Using independent contractors – sometimes referred to as freelancers – provides a compelling strategic opportunity for many employers for various tax and liability reasons. In fact, its reported that employers may save as much as 30% on wages by avoiding payroll taxes, unemployment insurance, worker’s compensation coverage, and benefits provided to regular W-2 employees. But these benefits are not without risks. 

One such risk arises under the Fair Labor Standards Act (FLSA), 29 U.S.C. § 201 et seq. 

The FLSA requires employees – but not independent contractors – to receive no less than the current minimum wage and not less than 1½ times the regular rate of pay for all hours worked in excess of 40 hours per week. But merely identifying an individual as an independent contractor and even memorializing that relationship in a written agreement does not preclude a judge from later finding that an individual was actually an employee and not an independent contractor. 

Instead, determining whether an independent contractor or actual employment relationship exists under the FLSA depends upon the economic reality of the relationship and not the labels the parties place on their relationship. In making this determination, courts apply what is referred to as an “economic reality test,” which focuses on:

1. The permanency of the relationship between the parties;
2. The degree of skill required for the rendering of the services;
3. The worker’s investment in equipment or materials for the task; 
4. The worker’s opportunity for profit or loss, depending upon his or her skill; 
5. The degree of the alleged employer’s right to control the manner in which the work is performed; and 
6. The extent to which the employee’s service is an integral part of the alleged employer’s business. This is determined by analyzing “the worker’s economic dependence upon the business for which he or she is laboring, which is in turn analyzed by determining if similar work is available elsewhere, who controls the rate of pay and whether the employee is forced to work either long hours or for low pay.

The Importance of Getting “it” Right the First Time

Three additional considerations should give employers pause for concern that their independent contractor designation may be “second-guessed” by a judge and exposing the employer to liability: 

First, none of the preceding six factors are determinative.

Second, the remedial purposes of the FLSA require the courts to define “employer” more broadly than the term would be interpreted in traditional common law applications. 

Third, contractual intentions do not control whether a worker is considered an employee for FLSA purposes: A contractual arrangement may provide evidence of the economic relationship between parties, but the FLSA is designed to defeat rather than implement contractual arrangements.

The Take Away

Employers in general and, according to Businessweek, small companies especially, are likely to see the greatest scrutiny as government agencies crack down on independent contractors. And no company – large or small – can afford to make costly decision-making pitfalls when it comes to mis-classifying individuals as independent contractors rather than regular W-2 employees. Such mistakes may expose employers to liabilities that include back pay, liquidated damages, civil damages, attorney fees, or any combination of these remedies. It is, therefore, critical to revisit all independent contract relationships with experienced legal counsel.