Increased focus on employee misclassification

The Department of Labor is updating the record-keeping regulations under the Fair Labor Standards Act. The Spring 2011 Regulatory Agenda announced "The Right To Know Under the FLSA," a proposal to enhance transparency and disclosure in classification. "The Right To Know" would require employers to inform workers of their status as an employee or independent contractor, and how their pay is computed.

The Department of Labor says this update is necessary because "essential information about an employee's earnings and employment status should be made available to the worker, and this greater transparency will provide employees with essential information about their earnings."

The Department of Labor will release the Advanced Notice of Proposed Rulemaking on classification in the Fall of 2011. Based on available information, the employer would be required to analyze each exempt position classification and each independent contractor position. Employers would be required to document and retain the information used in the classification analysis, along with the justification for finding that workers are properly classified as exempt or independent contractors.

Independent contractors are a "classification hotspot" and everyone from the Department of Labor to the IRS is concerned. Courts and regulatory agencies use different tests to determine whether an individual is an independent contractor or an employee. The tests vary, but they share nine common elements:

1. Right to Control. An employer has the right to control the performance of an employee's job duties. A company does not control an independent contractor's method or manner of performance of services;
2. Right to Discharge. An employee may be terminated with little notice, without cause, or for failure to follow specified rules or methods. There is no right to discharge if an independent contractor produces an end result that doesn't measure up to contract specifications;
3. Termination. An employee has the right to terminate the working relationship with the purported employer at will and without incurring liability for non-completion. Independent contractors agree to complete a specific job and are liable for failure to complete the job;
4. Compensation. Employees are paid by the hour, week or month and the employer sets and monitors the work hours. Employers reimburse business expenses. Independent contractors are paid on a job basis and pay their own overhead expenses;
5. Availability to the Public. Employees make services available only to their employer. Independent contractors make services available to the general public;
6. Realization of Profit or Loss. Employees typically have no opportunity to share in the profits or losses of the business. Independent contractors are in a position to realize a profit or suffer a loss;
7. Substantial Investment. The furnishing of all necessary facilities, tools, clothing and instruments by the employer indicates employee status. A substantial investment by a person in facilities or tools used in performing services indicates independent contractor status;
8. Company Responsibility. Employers are responsible for the negligence, personal behavior, and work actions of employees who are in contact with customers and the general public while the employee is working. They are not responsible for the actions of independent contractors unless the contract specifically says so;
9. Services Fundamental to the Business. An employee's services are necessary to the fundamental business purpose for which the organization exists. An independent contractor's services typically are not, as they have the right to substitute services of others for their own.

On February 10, 2011, Pennsylvania enacted the Construction Workplace Misclassification Act. Although the act is specific to classification of independent contractors in the construction industry, it is a signal that the state is concerned about misclassification in general.

Pennsylvania is among an increasing number of states that have independent contractor classification laws on the books. States are increasingly tracking misclassified independent contractors and will be sharing that information with federal agencies, including the IRS, Department of Labor, and Wage and Hour Division.

If you have questions about proper classification, consult with legal counsel. It's always a good idea to get expert legal advice on any questions you may have about classification of employees and independent contractors.