THE proper classification of workers under the Fair Labor Standards Act (FLSA) as either employees or independent contractors and of employees as either exempt or nonexempt are two of the most important determinations any business makes regarding its workers.
A Department of Labor study in 2000 found that as many as 30% of businesses had misclassified employees as independent contractors.
Since then the Government Accountability Office has estimated that number to have increased to 50%.
In an effort to increase enforcement, the Department of Labor was given increased funding in its 2011 budget in order to hire an estimated 250 additional investigators to detect misclassification issues.
Congress recently introduced two bills, the Employee Misclassification Prevention Act and the Fair Playing Field Act of 2010, that were directly aimed at increasing compliance with the requirements of the FLSA.
While neither of these proposed bills passed, they demonstrated a concerted effort to strengthen enforcement on the misclassification of workers.
Also, in the last several years, many states have enacted new classification laws or have stepped up their enforcement efforts.
With this increased attention on the classification of employees, it is imperative that employers carefully determine if a worker is an independent contractor or an employee. The FLSA requires the use of the “economic realities test” to determine a worker’s status.
The economic realities test focuses on: the degree to which the worker is controlled by the employer with respect to the way the work is done; the worker’s opportunities for profit and loss; the worker’s investment in the facilities and equipment of the business; the permanency and length of the relationship between the business and the worker; the degree of skill needed to do the work performed; and whether the work performed is an integral part of the employer’s business.
The Internal Revenue Service uses a similar three-part “control” test to determine a worker’s independent contractor status for employment tax purposes.
While none of the factors under the FLSA or IRS tests are determinative, the proper classification of a worker is often determined by the degree of control that an employer exercises over the worker and their work. The more control an employer exercises, the more likely that worker is properly classified as an employee.
Long-term and permanent relationships weigh in favor of employee status. The same is true of relationships where the employer provides the equipment and tools necessary to perform the work or where the worker has limited opportunity for profit or loss.
Conversely, the more specialized skills that are possessed by the workers and the less integral the work being performed is to the employer’s business, the more likely it is that a worker is properly classified as an independent contractor.
Given the possible risks of misclassification including, but not limited to, liability for unpaid federal, state, and local income taxes and Social Security and Medicare contributions, unpaid workers compensation and unemployment insurance premiums, unpaid pension and health and welfare fund contributions, and unpaid overtime compensation, it is important to examine each of the economic reality factors before a worker is classified as an independent contractor.
Once a worker has been determined to be an employee, it is then critical to properly determine if that employee is exempt or nonexempt under the FLSA.
All employees are unofficially covered by these provisions of the FLSA, unless the FLSA classIfies an employee as being exempt.
Employees who are exempt are not covered by the FLSA’s minimum wage and overtime provisions. Two of the most common exemptions are the executive and administrative exemptions.
In order for an employee to be exempt they must be compensated on a salary basis at a rate of not less than $455 per week and must meet additional requirements.
Under the executive exemption, the employee’s primary duty must be managing the enterprise.