Many Massachusetts employers are subject to two different legal schemes regarding the proper classification of employees: Massachusetts state law, and federal law. It is important for employers to be familiar with both schemes in order to avoid a state or federal misclassification investigation. The Department of Labor Wage and Hour Division (“DOL”) recently issued an Administrator’s Interpretation addressing the legal standard used to determine if an individual should be classified as an “employee” or an “independent contractor” under the Fair Labor Standards Act (“FLSA”).

The Supreme Court and lower courts have developed an “economic realities” test which examines the actual relationship between the employer and the individual. The DOL’s interpretation attempts to clarify that test, to answer the question of “whether the worker is economically dependent on the employer or truly in business for herself.” Although the court system is not strictly bound by DOL interpretations, courts usually find such interpretations persuasive, and this interpretation is consistent with case-law. Under the test, each factor must be analyzed in relation to the other factors, and no single element of the test outweighs the others. While the elements of the test vary slightly under case law from different courts, they generally consist of the following six factors:

Whether the Work is an Integral Part of the Employer’s Business

Where the work performed “is integral to the employer’s business,” as it is more likely than not that the worker is economically dependent on the employer, and therefore an employee. This factor is considered a compelling factor and exists “even if the work is just one component of the business and/or is performed by hundreds or thousands of other workers.” Along those lines, the work can be considered integral if it is the same as the work of many other employees, such as at telemarketing call center, or even if the work is performed outside of the employer’s premises, such as at an employee’s home or at a customer’s location. For example, in a construction company that builds residential homes, a carpenter is integral to the business, while the accountant that handles the company’s annual tax returns is not.

Whether the Worker’s Managerial Skills Affect Their Opportunity for Loss or Profit

The next factor is whether the worker’s profit or loss is affected by their level of managerial skills and input. An analysis of the worker’s “managerial skills” focuses on that worker’s ability to affect the profitability of the employer’s business based on the managerial role the worker has. “Managerial skills” are those normally associated with operating an independent business, e.g. the individual’s ability to make hiring decisions, to determine what materials and equipment to purchase, how and where to advertise, and what location should be rented for the business. Merely working more hours does not demonstrate managerial skill. The corollary to the ability to increase profit is the risk of suffering loss. A true independent contractor is in business for themselves and may directly profit or loss based on the business’s success.

How the Worker’s Relative Investment Compares to the Employer’s Investment

Next is the value and degree of investment by the worker. The worker’s investment must be considered against the investment made by the employer. Independent contractors typically make investments that support a business as an independent going concern beyond the current job, and affect that businesses’ growth, its cost structure, and its presence in the applicable marketplace. Workers who make substantial monetary investments, even in tools or equipment used for the employer’s business, may still be classified as employees. To weigh in favor of an independent contractor, an investment must be a legitimate “business investment” or “capital expenditure,” not merely a tool or piece of equipment necessary to do the job, and such investment must be substantial. Even a seemingly large expenditure such as a vehicle may pale in comparison to the investment made by an employer which includes land and heavy machinery.

Whether the Work Performed Requires Special Skills and Initiative

In weighing this factor, the DOL is not assessing the specialty of the worker’s technical skills, but determines whether the worker utilizes “special skills,” involving business judgment and initiative. In other words, the skills of building and running the business, not technical skills. To be properly classified as an independent contractor, those skills must demonstrate that the worker is in business for themselves. A true independent contractor performs independent judgments beyond the current project, has autonomy in deciding the sequence of the work performed, has control over whether additional work is performed, and is responsible for acquiring the next job. An electrician is a technically skilled worker, but is only an independent contractor when actually running his or her own electrician business, not merely reporting to work as an electrician for another company.

Whether the Worker’s and Employer’s Relationship is Permanent and Indefinite

The “permanence” of the relationship is not tied to the actual length of employment. Rather, a court will examine whether the relationship is only tied to the length of one project, or is to be continuous and repeated until either the worker or the employer elects to terminate the engagement. An independent contractor often handles one job or project for an employer, and does not work continuously or repeatedly for the same employer. This evaluation must also be made with consideration to the type of industry the work is being performed in. A lack of permanence or indefiniteness may be due to “operational characteristics intrinsic to the industry,” e.g. the use of part-time workers, seasonal workers, or staffing agencies, which still weighs on the side of employee if, for example, a particular worker works every applicable season for the same employer. True independent contractors function under their “own business initiative” and are running a business separate from that of the employer.

The Nature or Degree of Control the Employer Assert Over the Worker

The final factor of the “economic realities” test involves a determination of the type of control exercised over the worker by the employer. Employers who control the meaningful portions of the work performed by the worker are utilizing employees, not independent contractors. The “independent” work performed must be more than mere theory; the worker must actually exercise control over the meaningful aspect. Additionally, lack of direct supervision by the employer will not necessarily be indicative of independent contractor status where the worker performs work from home or at offsite locations. Examples of control indicating an employer-employee relationship includes regulating aspects of the worker’s job; setting work schedules; standardizing a dress code; and directing what tasks are carried out by the worker. The DOL’s interpretation cautions against giving the “control” factor an oversized role and states that this factor must be analyzed in the context of whether the worker is economically independent from the employer.

Impact of the DOL’s Interpretation

The DOL’s interpretation sets forth its official position on how employment relationships should be evaluated under the FLSA. Although the DOL’s interpretation is not binding on courts, it is persuasive and should be considered by employers. Businesses will benefit from reviewing their use of independent contractors, both in regard to the current legal standard and under the changes in the DOL’s interpretation, to evaluate any potential misclassifications. Federal investigations are time-consuming and the monetary penalties for misclassification can be severe.

The foregoing information is a general summary of the Administrator’s Interpretation published by the DOL. If you are operating your own company or are concerned about your rights as an employee, contact a knowledgeable employment attorney to review your classification scheme.