The traditional lines between contractors and employees are fading fast as outsourcing continues to gain popularity. The “gig” economy leads people to pursue freelance careers, working several jobs or maintaining a “side hustle.” Technological advancements allow more flexibility in where, when, and how jobs are completed, further blurring traditional distinctions between contractors and employees. Yet the risk associated with misclassifying an employee as an independent contractor can be catastrophic for an organization.
To navigate those minefields, you must understand the six-factor “economic realities test” used to determine if a worker is an employee or an independent contractor under the Fair Labor Standards Act (FLSA). You must ascertain whether the worker is economically dependent on your organization or if he is essentially in business for himself, which captures one basic underlying principle: control.
To avoid the dire consequences of misclassification, savvy organizations should review and apply the following six factors before retaining independent contractors. You should also periodically reevaluate your “contractor” positions to determine if the nature of the relationship (and workers’ independent contractor status) has changed.
Applying the 6-Factor Test
1. Degree of skill required. Independent contractors often come into the commercial relationship with skills and specialization that have been marketed to increase their income. If the essential functions of the position require a high degree of skill or specialization, courts are more likely to find in favor of independent contractor status.
However, when an organization provides the training or certification to develop the necessary skills, courts may weigh this factor in favor of an employment relationship.
2. Investment in specialized equipment. This inquiry goes to the heart of economic independence. If a worker is reliant on a company’s equipment, she will be unable to pursue other economic opportunities, making her economically dependent on the company.
When the worker owns the tools and has the skill and independence necessary to ply her trade for profit, she is more likely to be an independent contractor. If the company provides the necessary equipment, it’s more likely that an employment relationship exists.
3. Permanence of the relationship. Independent contractors traditionally perform itinerant work, moving from job to job and billing separately for their services. The more enduring the relationship, the more likely the worker is an employee. There’s no bright-line (clear-cut) rule, however.
An association as short as a few months has been deemed an employment relationship. But even if the association is of short duration, an employment relationship probably exists if the company requires the worker to agree to a fixed term or face penalties for leaving the job to pursue other economic opportunities.
4. Opportunity for profit or loss. A worker is more likely to be an independent contractor when he has the opportunity to receive additional compensation based on his exercise of initiative, judgment, or efficiency. When a worker’s opportunity for profit is determined solely by the company’s need for his work, it’s indicative of an employment relationship.
If the worker can complete work efficiently and move on to other paying work for another principal, this factor favors independent contractor status. In addition, if the worker has the flexibility to renegotiate his compensation throughout the relationship or has capital expenditures at risk, a court is more likely to find there’s an independent contractor relationship.
5. Right to control. If the company retains the right to dictate the nature and manner of the worker’s performance of the work, a court is likely to find there’s an employment relationship. The worker’s autonomy is central to the analysis. The existence of company policies and procedures applicable to the worker, and the resulting discipline for any violations of those rules, demonstrates a level of control commensurate with an employment relationship.
A greater degree of supervision is also indicative of an employment relationship. At the same time, requiring work to meet exacting technical specifications set by the company may be consistent with the highly technical work of an independent contractor. The company just needs to be sure to leave control and autonomy over the work with the worker himself and keep its control over the expected final product separate.
6. Integral part of the business. The more integral the worker’s services are to the business, the more likely an employment relationship exists. This factor requires an understanding of the company’s broader commercial operations and the worker’s role within that broader context. Workers are more likely to be considered employees if their work is part of the company’s integrated unit of production.
Distinguishing between employees and independent contractors is difficult, but if you evaluate your relationships in light of the FLSA’s economic realities test, you will be more likely to classify workers properly and avoid significant hardships later.