November 2015 Bar Bulletin
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November 2015 Bar Bulletin

Navigating the Risks of Utilizing Independent Contractors

By Patrick Pearce


Use of independent contractors can be a rewarding business strategy for both employers and contractors providing services. Entering into the arrangement, however, carries substantial risks.

The U.S. Department of Labor has placed a priority enforcement focus on misclassification of workers as independent contractors instead of employees. To avoid problems, successfully navigating the legal pitfalls requires careful attention to the nature and structure of the particular relationship.

The position of the Department of Labor's Wage and Hour Division is that employee misclassification is currently one of the most serious workplace problems. On July 15, the Wage and Hour Division issued Administrator's Interpretation No. 2015-1 addressing identification of employees misclassified as independent contractors.1

The increased emphasis on the issue is substantially rooted in the Department of Labor's position that misclassification results in excessive lost tax revenue to state and federal government with resulting lost funding for state unemployment insurance and workers' compensation funding. The Department is also concerned with worker access to health benefits, family and medical leave, and other aspects of status as an "employee" that are available to employees but not to independent contractors.

The July 15 guidance is part of a "Misclassification Initiative" currently being led by the Department. As part of this effort, the Department has so far entered into memoranda of understanding with 26 of the 50 states.2 These agreements allow increased information sharing, enhanced enforcement efforts and joint investigations between the Department and state governments. Along the Pacific Coast and in the Northwest, the Department has entered agreements with Washington, Idaho, California, Hawaii and Alaska. Oregon is the only state in this region that does not yet have an agreement with the Department.

The July 15 guidance provides extensive analysis of the various factors and considerations the Department will apply to determine whether workers labeled as independent contractors are in fact employees. In determining whether a worker is properly classified as an employee or a contractor, the analysis revolves around the Fair Labor Standards Act's definition of employment as "to suffer or permit to work" in light of congressional intent that the FLSA be applied expansively.

Several factors will be significant to the Department in examining the relationship. First, the Department will assess the extent to which the work performed is an integral part of the employer's business. In an example used by the Department, services of a carpenter will be integral to house construction, while services of a specialty woodworker for cabinets or other detail may not, therefore allowing the possibility of an independent contractor relationship.

Next, the worker should have opportunity for increased profit or loss depending on the exercise of his own managerial skill and efficiency in approaching the work. Third, relative investment by both worker and employer will be assessed. Purchasing tools and equipment may not be enough of an investment, while incurring the costs of maintaining a physical business location can help indicate true independence.

The Department will look to whether special skill or initiative is required - referencing a previous example, a journeyman carpenter in house construction is unlikely to qualify while a specialty woodworker providing to-order finishing details might. The permanency of the relationship also will be considered with an open-ended continuing relationship indicating employee-employer status.

Finally, the degree of control exercised or retained by the employer will be significant. The greater the control of how, where and when work is to be performed, the greater the likelihood that the relationship will be considered employer and employee.

For the Department, the ultimate determination is whether the worker is in fact in business for himself and therefore an independent contractor, or whether the worker is economically dependent on the employer and therefore an employee regardless of label. No single factor will be determinative to the question, and assessments will be made on a case-by-case basis addressing the particular facts.

To help avoid misclassification problems, both contractors and employers should address certain considerations at the outset of the relationship.

Carefully consider what work is being done. Attempting to contract out work that is integral to the nature of the business will very likely result in problems if independent contractor status is challenged.

Potential parties to an agreement should carefully examine the core nature of the employer's business operations and what the worker is being asked to do. If critical and core requirements for the employer's operations are involved, there is significant risk that the relationship would be found to be employer-employee instead of employer-contractor.

Ensure the intended independent contractor is not economically depending on the employer. Economic dependence on a particular employer by the worker will be a strong indicator that the employer controls the relationship and the worker is in fact an employee. If the worker has other sources of income, that can be a key consideration.

Additionally, a long-term working relationship presents risk to independent status as an indication of a permanent relationship, which will be interpreted as reflecting employee status.

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