With both federal and state agencies cracking down on worker misclassification, here’s what you need to know to be compliant.
The U.S. Department of Labor’s Wage and Hour Division (WHD) and the National Labor Relations Board (NLRB) have announced that they will be collaborating in a new effort to improve compliance with the laws they enforce, including worker misclassification.
“Practically speaking, the partnership between the NLRB and DOL/WHD could spell trouble for employers that fail to comply with misclassification and related provisions enforced by those agencies,” attorneys Kathleen McLeod Caminiti and Alba V. Aviles wrote in a blog post for law firm Fisher Phillips.
“Routine wage-hour audits, employee complaints, and alleged minimum wage or overtime violations are likely to take on broader significance, and with that greater exposure to damage awards and penalties,” Caminiti and Aviles continued.
Businesses need to be extra careful when it comes to compliance.
The Wage and Hour Division enforces the Fair Labor Standards Act (FLSA), and the Family and Medical Leave Act (FMLA). The FLSA is a federal law that requires employers to pay a minimum wage and overtime compensation for hours worked in excess of a 40-hour workweek. The FMLA is a federal law that guarantees eligible workers of covered employees 12 weeks of unpaid, job-protected leave for family and medical reasons.
The NLRB administers the National Labor Relations Act (NLRA) which guarantees the right of private sector employees to organize into trade unions and engage in collective bargaining, among other activities.
Memorandum of Understanding
The NLRB explained in a press release that the Jan. 6 Memorandum of Understanding will allow for “better enforcement against unlawful pay practices, misclassification of workers as independent contractors, and retaliation against workers who exercise their rights.”
Under the MOU, the agencies will be sharing information, data, and investigative files. The agreement will be in effect until December 2026.
Staffing might not be an issue. The Labor Department announced on Feb. 1 that it will be adding 100 investigators to support its Wage and Hour Division.
Worker misclassification on the chopping block
“Organizations utilizing independent contractors should be especially mindful of increased enforcement mandates on the federal and state level,” Caminiti and Aviles said.
Employee misclassification occurs when employers label workers as freelancers when they are really employees. The practice substantially reduces labor costs for employers by allowing them to avoid paying vacation, sick and other benefits for workers as well as unemployment and other taxes.
Businesses need to reconsider whether or not their independent contractors should, in fact, be employees.
There is no single rule for determining whether individuals are employees or independent contractors. The legal definition of an independent contractor varies depending on who is examining the employer’s classification. Federal and state examiners use a variety of different legal standards depending on whether they are looking at wage and hour compliance, unemployment compensation, or other situations.
The simplest standard examines the level of control that the employer exercises over the worker, the more control exerted by the employer, the more the likelihood that the worker is an employee. More complicated standards include an examination of factors including whether the worker is financially dependent on the employer and the worker’s opportunity for profit and loss.
In the beginning, it’s up to the employer and the worker to decide whether the workers will be classified as freelancers or employees. But this decision can be subject to review by state and federal government agencies as well as the courts.
WHD test for worker classification
The Labor Department’s Wage and Hour Division uses the “economic realities” test when examining whether a worker is an independent contractor under the Fair Labor Standards Act, according to an April 2021 report by the Congressional Research Service (CRS).
This test looks at the dependence of the worker on the business for which they work. If a substantial portion of the individual’s salary comes from the business, the worker is probably an employee. The test also considers elements such as the:
- Level of skill
- Nature of the work
- Intent of the parties
- Payment of Social Security taxes and benefits
NLRB definition of independent contractor
The NLRB and many courts use the “common law agency” test, according to the CRS report.
A variety of factors based on the legal principle of agency — when a person delegates work to another — are used under this standard to determine whether a worker is an employee or independent contractor.
These factors include:
- The extent of control exercised by a hiring entity over the worker
- Whether the worker is engaged in a distinct occupation or business
- The level of skill required by the worker to provide services
The CRS report notes that in 2019, the NLRB indicated that a worker’s entrepreneurial opportunity for economic gain or loss would be a “prism” through which to examine the common law factors.
However, revisions to the NLRB standard might be on the horizon. The agency recently announced that it seeks to change the independent contractor standard. The NLRB invited public input in December 2021 as to whether it should abandon the current standard. Comments closed Feb. 10.
Legal experts say the federal agency seems poised to revert to a more worker-friendly standard under federal labor law for determining classification.
Other tests for determining independent contractor status
Some states use the “ABC” test to determine whether a worker is a freelancer. The ABC test has been adopted in at least 20 states and the District of Columbia.
Some states use the ABC test to decide if someone should be a freelancer or employee.
In general, the “ABC” test calls for the application of three elements to determine if a worker is an independent contractor. To classify someone as an independent contractor under this test, a business must prove all three elements. It must show that the worker:
- Is free from the control and direction of the employer
- Performs work that is outside the hirer’s core business
- Customarily engages in “an independently established trade, occupation or business”
In a move deeply opposed by California’s gig employers, California Gov. Gavin Newsom signed into law in 2019 a measure that codified a state supreme court decision that adopted the “ABC” test, making it more difficult for Golden State employers to classify workers as independent contractors.
Factors that don’t count towards worker misclassification
There are some factors that don’t count when determining a worker’s classification, such as:
- Common industry practice
- The parties’ preference
- A signed agreement
- Whether a worker is licensed by the state or local government
Employers in some industries, such as the trucking industry and delivery services, often classify drivers as independent contractors. However, the U.S. Department of Labor has noted that employers can’t rely on common industry practices to misclassify workers under the FLSA.
Signed agreements are not always definitive. Some courts have found that workers were employees even though they had agreements in place indicating that they were independent contractors. A California appeals court decided in 2019 that the amount of control 7-Eleven exerted over its franchisees was more significant in determining worker classification than a signed agreement that the workers were independent contractors. In a similar instance, an Alabama federal court determined that a delivery driver was an employee in spite of the fact that he had signed a form stating he was an independent contractor.
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Stepped-up enforcement by the states
As federal agencies step up enforcement of worker misclassification, some states have also shown their intent to address the issue.
New Jersey’s Gov. Phil Murphy in July signed into law several measures aimed at addressing worker misclassification that provide additional enforcement options to the state’s labor and workforce development commissioner and make it illegal for employers to misclassify workers for the purpose of avoiding insurance expenses.
Compliance is key
Compliance will be the key to a successful 2022 for many organizations, attorneys Caminiti and Aviles said. Legal experts recommend that employers make sure they are in compliance with the independent contractor standards used by the relevant examining authorities.
What’s next for worker misclassification
With federal and state authorities taking a hard look at worker misclassification, the risks to employers are increasing. It’s important for employers to understand the varying tests used by state and federal examiners and stay in compliance with the rules.