetts and New Jersey, apply a more stringent standard known as the "ABC test."

Christine White, an attorney with Baker Donelson in New Orleans, explained that under the ABC test, the following factors must be met for a worker to be properly classified as an independent contractor:

• The worker is free from the control and direction of the hiring entity in connection with the performance of the work (Absence of control).
• The worker performs tasks that are outside the usual course of the hiring entity's business (Business of the worker).
• The worker is customarily engaged in an independently established trade, occupation or business of the same nature as the work performed for the hiring entity (Customarily engaged).

Under the ABC test, a worker is presumed to be an employee unless a hiring entity can show all three factors, noted Adam Sencenbaugh, an attorney with Haynes and Boone in San Antonio and Austin, Texas.

"Of these three criteria, most of the focus is on the B prong, with litigants regularly disputing how broadly courts should interpret the usual course of the alleged employer's business," said Andrew Murphy, an attorney with Faegre Drinker in Minneapolis. "If the B prong is interpreted broadly—and there is still much dispute over the issue—it can make it more difficult for companies in many industries, such as the transportation industry, to use independent contractors."

An example of a worker who typically would meet the ABC test is a freelance IT consultant who installs and services computers at various restaurants, said Jeff Mayes, an attorney with Ogletree Deakins in Houston.

True Independence

"Control is still king," said Jennifer Taylor, an attorney with Cozen O'Connor in Miami.

The hiring entity can dictate the timeline and due date as well as the finished product but should not be directing the means by which the contractor performs the work, Delaney cautioned.

The company hiring the independent contractor should not look to control how, where or when the work is performed—just whether the work meets the standards and project needs, she said. "The contractor should not be supervised, should not be attending company events and functions, should not be subject to discipline under the employee handbook, or [subject to a] performance review." No micromanaging, she said.

The contractor can attend project meetings, but this is very different from having to check in with a supervisor on how well the individual is performing or having to work specific hours, Delaney noted.

"The contractor should be working with other clients," she added.

"The more the relationship looks like the vendor relationship, the more defensible the classification as an independent contractor," Bulut said.

Once potential misclassifications are identified, employers "have to be willing to fix the problem," Delaney said. "The independent contractor needs to be truly independent."